The U.S. Securities Markets Coalition (comprised of all of the major options exchanges in the United States and OCC) submitted this letter to the IRS in March 2014 to weigh in on the proposed regulations issued under Section 871(m) of the Internal Revenue Code related to the imposition of U.S. withholding tax on "dividend equivalents" paid pursuant to certain notional principal contracts and other equity-linked instruments referencing U.S. equities. The Coalition is very concerned about the application of the proposed regulations to exchange-traded options.
The proposed regulations, if adopted as final, would apply much more broadly than intended by Congress and would have a disruptive effect on the U.S. options markets. They would treat all options transactions with initial "deltas" of 70 or higher as economic substitutes for owning the underlying stock even though the risks and rewards associated with such options deviate significantly from those associated with owning the stock. A rational foreign person would enter an options position to avoid withholding tax on a dividend only if the options position will result in a better risk-adjusted, after-tax return. Given that dividend withholding tax typically represents only a very small percentage of a stock's value, it is highly unlikely that a foreign person would assume the risks associated with a delta-70 option to avoid withholding tax. The Coalition has a number of additional concerns about the proposed regulations which are described in detail in the comment letter.