Deemed Distributions Under Section 305(c) of Stock and Rights to Acquire Stock, 21795-21808 [2016-08248]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 81, Number 71 (Wednesday, April 13, 2016)]
[Proposed Rules]
[Pages 21795-21808]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-08248]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-133673-15]
RIN 1545-BN07


Deemed Distributions Under Section 305(c) of Stock and Rights to 
Acquire Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding deemed 
distributions of stock and rights to acquire stock. The proposed 
regulations would resolve ambiguities concerning the amount and timing 
of deemed distributions that are or result from adjustments to rights 
to acquire stock. The proposed regulations also would provide 
additional guidance to withholding agents regarding their current 
withholding and information reporting obligations under chapters 3 and 
4 with respect to these deemed distributions. The proposed regulations 
would affect corporations issuing rights to acquire stock, their 
shareholders and holders of these rights, and withholding agents with 
respect to these deemed distributions.

DATES: Written or electronic comments and requests for a public hearing 
must be received by July 12, 2016.

ADDRESSES: 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 be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
133673-15), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, 20224 or sent electronically, via the 
Federal eRulemaking Portal at www.regulations.gov (indicate IRS and 
REG-133673-15).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations 
under section 305, Maurice M. LaBrie, (202) 317-5322; concerning the 
proposed regulations under sections 860G, 861, 1441, 1461, 1471, and 
1473, Subin Seth, (202) 317-6942; concerning the proposed regulations 
under section 6045B, Pamela Lew, (202) 317-7053; concerning submission 
of comments, contact Regina Johnson, (202) 317-6901 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

1. Overview

    This document contains proposed regulations that amend 26 CFR part 
1 under sections 305, 860G, 861, 1441, 1461, 1471, 1473, and 6045B of 
the Internal Revenue Code of 1986 (Code) concerning deemed 
distributions that are or result from adjustments to rights to acquire 
stock.
    Final regulations under section 305 were published in the Federal 
Register on July 12, 1973 (TD 7281, 38 FR 18531), and amendments to 
those final regulations were published in the Federal Register on 
October 15, 1974 (TD 7329, 39 FR 36860), and in the Federal Register on 
December 21, 1995 (TD 8643, 60 FR 66134).
    Final regulations under sections 1441 and 1461 were published in 
the Federal

[[Page 21796]]

Register on October 14, 1997 (TD 8734, 62 FR 53387), and the following 
amendments to those final regulations were published in the Federal 
Register on: December 31, 1998 (TD 8804, 63 FR 72187); December 30, 
1999 (TD 8856, 64 FR 73412); May 22, 2000 (TD 8881, 65 FR 32186); 
August 1, 2006 (TD 9272, 71 FR 43366); July 14, 2008 (TD 9415, 73 FR 
40172) (corrected on August 6, 2008 (73 FR 45612)); January 23, 2012 
(TD 9572, 77 FR 3109); December 5, 2013 (TD 9648, 78 FR 73081); March 
6, 2014 (TD 9658, 79 FR 12726) (corrected on July 1, 2014 (79 FR 
37175)); and, September 18, 2015 (TD 9734, 80 FR 56866). Final 
regulations under sections 1471 and 1473 were published in the Federal 
Register on January 28, 2013 (TD 9610, 78 FR 5874) (corrected on 
September 10, 2013 (78 FR 55202)), and the amendments to those final 
regulations were published as temporary regulations in the Federal 
Register on March 6, 2014 (TD 9657, 79 FR 12812) (corrected on July 1, 
2014 (79 FR 37175)).
    Final regulations under section 6045B were published in the Federal 
Register on October 18, 2010 (TD 9504, 75 FR 64072), and amendments to 
those final regulations were published in the Federal Register on April 
18, 2013 (TD 9616, 78 FR 23116).

