An entity lacking dealer or bank-type regulatory supervision is not a qualified derivatives dealer eligible entity, so its application should be rejected

Plain-English summary

U.S. tax rules on payments to foreign persons let certain foreign financial firms register as qualified derivatives dealers (QDDs), a status that changes how withholding applies to dividend-equivalent payments on equity derivatives under section 871(m). To qualify as an eligible entity, a firm generally must be a regulated equity derivatives dealer, a regulated bank or bank holding company, or a U.S. financial institution's foreign branch that would meet those tests. A catch-all category, Treas. Reg. § 1.1441-1(e)(6)(ii)(D), also allows any person "otherwise acceptable to the IRS." This Chief Counsel Advice answers whether a firm that fits none of the first three categories and is not under comparable regulatory supervision can still qualify under the catch-all. The answer is no. The catch-all is meant only for entities very similar to the listed dealer, bank, or bank holding company categories, not as a broad expansion, so an applicant that cannot show comparable regulatory supervision should be rejected. The memo also advises examiners to ask applicants for specific details about their own regulatory environment, and notes other factors may bear on whether an applicant is acceptable. This matters because it limits who can obtain QDD status and tells reviewers how to scrutinize borderline applications.

Ruling snapshot

• Question: Can an entity that is not subject to comparable dealer, bank, or bank holding company regulatory supervision qualify as a QDD eligible entity under the "otherwise acceptable to the IRS" catch-all?
• Outcome: Advice given (no; the application should be rejected)
• Key authorities: Treas. Reg. § 1.1441-1(e)(6)(ii)(A)-(D); IRC § 871(m); § 1441

Full text (IRS public release)

 ID:        CCA_2022082416402343                       Third Party Communication: None

 UILC:      1441.00-00, 871.02-03                      Date of Communication: Not Applicable

Number: 202235010
Release Date: 9/2/2022
From: ------------------
Sent: Wednesday, August 24, 2022 4:40:23 PM
To: ------------------------------------------------
Cc: ----------------
Bcc:
Subject: QDD Eligible Entity


Good Afternoon ---------------------,

You asked whether an entity that is not eligible for QDD status under Treas. Reg. §
1.1441-1(e)(6)(ii)(A)-(C) (copied below) and is not subject to comparable regulatory
supervision is an eligible entity under Treas. Reg. § 1.1441-1(e)(6)(ii)(D). As discussed
below, it is not an eligible entity under Treas. Reg. § 1.1441-1(e)(6)(ii)(D) and therefore
the QDD application should be rejected.

Treas. Reg. §1.1441-1(e)(6)(ii) specifies that a qualified intermediary ("QI") home office
or branch is a qualified derivatives dealer ("QDD") eligible entity if the home office or
branch, as applicable, when treated as a separate entity, is:

         (A) An equity derivatives dealer subject to regulatory supervision as a dealer by a governmental
             authority in the jurisdiction in which it was organized or operates;
         (B) A bank or bank holding company subject to regulatory supervision as a bank or bank holding
             company (as applicable) by a governmental authority in the jurisdiction in which it was
             organized, or operates or an entity that is wholly-owned (directly or indirectly) by a bank or
             bank holding company subject to regulatory supervision as a bank or bank holding company
             (as applicable) by a governmental authority in the jurisdiction in which the bank or bank
             holding company (as applicable) was organized or operates and that in its equity derivatives
             dealer capacity—
                     (1) Issues potential section 871(m) transactions to customers; and
                     (2) Receives dividends with respect to stock or dividend equivalent payments with
                          respect to potential section 871(m) transactions that hedge potential section
                          871(m) transactions that it issued;
         (C) A foreign branch of a U.S. financial institution, if the foreign branch would meet the
             requirements of paragraph (A) or (B) of this section if it were a separate entity; or
         (D) Any person otherwise acceptable to the IRS.

With respect to Treas. Reg. § 1.1441-1(e)(6)(ii)(D), an FAQ explained that "[t]his limited
category is intended to allow the IRS the discretion to treat an entity that is very similar
to the specified categories of eligible entities but that does not satisfy the precise
technical requirements in the definition as an eligible entity. It is not intended to function
as a significant expansion of the definition of eligible entity." Qualified Intermediary
General FAQs | Internal Revenue Service (irs.gov), New Applications/Renewals, Q14.

The QDD eligible entity categories described in Treas. Reg. § 1.1441-1(e)(6)(ii)(A)-(C)
are limited to entities subject to the dealer, bank, or bank holding company regulatory
regimes (directly or indirectly). An entity that does not establish that it is subject to
comparable regulatory supervision is not intended to be covered by Treas. Reg. §
1.1441-1(e)(6)(ii)(D) and therefore, the IRS should reject the application as not
"otherwise acceptable to the IRS" pursuant to Treas. Reg. § 1.1441-1(e)(6)(ii)(D).

In certain cases, it may not be clear from the application whether an applicant's
regulatory supervision is comparable to the regulatory supervision required of the QDD
eligible entity categories described in Treas. Reg. § 1.1441-1(e)(6)(ii)(A)-(C). Therefore,
in applying this advice to an application made for QDD status pursuant to Treas. Reg. §
1.1441-1(e)(6)(ii)(D), we recommend asking the applicant to provide information
regarding its regulatory environment (including how that environment is comparable to a
dealer, bank, or bank holding company regulatory regime) and ensuring that the
information provided is specific to the entity requesting QDD status, as opposed to other
entities, including the administrator of the entity.

Note that, in addition, there may be factors beyond comparable regulatory supervision
that are relevant to determine whether an applicant is "otherwise acceptable to the IRS."
Therefore, additional information may be necessary to determine whether an applicant
is an eligible entity under Treas. Reg. § 1.1441-1(e)(6)(ii)(D).

Thanks,
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