Code of Federal Regulations · Section

§ 1.59A-6 — a-6 Qualified Derivative Payment

26 C.F.R. § 1.59A-6

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(a) Scope. This section provides additional guidance regarding qualified derivative payments. Paragraph (b) of this section defines the term qualified derivative payment. Paragraph (c) of this section provides guidance on certain payments that are not treated as qualified derivative payments. Paragraph (d) defines the term derivative for purposes of section 59A. Paragraph (e) of this section provides examples illustrating the rules of this section.

(b) Qualified derivative payment—(1) In general. A qualified derivative payment means any payment made by a taxpayer to a foreign related party pursuant to a derivative with respect to which the taxpayer—

(i) Recognizes gain or loss as if the derivative were sold for its fair market value on the last business day of the taxable year (and any additional times as required by the Internal Revenue Code or the taxpayer's method of accounting);

(ii) Treats any gain or loss so recognized as ordinary; and

(iii) Treats the character of all items of income, deduction, gain, or loss with respect to a payment pursuant to the derivative as ordinary.

(2) Reporting requirements—(i) In general. No payment is a qualified derivative payment under paragraph (b)(1) of this section for any taxable year unless the taxpayer (whether or not the taxpayer is a reporting corporation as defined in § 1.6038A-1(c)) reports the information required in § 1.6038A-2(b)(7)(ix) for the taxable year. To report its qualified derivative payments, a taxpayer must include the payment in the aggregate amount of qualified derivative payments on Form 8991 (or successor).

(ii) Failure to satisfy the reporting requirement. If a taxpayer fails to satisfy the reporting requirement described in paragraph (b)(2)(i) of this section with respect to any payments, those payments are not eligible for the qualified derivative payment exception described in § 1.59A-3(b)(3)(ii) and are base erosion payments unless an exception in § 1.59A-3(b)(3) otherwise applies. A taxpayer's failure to report a payment as a qualified derivative payment does not impact the eligibility of any other payment which the taxpayer properly reported under paragraph (b)(2)(i) of this section from being a qualified derivative payment.

(iii) Reporting of aggregate amount of qualified derivative payments. The aggregate amount of qualified derivative payments is the sum of the amount described in paragraph (b)(3) of this section for each derivative. To the extent that the taxpayer is treated as receiving a payment, as determined in § 1.59A-2(e)(3)(vi), for the taxable year with respect to a derivative, the payment is not included in the aggregate qualified derivative payments.

(iv) Transition period for qualified derivative payment reporting. Before paragraph (b)(2)(i) of this section is applicable, a taxpayer will be treated as satisfying the reporting requirement described section 59A(h)(2)(B) to the extent that the taxpayer reports the aggregate amount of qualified derivative payments on Form 8991 (or successor). See § 1.6038A-2(g) (applicability date for § 1.6038A-2(b)(7)(ix)). Until paragraph (b)(2)(i) of this section is applicable, paragraph (b)(2)(ii) of this section will not apply to a taxpayer who reports the aggregate amount of qualified derivative payments in good faith.

(3) Amount of any qualified derivative payment—(i) In general. The amount of any qualified derivative payment excluded from the denominator of the base erosion percentage as provided in § 1.59A-2(e)(3)(ii)(C) is determined as provided in § 1.59A-2(e)(3)(vi).

(ii) Net qualified derivative payment that includes a payment that is a base erosion payment. Any net amount determined in paragraph (b)(3)(i) of this section must be reduced by any gross items that are treated as a base erosion payment pursuant to paragraph (c) of this section.

(iii) Special rule for mark-to-market gains and losses on the securities leg of a securities lending transaction—(A) In general. The amount of any qualified derivative payment with respect to the securities leg of a securities lending transaction as defined in §§ 1.861-2(a)(7) and 1.861-3(a)(6) that is excluded from the denominator of the base erosion percentage is determined under § 1.59A-3(b)(2)(iv)(B). The securities leg of a securities lending transaction refers to the rights, obligations, and transfers of securities and payments under the transaction other than the obligation to provide or right to receive cash collateral and interest thereon. Pursuant to § 1.59A-3(b)(2)(iv)(B), mark-to-market gains and losses on a securities leg of a securities lending transaction are not included in determining the amount of the qualified derivative payment with respect to that security. Thus, the amount of the qualified derivative payment with respect to the securities leg of a securities lending transaction is determined by taking into account only other items of income, gain, loss, or deduction during the taxable year that relate to the securities leg, such as substitute payments defined in §§ 1.861-2(a)(7) and 1.861-3(a)(6) and borrow fees. This paragraph (b)(3)(iii)(A) applies to a taxpayer that is either the borrower or lender with respect to the securities lending transaction.

(B) Examples. The following examples illustrate the application of this paragraph (b)(3)(iii).