2. Amount and Timing of Deemed Distributions Under Section 305(c)

A. Application of Section 305(b) and (c) Generally
    Section 305 and the regulations thereunder apply to actual and 
deemed distributions by a corporation of its own stock and rights to 
acquire its own stock. Section 305(a) provides the general rule that 
the receipt of these distributions is not included in the gross income 
of the recipient; however, under section 305(b)(1) through (b)(5) 
certain actual and deemed distributions of stock and stock rights are 
treated as distributions of property to which section 301 applies. For 
example, under section 305(b)(2), if a distribution (or series of 
distributions) by a corporation has the result of a receipt of property 
by some shareholders and an increase in the proportionate interests of 
other shareholders in the assets or earnings and profits of the 
corporation, all the distributions are treated as distributions of 
property to which section 301 applies.
    Section 305(c) authorizes the Secretary 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 section 305(d)(1) and current Sec.  1.305-1(d), for purposes 
of section 305 and the regulations thereunder, the term stock includes 
rights to acquire stock, and under section 305(d)(2), for purposes of 
section 305(b) and (c) and the regulations thereunder, the term 
shareholder includes a holder of rights to acquire stock. For purposes 
of this preamble:
    The term actual shareholder means a holder of stock (not including 
rights to acquire stock).
    The term deemed shareholder means a holder of a right to acquire 
stock.
    The term deemed distribution means a transaction or event, other 
than an actual distribution of stock, money, or other property, that is 
a distribution under section 305(b) and (c).
    The term applicable adjustment means 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.
    The term right to acquire stock means any right to acquire stock, 
whether pursuant to a convertible instrument (such as a debt instrument 
that is convertible into shares of stock), 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 such right (whether settled in stock or in cash).
    Under current Sec.  1.305-1(b)(1), when a distribution of stock 
(including a right to acquire stock) is a distribution of property to 
which sections 305(b) and 301 apply, 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.
B. Application of Section 305(b) and (c) to Adjustments to Rights To 
Acquire Stock
    A corporation may issue rights to acquire its stock in a number of 
forms, including warrants, subscription rights, options, convertible 
instruments that give the holder a right to convert the instruments 
into shares of stock in the issuing corporation, and similar 
instruments. In any of these forms, rights to acquire stock may provide 
for applicable adjustments that grant deemed shareholders economic 
benefits that correspond to distributions of stock, cash, or other 
property made to actual shareholders. Similarly, rights to acquire 
stock may provide for adjustments to prevent actual shareholders' 
interests from being diluted as a result of distributions of stock, 
cash, or other property to deemed shareholders (that is, holders of 
rights to acquire stock).
    An applicable adjustment to a convertible instrument may consist of 
an increase in the number of shares of stock a holder would receive 
upon conversion. Similarly, an applicable adjustment to a warrant, 
subscription right, stock right, option, or similar right to acquire 
stock may consist of an increase in the number of shares the holder 
would receive upon exercise. In either situation, the applicable 
adjustment may have the effect of increasing the deemed shareholders' 
proportionate interests in the assets or earnings and profits of the 
corporation. If this increase has a result described in section 305(b), 
then under section 305(c) the applicable adjustment is a deemed 
distribution to the deemed shareholder, and section 301 applies to the 
deemed distribution.
    Under current Sec.  1.305-7(b)(1), an applicable adjustment made 
pursuant to a bona fide, reasonable adjustment formula that has the 
effect of preventing dilution of a shareholder's interest is not a 
deemed distribution of stock to which sections 305(b) and 301 apply. 
However, also under current Sec.  1.305-7(b)(1), an applicable 
adjustment to compensate for a distribution of cash or property to 
actual shareholders that is taxable under section 301, 356(a)(2), 
871(a)(1)(A), 881(a)(1), 852(b), or 857(b) is not considered as made 
pursuant to such a bona fide, reasonable adjustment formula, and 
therefore may be a distribution to which sections 305(b) and 301 apply.
    The Treasury Department and the IRS have concluded that, under 
section 305(b) and (c) and the regulations thereunder, it is clear that 
an applicable adjustment is a deemed distribution to which section 301 
applies, if: (i) The applicable adjustment increases the proportionate 
interest of an actual shareholder or a deemed shareholder in the 
corporation's assets or earnings and profits; (ii) such increase in 
proportionate interest has a result described in section 305(b); and 
(iii) the anti-dilution exception of Sec.  1.305-7(b)(1) does not 
apply. For example, it has been the position of the Treasury Department 
and the IRS for over forty years that, under section 305(b) and (c) and 
the regulations thereunder, an increase in the conversion ratio of a 
convertible debt instrument may be treated as a deemed distribution to 
the deemed shareholder that holds the instrument, and, if so treated, 
section

[[Page 21797]]

