John M' Staples

1
Proposed Regulations Regarding 1441 Withholding
on Redemptions

• John M. Staples
• Bank Depository User Group 2008 Annual Meeting

September 15, 2008
2
Distributions in Redemption of Stock Background

• Redemption distribution treated as
• Distribution in part or full payment of stock
  (i.e., gain treatment), or
• Distribution of property to which 301 applies
• Distribution receives gain treatment if --
• Not essentially equivalent to a dividend
• Substantially Disproportionate
• Can be problematic because of 80 and voting
  stock requirements
• In complete redemption of all shareholders stock

3
Distributions in Redemption of Stock Background
(Contd)

• United States v. Davis, 397 U.S. 301 (1970).
  Supreme Court not essentially equivalent to a
  dividend requires meaningful reduction in
  proportionate interest in the corporation
• Application of Davis to publicly traded stock
• Rev. Rul. 76-385
• Reduction from 0.0001118 (actual and
  constructive) to 0.0001081 (all constructive) of
  stock in publicly traded corporation is
  meaningful reduction
• Rev. Rul. 81-289
• Shareholder who owned 0.2 of stock widely held
  publicly traded company before and after
  redemption did not satisfy meaningful reduction

4
Current Regulations

• Treas. Reg. 1.1441-3(d)(1) If do not know
  amount subject to withholding because
  calculation of amount depends upon unknown facts,
  must withhold on entire amount
• or
• Make a reasonable estimate of the amount and
  hold such portion in escrow until amount
  determined

5
Current Regulations (Contd)

• Treas. Reg. 1.1441-3(c)(1) intermediary
  required to withhold on entire amount of
  corporate distribution unless it elects to reduce
  the withholding under exceptions of -3(c)(2)
• Treas. Reg. 1.1441-3(c)(2)(B) intermediary may
  elect not to withhold on a distribution to the
  extent it represents a distribution in part or
  full payment in exchange for stock

6
Issue Addressed by Proposed Regulations

• Do reasonable estimate/escrow procedures apply to
  situations where distribution may be dividend or
  gain?
• If so, how?
• PLR 200552007 addressed issue
• Prop. Reg. generally follows PLR

7
Prop. Reg. In General

• Would apply to distributions after 12/31/2008,
  but preamble states may apply before that date
• Applies only to distributions in redemption of
  stock for which there is an established financial
  market (a Public 302 Distribution)
• Must withhold on entire distribution unless apply
  Escrow Procedure

8
Escrow Procedure Establishing Escrow

• Can be used only by an intermediary that is a
  U.S. financial institution
• Can be used only for documented foreign
  beneficial owners
• Note current reg. does not require
  documentation (Treas. Reg. 1.1441-3(c)(1))
• Set aside 30 (or applicable treaty dividend
  rate) of distribution attributable to stock of
  foreign account holders

9
Escrow Procedure Information Provided to
Foreign Beneficial Owner

• U.S. financial institution provides to foreign
  beneficial owner --
• Total number of shares outstanding before and
  after Public 302 Distribution
• Explanation of when a Public 302 Distribution
  will be treated as a dividend or a payment in
  exchange for stock (including an explanation of
  constructive ownership rules)
• Request for beneficial owner to provide a
  certification (302 Payment Certification)
  within 60 days stating whether Public 302
  Distribution is a dividend or payment in exchange
  for stock (gain)

10
Escrow Procedure - 302 Payment Certification

• 302 Payment Certification must contain
• Beneficial owners name and account number
• Distributing corporations name
• Total shares outstanding before and after Public
  302 Distribution
• Certification that the Public 302 Distribution
  is a --
• Payment in exchange for stock because beneficial
  owners proportionate interest has been reduced
  (gain treatment)
• Payment in exchange for stock because beneficial
  owners interest completely terminated (gain
  treatment)
• Dividend

11
Escrow Procedure - 302 Payment Certification
(Contd)

• 302 Payment Certification must contain
• Number of shares owned by beneficial owner and
  percentage ownership before and after
  distribution
• Penalties of perjury statement
• Signature and date of signature

12
Escrow Procedure Certification of Gain

• If 302 Payment Certification received within 60
  days specifies gain treatment, amount set aside
  in escrow credited to beneficial owner
• Entire amount reported on Form 1042-S as capital
  gains
• Subject to know or have reason to know standard

13
Escrow Procedure - Certification of Dividend

• If payment certification received within 60 days
  specifies dividend treatment, amount set aside
  treated as tax withheld and deposited with IRS
• Entire amount reported on Form 1042-S as dividend

14
Escrow Procedure No or Unreliable Certification

• If no payment certification received or if U.S.
  financial institution believes 302 Payment
  Certification claiming gain treatment is
  unreliable or incorrect, must treat amount set
  aside as tax withheld as of 61st day and deposit
• Entire payment reported on Form 1042-S as dividend

15
Escrow Procedure Late Certifications

• If certification stating gain treatment received
  after 60 day period, U.S. financial institution
  may apply reimbursement or set-off procedures of
  1.1461-2(a)

16
Escrow Procedure Miscellaneous

• U.S. non-exempt recipients holding stock through
  foreign intermediaries or flow-throughs are
  treated in accordance with the 302 Payment
  Certifications they provide
• U.S. financial institution must notify
  distributing corporation by filing date of Form
  1042-S of aggregate amounts treated as capital
  gains and dividends

17
Qualified Intermediaries

• QIs cannot use escrow procedure
• Escrow amount of U.S. financial institution
  includes 30 (or applicable treaty dividend rate)
  of amount attributable to QIs
• U.S. financial institution provides same
  information to QI as it does to its direct
  foreign beneficial owners
• QI provides information to its account holders
• QI receives 302 Payment Certifications from its
  account holders
• QI incorporates results in its withholding
  statement
• Same procedures apply to withholding foreign
  partnerships and withholding foreign trust

18
Implementation Issues

• Implement now or wait
• How can financial institution identify affected
  transactions
• Prop. Regs. apply to more than just self-tenders
• How much detail should be provided regarding
  dividend vs. exchange and constructive ownership
  rules
• Capital gains reporting on Form 1042-S required
• Currently, capital gain reporting not required
• Systems issues
• Indirect U.S. non-exempt shareholders must
  apparently get 1099-DIV or 1099-B whereas direct
  U.S. non-exempt shareholders can get 1099-B
  explanation.
• Systems issues
• Effect on 1099-B explanation rule

19
Implementation Issues (Contd)

• Procedures for notifying distributing corporation
  of treatment
• Usefulness of requirement?
• Different reporting treatment of direct and
  indirect U.S. non-exempt recipients
• No reporting for U.S. exempt recipients.
• How to handle inconsistencies between Prop. Reg
  and PLR (deliberate changes vs. oversights)
• Interest on escrow accounts
• 60 day period very short retail business issues
• Prop. Regs. ask for comments

20
Is This An Effective Solution?

• Small shareholders in publicly traded companies
  do not have control and cannot manipulate
  redemption
• If redemption not pro rata, dividend treatment
  unlikely
• Increased compliance costs
• Requires non-U.S. passive investors to apply
  substantive tax rules
• Probably little tax gain to government
• Could complicate future basis reporting
• Is it proper to extend Davis to small
  shareholders in publicly traded corporations?

21
Contact Information

• John M. Staples
• Burt, Staples Maner LLP
• 1250 Eye St. NW, Suite 850
• Washington, DC 20005-3922
• jstaples_at_bsmlegal.com
• Phone [phone] ? Fax [phone]