(1) Example 1: Securities loan—(i) Facts. FP is a foreign corporation that owns all of the shares of DC, a domestic corporation. FP is a foreign related party of DC under § 1.59A-1(b)(12). DC is a registered securities dealer. On September 1 of year 1, DC enters into a securities lending transaction with FP in which it borrows stock from FP. DC provides cash collateral for the loan and receives a rebate on that collateral from FP. On September 1, year 1, the stock has a value of $100x. On November 1, year 1, a dividend of $1x is paid by the issuer on the stock. DC pays a substitute dividend of $1x to FP on November 1, year 1 under the terms of the securities loan. There are no other payments made or received in year 1. On December 31, year 1, the stock has a value of $106x. DC is required to mark-to-market the securities leg of the securities lending transaction for U.S. Federal income tax purposes. DC is a calendar year taxpayer.

(ii) Analysis. DC has a deduction of $1x as a result of the substitute dividend it pays to FP. Assuming that the securities lending transaction otherwise meets the requirements of this section (including reporting the information required by § 1.6038A-2(b)(7)(ix)), the amount of DC's qualified derivative payment with respect to the securities lending transaction is $1x. Payments with respect to the cash collateral are not treated as part of the securities lending transaction. See paragraph (d)(2)(iii)(B) of this section. With respect to the securities leg of the securities lending transaction, DC has a mark-to-market loss of ($6x). Under paragraph (b)(3)(iii)(A) of this section, the amount of this mark-to-market loss is not included when determining the amount of the qualified derivative payment. Under § 1.59A-3(b)(2)(iv)(B), DC's ($6x) mark-to-market loss on the securities leg of the securities lending transaction also is not taken into account in determining the base erosion tax benefit amount for purposes of the numerator of the base erosion percentage. The ($6x) loss is taken into account in the denominator of the base erosion percentage, while the $1x substitute dividend payment is not taken into account for that purpose because it is a qualified derivative payment. See § 1.59A-2(e)(3)(ii)(C) and (e)(3)(vi). The amount of the qualified derivative payment would be the same if the lender paid a rebate on the cash collateral in year 1, without regard to whether the parties agree to pay and receive a net payment reflecting the difference between the amount of the rebate and the amount of the substitute payment.

(2) Example 2: Securities loan. The facts are the same as in paragraph (b)(3)(iii)(B)(1) of this section (Example 1) except that on December 31, year 1, the stock has a value of $94x. With respect to the securities leg of the securities lending transaction, DC has a mark-to-market gain of $6x. Under paragraph (b)(3)(iii)(A) of this section, the amount of this mark-to-market gain is not included when determining the amount of the qualified derivative payment. DC has a deduction of $1x as a result of the substitute dividend payment it makes to FP. Assuming that the securities lending transaction otherwise meets the requirements of this section (including reporting the information required by § 1.6038A-2(b)(7)(ix)), the amount of DC's qualified derivative payment with respect to the securities lending transaction is $1x. Neither the $6x gain nor the $1x substitute dividend payment, which is a qualified derivative payment, are taken into account in the denominator of the base erosion percentage.

(iv) Rule for determining the amount of a substitute payment or other payment paid with respect to a securities lending transaction to a foreign related party—(A) In general. When a taxpayer makes a substitute payment as defined in § 1.861-2(a)(7) or § 1.861-3(a)(6) or other payment with respect to the securities leg of a securities lending transaction, the taxpayer must determine whether the substitute payment or other payment is paid to a foreign related party. The amount of the substitute payment or other payment paid by the taxpayer to a foreign related party is determined under either paragraph (b)(3)(iv)(B) or (C) of this section.

(B) Specific identification method. The taxpayer may determine the amount of the substitute payments or other payments with respect to the securities leg of a securities lending transaction that it has paid to foreign related parties by using the amount actually paid by the taxpayer to the foreign related parties if the taxpayer can specifically identify all recipients of the substitute payments or other payments paid by the taxpayer during the taxable year with respect to the securities leg of a securities lending transaction or the taxpayer can specifically identify the payor for all substitute payments or other payments received by foreign related parties during the taxable year with respect to the securities leg of a securities lending transaction.

(C) Alternative method. If the taxpayer has paid any substitute payment or other payment with respect to the securities leg of a securities lending transaction to which the taxpayer cannot apply paragraph (b)(3)(iv)(B) of this section, the taxpayer must use the methodology provided in this paragraph (b)(3)(iv)(C).

(1) Step 1: Determining the total amount of substitute payments and other payments received by foreign related parties. The taxpayer must determine the total amount of substitute payments and other payments with respect to the securities leg of a securities lending transaction received by all foreign related parties of the taxpayer during the taxable year.