301 applies to the deemed distribution. See Rev. Rul. 75-513 (1975-2 CB 
114) (section 301 applied to deemed distribution where conversion ratio 
of convertible debentures increased due to payment of cash dividend to 
common shareholders); and Rev. Rul. 76-186 (1976-1 CB 86) (same; basis 
of the convertible debentures was increased by the value of the deemed 
distribution); cf. Rev. Rul. 77-37 (1977-1 CB 85) (no deemed 
distribution because anti-dilution exception of Sec.  1.305-7(b) 
applied where distribution to actual shareholders was tax-free under 
section 355).
    The current regulations are unclear, however, as to the amount of a 
deemed distribution to a deemed shareholder. The current regulations 
may reasonably be interpreted as providing either that such a deemed 
distribution is treated as a distribution of a right to acquire stock 
(the amount of which is the fair market value of the right), or that 
such a distribution is treated as a distribution of the actual stock to 
which the right relates (the amount of which is the fair market value 
of the stock). Accordingly, for deemed distributions to deemed 
shareholders occurring before final regulations are published, the IRS 
will not challenge either position.
    The current regulations are also unclear as to the timing of such a 
distribution. Under the proposed regulations, such a distribution 
generally would be deemed to occur at the time the 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 (taking into account Sec.  1.305-3(b)).
    These proposed regulations would amend the current regulations 
under section 305(b) and (c) only to clarify the amount and timing of 
such deemed distributions, not the fact of their occurrence, which is 
clear under current law.
C. Summary of Proposed Regulations
i. Amount of Deemed Distributions
    After studying this area, the Treasury Department and the IRS have 
concluded that a deemed distribution of a right to acquire stock is 
more accurately viewed as a distribution of additional rights to 
acquire stock, the amount of which is the fair market value of the 
right.
    Under the terms of a convertible instrument, a distribution of cash 
or property to actual shareholders may increase the number of shares 
the holder of the convertible instrument would receive upon conversion. 
Similarly, a distribution of cash or property to actual shareholders 
may increase the number of shares the holder of other rights to acquire 
stock, such as warrants or options, would receive upon exercise. In 
either case, the increase is an applicable adjustment and a deemed 
distribution of additional rights to acquire stock to the holders of 
the rights to acquire stock. Under the proposed regulations, the amount 
of the deemed distribution would be the excess of (i) the fair market 
value of the right to acquire stock immediately after the applicable 
adjustment over (ii) 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.
    Also, 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. Thus, 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, determined in 
accordance with Sec.  1.305-3(e), Examples 8 and 9 (relating to deemed 
distributions to shareholders resulting from certain redemptions of 
stock from other shareholders). See also Tax Revenue Act of 1969: 
Hearings on H.R. 13270 Before the House Ways and Means Comm., 91st 
Cong. 1st Sess., pt. 14, 5196-98 (1969).
ii. Timing of Deemed Distributions
    When an applicable adjustment is or results in a deemed 
distribution under proposed Sec.  1.305-7(c)(1) or (2), 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 (taking 
into account Sec.  1.305-3(b)). 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.

3. Withholding Under Chapters 3 and 4 on Deemed Distributions Under 
Section 305(c)

    This section provides a discussion of the proposed rules regarding 
deemed distributions under section 305(c). Section 4 of the preamble 
provides a discussion of the proposed rules regarding substitute 
dividend payments that are deemed payments determined with respect to a 
deemed distribution under section 305(c). The proposed rules that would 
apply for deemed payments are analogous to the proposed rules that 
would apply to deemed distributions.
A. Background
    Sections 1441 and 1442 (referred to herein as ``chapter 3'') 
require all persons having the control, receipt, custody, disposal, or 
payment of items of income subject to withholding of any nonresident 
alien, foreign partnership, or foreign corporation to withhold tax at a 
30-percent rate unless a reduced rate of withholding applies. Amounts 
subject to withholding include amounts from sources within the United 
States that are fixed or determinable annual or periodical income, 
which generally includes, among other things, interest, dividends, and 
similar types of investment income. Sec.  1.1441-2(b)(1)(i). Under 
Sec.  1.1441-2(e)(1), ``a payment'' is considered made to a person ``if 
that person realizes income whether or not such income results from an 
actual transfer of cash or other property.'' For this purpose, a 
payment is considered made when the amount would be includible in the 
income of the beneficial owner under the U.S. tax principles governing 
the cash basis method of accounting. Sec.  1.1441-2(e)(1).
    On March 18, 2010, the Hiring Incentives to Restore Employment Act 
of 2010, Public Law 111-147 (H.R. 2847), added chapter 4 to the Code 
(sections 1471 through 1474, commonly known as ``FATCA''). Chapter 4

