Qualified Intermediary News Issue 2016-03

Qualified Intermediary News Issue 2016-03

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Deemed Distributions of Stock and Rights to Acquire Stock

On April 12, 2016, Treasury and the IRS issued proposed regulations regarding deemed distributions of stock and rights to acquire stock (REG-133673-15). The proposed regulations will affect corporations issuing rights to acquire stock, their shareholders and holders of rights, and withholding agents with respect to deemed distributions. The regulations are intended to:

  • Resolve ambiguities concerning the amount and timing of deemed distributions that are or result from adjustments to rights to acquire stock.
  • Provide additional guidance to withholding agents regarding their withholding and reporting obligations under chapters 3 and 4 with respect to deemed distributions.

Background

The regulations under Section 305 govern actual and deemed distributions by a corporation of its own stock and rights to acquire its own stock. Specifically:

  • Section 305(a) provides the general rule that the receipt of these distributions is not included in the gross income of the recipient;
  • Section 305(b) requires certain actual and deemed distributions of stock and stock rights to be treated as distributions of property to which the regulations under section 301 apply.
  • Section 305(c) authorizes Treasury to prescribe regulations to treat changes in the conversion ratio of instruments convertible into stock and other events having similar effects as distributions to shareholders whose proportionate interests in the assets or earnings and profits of the corporation are increased by such events.

Under current regulations, when a distribution of stock (including a right to acquire stock) is a distribution of property, the amount of the distribution is the fair market value, on the date of the distribution, of the stock or right to acquire stock that is distributed.

Summary of Proposed Regulations

Definitions:

  • Actual shareholder: a holder of stock, not including rights to acquire stock
  • Deemed shareholder: a holder of a right to acquire stock
  • Deemed distribution: a transaction or event, other than an actual distribution of stock, money, or other property, that is a distribution under section 305
  • Applicable adjustment: an adjustment to a right to acquire stock, including an increase or reduction in conversion ratio, conversion price, option price, or number of shares the holder would receive upon conversion or exercise.
  • Right to acquire stock: any right to acquire stock, whether through a convertible instrument, a warrant, subscription right, or stock right issued by the corporation that issued or will issue the underlying stock, or any other right to acquire stock of the corporation issuing the right
  • Amount of deemed distributions: A deemed distribution of a right to acquire stock is the fair market value of the right.
  • Substitute dividend payment: a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to a dividend distribution which the owner of the transferred security is entitled to receive during the term of the transaction.

 

Amount of Deemed Distribution:

  • Under the proposed regulations, the amount of the deemed distribution would be the excess of the fair market value of the right to acquire stock immediately after the applicable adjustment over the fair market value of the right to acquire stock without the applicable adjustment.
  • In determining the fair market value of a right to acquire stock, any particular facts pertaining to the deemed shareholder’s rights, including the number of actual shares of stock or rights to acquire stock held by such deemed shareholder, would be disregarded.
  • Under the terms of a convertible debt instrument or other right to acquire stock, a payment of cash or property to the holder may cause a reduction in the number of shares the holder would receive upon conversion or exercise. Such a reduction is an applicable adjustment that increases the actual shareholders’ proportionate interests in the assets or earnings and profits of the corporation. Therefore, the applicable adjustment results in a deemed distribution of stock to the actual shareholders, and section 301 applies to the deemed distribution. Under the proposed regulations, the amount of this deemed distribution would be the fair market value of the stock deemed distributed.

 

Timing of deemed distributions

  • When an applicable adjustment is or results in a deemed distribution, the deemed distribution occurs at the time such applicable adjustment occurs, in accordance with the instrument setting forth the terms of the right to acquire stock, but in no event later than the date of the distribution of cash or property that results in the deemed distribution.
    • For such an applicable adjustment relating to a right to acquire publicly-traded stock, if the instrument setting forth the terms of such right does not set forth the date and time the applicable adjustment occurs, the deemed distribution would occur immediately prior to the opening of business on the ex-dividend date for the distribution of cash or property that results in the deemed distribution.
    • For such an applicable adjustment relating to a right to acquire non-publicly traded stock, if the instrument setting forth the terms of such right does not set forth the date and time the applicable adjustment occurs, the deemed distribution occurs on the date that a holder is legally entitled to the distribution of cash or property that results in the deemed distribution.