(2) Step 2: Determining the total amount of substitute payments and other payments paid by taxpayer. The taxpayer must determine the total amount of substitute payments and other payments with respect to the securities leg of a securities lending transaction paid by the taxpayer during the taxable year.

(3) Step 3: Determining the amount of substitute payments and other payments paid by the taxpayer to foreign related parties. The amount of substitute payments and other payments with respect to the securities leg of a securities lending transaction paid by the taxpayer is treated as being paid first to foreign related parties of the taxpayer up to the total amount of substitute payments and other payments with respect to the securities leg of a securities lending transaction received by foreign related parties. Any amount of substitute payments and other payments with respect to the securities leg of a securities lending transaction paid by the taxpayer that exceeds the amount of substitute payments and other payments received by foreign related parties is treated as paid to unrelated parties for purposes of this paragraph (b)(3)(iv)(C)(3).

(D) Example—(1) Facts. FP is a foreign corporation that owns all of the shares of DC, a domestic corporation, and all of the shares of several foreign subsidiaries. FP and its foreign subsidiaries are foreign related parties of DC under § 1.59A-1(b)(12). DC is a registered securities dealer. DC enters into securities lending transactions pursuant to which it borrows securities both from foreign affiliates that are members of the FP controlled group and from unrelated customers. DC obtains the securities from a common pool of available securities that includes securities from DC's U.S. customer accounts as well as securities held by members of the FP controlled group for their own account and for the account of customers. DC is unable to determine from its records either the identities of the counterparties from which DC has borrowed securities or whether it has entered into a securities lending transaction with a foreign affiliate. In year 1, DC makes substitute payments of $500x in aggregate with respect to the securities lending transactions. DC's foreign affiliates receive substitute payments in year 1 totaling $100x. Because DC cannot determine whether it has entered into a securities lending transaction with a foreign affiliate, DC does not know what portion of the $100x received by DC's foreign affiliates was paid by DC.

(2) Analysis. Because DC is unable to determine the actual amount of substitute payments it has paid to DC's foreign affiliates, DC cannot use the specific identification method of paragraph (b)(3)(iv)(B) of this section to determine the amount of substitute payments it has paid to foreign related parties for QDP reporting purposes. Instead, DC must use the alternative method set forth in paragraph (b)(3)(iv)(C) of this section to determine the amount of substitute payments treated as made to foreign related party recipients. Under Step 1, DC determines that its foreign affiliates have received substitute payments of $100x. Under Step 2, DC determines that it has paid substitute payments totaling $500x. Under Step 3, DC is treated as having paid substitute payments to its foreign affiliates of $100x, up to the total amount of substitute payments they received in year 1. The remaining $400x of substitute payments paid by DC is treated as having been paid to unrelated parties for purposes of paragraph (b)(3)(iv)(C)(3) of this section.

(c) Exceptions for payments otherwise treated as base erosion payments. A payment does not constitute a qualified derivative payment if—

(1) The payment would be treated as a base erosion payment if it were not made pursuant to a derivative, including any interest, royalty, or service payment; or

(2) In the case of a contract that has derivative and nonderivative components, the payment is properly allocable to the nonderivative component.

(d) Derivative defined—(1) In general. For purposes of this section, the term derivative means any contract (including any option, forward contract, futures contract, short position, swap, or similar contract) the value of which, or any payment or other transfer with respect to which, is (directly or indirectly) determined by reference to one or more of the following:

(i) Any share of stock in a corporation;

(ii) Any evidence of indebtedness;

(iii) Any commodity that is actively traded;

(iv) Any currency; or

(v) Any rate, price, amount, index, formula, or algorithm.

(2) Exceptions. The following contracts are not treated as derivatives for purposes of section 59A.

(i) Direct interest. A derivative contract does not include a direct interest in any item described in paragraph (d)(1)(i) through (v) of this section.

(ii) Insurance contracts. A derivative contract does not include any insurance, annuity, or endowment contract issued by an insurance company to which subchapter L applies (or issued by any foreign corporation to which the subchapter would apply if the foreign corporation were a domestic corporation).

(iii) Securities lending and sale-repurchase transactions—(A) Multi-step transactions treated as financing. For purposes of paragraph (d)(1) of this section, a derivative does not include any securities lending transaction, sale-repurchase transaction, or substantially similar transaction that is treated as a secured loan for federal tax purposes. Securities lending transaction and sale-repurchase transaction have the meanings provided in § 1.861-2(a)(7).

(B) Special rule for payments associated with the cash collateral provided in a securities lending transaction or substantially similar transaction. For purposes of paragraph (d)(1) of this section, a derivative does not include the cash collateral component of a securities lending transaction (or the cash payments pursuant to a sale-repurchase transaction, or similar payments pursuant to a substantially similar transaction).