[[Page 21798]]

generally requires a withholding agent to withhold tax at a 30-percent 
rate on a ``withholdable payment'' (as defined in Sec.  1.1473-1(a)) 
made to a foreign financial institution (FFI) unless the FFI has 
entered into an agreement described in section 1471(b) to obtain status 
as a participating FFI or the FFI is deemed to have satisfied the 
requirements of section 1471(b). Chapter 4 also generally requires a 
withholding agent to withhold tax at a 30-percent rate on a 
withholdable payment made to a nonfinancial foreign entity (NFFE) 
unless the NFFE has provided information to the withholding agent with 
respect to the NFFE's substantial U.S. owners or has certified that it 
has no such owners. See section 1472.
    These proposed regulations would provide guidance to withholding 
agents regarding their obligations to withhold under chapters 3 and 4 
on deemed distributions under section 305(c). Withholding agents have 
commented that ambiguities in the current law have made it difficult 
for them to satisfy their withholding obligations. In particular, 
withholding agents have commented that these deemed distributions often 
occur when there is no cash payment that corresponds to the deemed 
distribution, which makes it difficult for them to satisfy their 
withholding obligation on the date of the deemed distribution. In 
addition, withholding agents commented that they often lack knowledge 
of the fact that a deemed distribution on a security has been made and 
are therefore unable to withhold on the date of the deemed 
distribution.
B. Amendments to Chapter 3
i. Withholding on Deemed Distributions, and New Exception for Deemed 
Distributions on Specified Securities
    Proposed Sec.  1.1441-2(d)(4)(i) would clarify that a withholding 
agent has an obligation to withhold on a deemed distribution (as 
defined in Sec.  1.305-1(d)(7)) that is made on a security. Proposed 
Sec.  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 (for example, through an account maintained for an 
intermediary) a security on behalf of the beneficial owner of the 
security, or a flow-through entity that owns directly or indirectly 
(through another flow-through entity) 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 current Sec.  1.1441-2(d)(1), a withholding agent does not 
have an obligation to withhold on a payment when it lacks control over, 
or custody of, money or property of the recipient, or knowledge of the 
facts giving rise to the payment (the general exception). This general 
exception does not apply when, in relevant part, the payment is a 
distribution with respect to stock. The proposed regulations, however, 
would allow a withholding agent (other than the issuer of the specified 
security) to benefit from a new exception to withholding in proposed 
Sec.  1.1441-2(d)(4) for deemed distributions (as defined in Sec.  
1.305-1(d)(7)) of stock or a right to acquire stock on a specified 
security (as defined in Sec.  1.6045-1(a)(14)). Under this new 
exception, a withholding agent (other than the issuer of the specified 
security) would have an obligation to withhold on such a deemed 
distribution only if, before the due date (not including extensions) 
for filing Form 1042, Annual Withholding Tax Return for U.S. Source 
Income of Foreign Persons, with respect to the calendar year in which 
the deemed distribution occurred, either (i) the issuer meets its 
reporting requirements under Sec.  1.6045B-1 (by furnishing an issuer 
statement or publicly reporting the information required under that 
section) or (ii) the withholding agent has actual knowledge that a 
deemed distribution has occurred, in which case the obligation to 
withhold would not arise until January 15 of the year following the 
calendar year of the deemed distribution.
ii. When and How To Withhold
    Once the requirements of proposed Sec.  1.1441-2(d)(4)(i) have been 
satisfied, a withholding agent would have an obligation to withhold on 
a deemed distribution. Except as provided in Sec.  1.1441-5 regarding 
the time to withhold for partnerships and trusts, under proposed Sec.  
1.1441-2(d)(4)(ii), a withholding agent would be required to satisfy 
its withholding obligation by withholding on the earliest of (i) the 
date on which a future cash payment is made with respect to the 
security; (ii) 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 (iii) the due date (not including extensions) 
for filing Form 1042 with respect to the calendar year in which the 
deemed distribution occurred. Under this approach, a withholding agent 
that continues to directly or indirectly hold or own the security when 
the requirements of proposed Sec.  1.1441-2(d)(4)(i) are satisfied 
generally would be able to satisfy its withholding obligation by 
withholding on future cash payments on the security (for example, an 
interest payment on a convertible bond). If, however, the security is 
disposed of before sufficient future cash payments have been made on 
the security, the withholding agent would be required to withhold at 
the time of disposition and generally would be expected to do so by, 
for example, withholding on the proceeds from the disposal, liquidating 
other property held in custody for the beneficial owner, or obtaining 
other funds directly or indirectly from the beneficial owner to satisfy 
the withholding.
    If there are not sufficient future cash payments on the security 
and the security has not been disposed of or transferred before the due 
date (not including extensions) for filing Form 1042 with respect to 
the calendar year in which the deemed distribution occurred, then, to 
avoid having to pay the tax out of the withholding agent's own funds, 
the withholding agent may apply current Sec.  1.1461-2(b) in order to 
collect the underwithheld amount. Under these rules, the withholding 
agent can satisfy the tax by withholding on other cash payments made to 
the same beneficial owner or by liquidating other property held in 
custody for the beneficial owner or over which it has control. The 
proposed regulations would amend current Sec.  1.1461-2(b) to clarify 
that a withholding agent may obtain the property from which to withhold 
under these rules through additional contributions obtained directly or 
indirectly from the beneficial owner. The proposed regulations also 
would add a sentence to current Sec.  1.1461-2(b) to clarify that a 
withholding agent that satisfies its obligation to withhold under Sec.  
1.1461-2(b) will not be subject to any penalties for failure to deposit 
or failure to pay under sections 6656, 6672, and 7202 when it deposits 
the amounts obtained in this manner by the due date (not including 
extensions) for filing Form 1042 with respect to the calendar year in 
which the deemed distribution occurred. These clarifications reflect 
the IRS interpretation of current Sec.  1.1461-2(b) in applying these 
penalties, and thus no penalties will be imposed for withholding agents 
that apply these rules to satisfy their obligations to withhold before 
the effective date of these regulations.
    When the requirements of proposed Sec.  1.1441-2(d)(4)(i) are 
satisfied after a withholding agent has terminated its relationship 
with the beneficial owner