 

Withholding on Deemed Distributions

  • Withholding on deemed distributions, and new exception for deemed distributions on specified securities: Proposed §1.1441-2(d)(4)(i) provides that a withholding agent has an obligation to withhold on a deemed distribution that is made on a security. Proposed §1.1441-7(a)(4) would clarify that an issuer of a security upon which a deemed distribution is made and any person that holds directly or indirectly a security on behalf of the beneficial owner of the security, or a flow-through entity that owns directly or indirectly a security, is considered to have custody of or control over the deemed distribution made on the security and, therefore, is a withholding agent with respect to the distribution. Under this new exception, a withholding agent would have an obligation to withhold on such a deemed distribution only if, before the due date for filing Form 1042 with respect to the calendar year in which the deemed distribution occurred, either the issuer meets its reporting requirements under by furnishing its required issuer statement or publicly reporting the information required or the withholding agent has actual knowledge that a deemed distribution has occurred (the latter case in which the obligation to withhold would not arise until January 15 of the year following the calendar year of the deemed distribution).
  • When and how to withhold: Once it has the requisite knowledge, a withholding agent would be required to satisfy its withholding obligation by withholding on the earlier of: 1) the date on which a future cash payment is made with respect to the security; 2) the date on which the security is sold, exchanged, or otherwise disposed of (including a transfer of the security to another account not maintained by the withholding agent or a termination of the account relationship); or 3) the Form 1042 reporting deadline (March 15) with respect to the calendar year in which the deemed distribution occurred.

 

Foreign entities assuming withholding responsibilities

  • The proposed regulations under chapter 3 provide that a withholding agent may treat certain foreign entities (qualified intermediaries that have assumed withholding responsibilities, withholding foreign partnerships, withholding foreign trusts, and U.S. branches treated as U.S. persons) as having primary chapter 3 withholding responsibilities for a deemed distribution on a specified security only if the withholding agent provides the foreign entity with a copy of the issuer statement within 10 days of the issuer furnishing the statement to the holder of record or its nominee, or the issuer has met the public reporting requirements. Thus, these foreign entities would have an obligation to withhold on the deemed distribution only if they receive a copy of the issuer statement or if the issuer has met the public reporting requirements by the due date (not including extensions) for filing Form 1042 with respect to the calendar year in which the deemed distribution occurred.
  • A withholding agent that fails to provide a copy of the issuer statement to a foreign entity (in the absence of public reporting) would not be permitted to treat the foreign entity as having assumed primary withholding responsibilities for the deemed distribution and would therefore have to withhold and report based on the information that it has regarding the recipient of the deemed distribution.

 

Reliance on issuer information reportin

  • Under proposed regulations, a withholding agent (other than the issuer of the specified security) would be permitted to rely on the information that an issuer provides on an issuer statement or on a public website to determine the proper amount of withholding on a deemed distribution on a specified security unless it knows that the information is incorrect or unreliable. Additionally, a foreign entity that has assumed primary withholding responsibilities would be permitted to rely on the copy of the issuer statement that it receives from another withholding agent unless it knows that the information is incorrect or unreliable.

 

Substitute Dividends

  • The proposed regulations provide that a substitute dividend payment includes a deemed payment made in the amount of a deemed distribution.

 

Issuer Reporting Under Section 6045B

  • To facilitate broker reporting of a security’s adjusted basis to the holder of the security, an issuer of a specified security must report certain information relating to an organizational action that affects the basis of the security to both the IRS and the holders of the security. An issuer must file an issuer return with the IRS by the earlier of 45 days after the organizational action or January 15 of the calendar year following the organizational action. In addition, the issuer must send a written statement to holders by January 15 of the calendar year following the organizational action, including to exempt recipients. In lieu of filing the issuer return with the IRS and furnishing the written statement to holders, an issuer is permitted to post the required information on its public website by the due date for reporting the issuer return to the IRS.
  • The proposed regulations also require an issuer to provide an issuer return to the IRS and a written statement to each holder of record of a specified security (or to the holder’s nominee) relating to a deemed distribution on the security, without regard to any of the general exceptions in the current regulations under section 6045B or in the instructions to Form 8937 (e.g., an issuer must provide the statement to all shareholders, including exempt recipients). As indicated, the proposed regulations, like the current regulations, permit an issuer to not provide an issuer return to the IRS or a written statement to the holders regarding the deemed distribution if the issuer satisfies the public reporting requirements.

 

Reporting for U.S. Persons

  • Section 1.6045B-1 generally applies when a deemed distribution affects the basis of a specified security. It is expected that similar principles would apply under section 6042 with respect to reporting of deemed distributions made to U.S. persons on Form 1099-DIV.

Proposed Effective/Applicability Date

The proposed regulations under section 305 would apply to deemed distributions occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. A taxpayer, however, may rely on these proposed regulations for deemed distributions that occur on or after January 1, 2016.

 

KPMG Observation:

It is significant to note that the proposed regulations only address withholding requirements on section 305(c) distributions on or after January 1, 2016. They do not address what withholding agents should do to remediate past years. It is anticipated that future guidance will address that issue.
 

Comments

Written or electronic comments and requests for a public hearing must be received by July 12, 2016. Send submissions to: CC:PA:LPD:PR (REG-133673-15), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC, 20044. Submissions may also be hand-delivered, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-133673-15).

For Your Reference

The proposed regulations described above can be obtained by clicking here: https://s3.amazonaws.com/public-inspection.federalregister.gov/2016-08248.pdf


For further information, please do not hesitate to contact us.

 

 

 

 

Any tax advice in this communication is not intended or written by KPMG to be used, and cannot be used, by a client or any other person or entity for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing, or recommending to another party any matters addressed herein.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
 

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