(C) Anti-abuse exception for certain transactions that are the economic equivalent of substantially unsecured cash borrowing. For purposes of paragraph (d)(1) of this section, a derivative does not include any securities lending transaction or substantially similar transaction that is part of an arrangement that has been entered into with a principal purpose of avoiding the treatment of any payment with respect to that transaction as a base erosion payment and that provides the taxpayer with the economic equivalent of a substantially unsecured cash borrowing. The determination of whether the securities lending transaction or substantially similar transaction provides the taxpayer with the economic equivalent of a substantially unsecured cash borrowing takes into account arrangements that effectively serve as collateral due to the taxpayer's compliance with any U.S. regulatory requirements governing such transaction.

(3) American depository receipts. For purposes of section 59A, American depository receipts (or any similar instruments) with respect to shares of stock in a foreign corporation are treated as shares of stock in that foreign corporation.

(e) Examples. The following examples illustrate the rules of this section.

(1) Example 1: Notional principal contract as QDP—(i) Facts. Domestic Corporation (DC) is a dealer in securities within the meaning of section 475. On February 1, 2019, DC enters into a contract (Interest Rate Swap) with Foreign Parent (FP), a foreign related party, for a term of five years. Under the Interest Rate Swap, DC is obligated to make a payment to FP each month, beginning March 1, 2019, in an amount equal to a variable rate determined by reference to the prime rate, as determined on the first business day of the immediately preceding month, multiplied by a notional principal amount of $50x. Under the Interest Rate Swap, FP is obligated to make a payment to DC each month, beginning March 1, 2019, in an amount equal to 5% multiplied by the same notional principal amount. The Interest Rate Swap satisfies the definition of a notional principal contract under § 1.446-3(c). DC recognizes gain or loss on the Interest Rate Swap pursuant to section 475. DC reports the information required to be reported for the taxable year under § 1.6038A-2(b)(7)(ix).

(ii) Analysis. The Interest Rate Swap is a derivative as described in paragraph (d) of this section because it is a contract that references the prime rate and a fixed rate for determining the amount of payments. The exceptions described in paragraph (c) of this section do not apply to the Interest Rate Swap. Because DC recognizes ordinary gain or loss on the Interest Rate Swap pursuant to section 475(d)(3), it satisfies the condition in paragraph (b)(1)(ii) of this section. Because DC satisfies the requirement relating to the information required to be reported under paragraph (b)(2) of this section, any payment to FP with respect to the Interest Rate Swap will be a qualified derivative payment. Therefore, under § 1.59A-3(b)(3)(ii), the payments to FP are not base erosion payments.

(2) Example 2: Securities lending anti-abuse rule—(i) Facts. (A) Foreign Parent (FP) is a foreign corporation that owns all of the stock of domestic corporation (DC) and foreign corporation (FC). FP and FC are foreign related parties of DC under § 1.59A-1(b)(12) but not members of DC's aggregate group. On January 1 of year 1, with a principal purpose of providing financing to DC without DC making a base erosion payment to FC, FC lends 100x U.S. Treasury bills with a remaining maturity of 11 months (Securities A) to DC (Securities Lending Transaction 1) for a period of six months. Pursuant to the terms of Securities Lending Transaction 1, DC is obligated to make substitute payments to FC corresponding to the interest payments on Securities A. DC does not post cash collateral with respect to Securities Lending Transaction 1, and no other arrangements of FC or DC effectively serve as collateral under any U.S. regulatory requirements governing the transaction. Immediately thereafter, DC sells Securities A for cash.

(B) On June 30 of year 1, FC lends 100x U.S. Treasury bills with a remaining maturity of 11 months (Securities B) to DC (Securities Lending Transaction 2) for a period of six months. Pursuant to the terms of Securities Lending Transaction 2, DC is obligated to make substitute payments to FC corresponding to the interest payments on Securities B. Immediately thereafter, DC sells Securities B for cash and uses the cash to purchase U.S. Treasury bills with a remaining maturity equal to the Securities A bills that DC then transfers to FC in repayment of Securities Lending Transaction 1.

(ii) Analysis. Securities Lending Transaction 1 and Securities Lending Transaction 2 are not treated as derivatives for purposes of paragraph (d)(1) of this section because the transactions are part of an arrangement that has been entered into with a principal purpose of avoiding the treatment of any payment with respect to Securities Lending Transaction 1 and Securities Lending Transaction 2 as a base erosion payment and provides DC with the economic equivalent of a substantially unsecured cash borrowing by DC. As a result, pursuant to paragraph (d)(2)(iii)(C) of this section, the substitute payments made by DC to FC with respect to Securities A and Securities B are not eligible for the exception in § 1.59A-3(b)(3)(ii) (qualified derivative payment).

26 C.F.R. § 1.59A-5 26 C.F.R. § 1.59A-7

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