[[Page 21799]]

of the security, the withholding agent would remain liable for any 
underwithheld amount with respect to the deemed distribution. In order 
to avoid having to pay the tax due out of the withholding agent's own 
funds, before terminating an account relationship, a withholding agent 
should make arrangements with the beneficial owner to ensure that the 
withholding agent can satisfy any tax due, such as by retaining funds 
or other property of the owner.
iii. Foreign Entities Assuming Withholding Responsibilities
    Proposed Sec.  1.1441-2(d)(4)(iii) would provide that a withholding 
agent may treat certain foreign entities (qualified intermediaries, 
withholding foreign partnerships, withholding foreign trusts, and U.S. 
branches treated as U.S. persons) as assuming primary chapter 3 
withholding responsibilities for a deemed distribution on a specified 
security only if (i) the withholding agent provides the foreign entity 
with a copy of the issuer statement described in Sec.  1.6045B-1(b)(1) 
within 10 days of the issuer furnishing the statement to the holder of 
record or its nominee, or (ii) the issuer has met the public reporting 
requirements under Sec.  1.6045B-1(a)(3). The foreign entity would have 
an obligation to withhold on the deemed distribution only if it 
receives 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. The purpose of this proposed rule is to ensure 
that foreign entities that assume primary withholding responsibilities 
for deemed distributions will possess the information described in 
Sec.  1.6045B-1 to meet their withholding and information reporting 
obligations, as these entities (or their nominees) may not be holders 
of record that otherwise would receive the issuer statement described 
in Sec.  1.6045B-1(b)(1).
iv. Reliance on Issuer Information Reporting
    Under proposed Sec.  1.1441-3(c)(5), 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 
described in Sec.  1.6045B-1(b)(1) or on a public Web site described in 
Sec.  1.6045B-1(a)(3) 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 described in 
Sec.  1.6045B-1(b)(1) that it receives from another withholding agent 
under the circumstances described in proposed Sec.  1.1441-2(d)(4)(iii) 
unless it knows that the information is incorrect or unreliable.
v. Other Changes to Current Sec.  1.1441-2(d)(1)
    The proposed regulations would add language to Sec.  1.1441-2(d)(1) 
to clarify that a withholding agent does not lack control over money or 
property if it directs another person to make a payment, and that a 
withholding agent does not lack knowledge of the facts that give rise 
to a payment merely because the withholding agent does not know the 
character or source of the payment for U.S. tax purposes. The proposed 
regulations also would add an example to Sec.  1.1441-2(d)(1) of when a 
withholding agent lacks knowledge of the facts that give rise to a 
payment. These clarifications and the example are consistent with 
similar rules in current Sec.  1.1471-2(a)(4)(i) that apply for chapter 
4 purposes.
    The proposed regulations also would make nonsubstantive changes to 
reorganize the structure of current Sec.  1.1441-2(d)(1).
C. Amendments to Chapter 4
    The proposed regulations would modify the regulations under chapter 
4 to provide guidance similar to the rules described in proposed 
Sec. Sec.  1.1441-2(d)(1), 1.1441-2(d)(4), 1.1441-3(c)(5), and 1.1441-
7(a)(4) for withholding on a deemed distribution (as defined in Sec.  
1.305-1(d)(7)) that is a withholdable payment under chapter 4. The 
amendment to proposed Sec.  1.1461-2(b) that clarifies that a 
withholding agent may obtain additional contributions of property 
directly or indirectly from a beneficial owner and the new sentence 
added to proposed Sec.  1.1461-2(b) regarding penalties also would 
apply to withholding agents adjusting underwithholding under chapter 4 
through cross-reference in Sec.  1.1474-2(b). The proposed regulations 
also would make nonsubstantive changes to reorganize the structure of 
current Sec.  1.1471-2(a)(4)(i), which are consistent with the 
organizational changes proposed for current Sec.  1.1441-2(d)(1).

4. A Substitute Dividend May Include Deemed Payments

    Section 1.861-3(a)(6) provides that a substitute dividend payment 
made to a transferor in a securities lending transaction or sale-
repurchase transaction is sourced in the same manner as a dividend on 
the transferred securities. The regulations define a substitute 
dividend payment as ``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.'' These proposed regulations would modify Sec.  1.861-
3(a)(6) to clarify that a substitute dividend payment includes a deemed 
payment made in the amount (as determined under Sec.  1.305-7(c)(4)) of 
a deemed distribution (as defined in Sec.  1.305-1(d)(7)).
    These proposed regulations would provide that the general exception 
to withholding in Sec.  1.1441-2(d)(1)(i) does not apply for deemed 
payments (as defined in Sec.  1.861-3(a)(6)). However, proposed Sec.  
1.1441-2(d)(4) would allow a withholding agent to benefit from the same 
exception to withholding that would apply to deemed distributions (as 
defined in Sec.  1.305-1(d)(7)) on a specified security for deemed 
payments (as defined in Sec.  1.861-3(a)(6)) that are determined with 
respect to a deemed distribution on a specified security. Thus, a 
withholding agent would have an obligation to withhold on such a deemed 
payment only if, before the due date (not including extensions) for 
filing Form 1042, Annual Withholding Tax Return for U.S. Source Income 
of Foreign Persons, with respect to the calendar year in which the 
deemed distribution on a specified security occurred, either (i) the 
issuer meets its reporting requirements under Sec.  1.6045B-1 (by 
furnishing an issuer statement or publicly reporting the information 
required under that section) or (ii) the withholding agent has actual 
knowledge that a deemed distribution has occurred, in which case the 
obligation to withhold would not arise until January 15 of the year 
following the calendar year of the deemed distribution or the deemed 
payment. If a withholding agent has an obligation to withhold on a 
deemed payment (as defined in Sec.  1.861-3(a)(6)) under Sec.  1.1441-
2(d)(4)(i), it would be required

[[Page 21800]]

to withhold subject to the rules regarding when and how to withhold in 
proposed Sec.  1.1441-2(d)(4)(ii) and the rules regarding foreign 
entities that assume withholding responsibilities in Sec.  1.1441-
2(d)(4)(iii). These proposed regulations also would modify the 
regulations under chapter 4 to provide similar guidance with respect to 
deemed payments that are withholdable payments.

5. Issuer Reporting Under Section 6045B

    To facilitate broker reporting of a security's adjusted basis to 
the holder of the security under section 6045, section 6045B provides 
that, according to the forms or regulations prescribed by the 
Secretary, an issuer of a specified security (for example, stock, a 
convertible debt instrument, or a warrant) 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. Under 
section 6045B and current Sec.  1.6045B-1, an issuer must file an 
issuer return (Form 8937, Report of Organizational Actions Affecting 
Basis of Securities) 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 (for example, a copy of the issuer return) to holders by 
January 15 of the calendar year following the organizational action. In 
lieu of filing the issuer return with the IRS and furnishing the 
written statement to holders, current Sec.  1.6045B-1(a)(3) permits an 
issuer to post the required information on its public Web site by the 
due date for reporting the issuer return to the IRS. Under current 
Sec.  1.6045B-1, however, an issuer is not required to send a statement 
to exempt recipients, such as C corporations and foreign persons, nor 
is an issuer required to file an issuer return if the issuer reasonably 
determines that all of the holders of the security are exempt 
recipients. An issuer must comply with current Sec.  1.6045B-1 for an 
organizational action that occurs on or after the applicability date 
prescribed in current Sec.  1.6045B-1(j). For example, an issuer of a 
convertible debt instrument must comply with current Sec.  1.6045B-1 
for an organizational action that occurs after December 31, 2015.
    An applicable adjustment, including a conversion ratio adjustment, 
is an organizational action that often will affect the holder's basis 
in a specified security. For example, the instructions to Form 8937 
provide that if a conversion ratio adjustment on a convertible debt 
instrument occurring after December 31, 2015, results in a distribution 
under section 305(c) (for example, because it is made in conjunction 
with a cash distribution to shareholders), the issuer of the debt 
instrument must file Form 8937.
    Brokers and withholding agents have expressed concerns about the 
difficulty of complying with their reporting and withholding 
obligations in the absence of information about the fact and amount of 
a deemed distribution under section 305(c), including a deemed 
distribution under section 305(c) resulting from an applicable 
adjustment. Even after December 31, 2015, when issuers are generally 
required to report an applicable adjustment on a convertible debt 
instrument, brokers and withholding agents may not have the necessary 
information to comply with their reporting and withholding obligations 
because of the exempt recipient exception for providing a written 
statement (and assuming that the issuer does not choose the public 
reporting alternative). In response to these concerns, Sec.  1.6045B-
1(i)(2) of the proposed regulations would require that an issuer 
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 under section 305(c) 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. 
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 in current Sec.  
1.6045B-1(a)(3).

6. 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. Comments 
are requested on the implementation of Form 1099-DIV reporting on these 
amounts.

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 under section 305(c) that occur 
prior to such date. For purposes of determining the amount of a deemed 
distribution to a deemed shareholder occurring prior to the date of 
publication, a taxpayer may determine the amount of the deemed 
distribution by treating such distribution either as a distribution of 
a right to acquire stock or as a distribution of the actual stock to 
which the right relates.
    The proposed regulations under sections 860G, 861, 1441, 1461, 
1471, and 1473 would apply to payments made on or after the date of 
publication. A withholding agent, however, may rely on the proposed 
regulations under sections 861, 1441, 1471, and 1473 for all deemed 
distributions under section 305(c) or, to the extent applicable, deemed 
payments (as defined in Sec.  1.861-3(a)(6)) occurring on or after 
January 1, 2016 until the date of publication. No inference as to the 
application of these provisions under current law is intended by 
permitting reliance on these proposed regulations. A withholding agent 
also may rely on the proposed regulations under section 1461 for any 
payments occurring on or after January 1, 2016 until the date of 
publication, including for any deemed distribution under section 305(c) 
or deemed payment (as defined in Sec.  1.861-3(a)(6)) for which the 
withholding agent failed to withhold.
    Section 1.6045B-1(i)(2) would apply to a deemed distribution under 
section 305(c) occurring on or after the date of publication. In 
addition, an issuer would report the amount and timing of a deemed 
distribution in accordance with the proposed regulations under section 
305 for a deemed distribution occurring on or after the date of 
publication. For purposes of reporting the amount of a deemed 
distribution occurring prior to the date of publication, an issuer may 
determine the amount of the deemed distribution by treating such 
distribution either as a distribution of a right to acquire stock, or 
as a distribution of the shares of stock that would be received upon 
exercise of the right. In addition, an issuer may rely on Sec.  1.305-
7(c)(5) of the proposed regulations to determine the date of a deemed 
distribution occurring prior to the date of publication.

Statement of Availability of IRS Documents

    IRS Revenue Rulings cited in this preamble are published in the 
Internal Revenue Bulletin (or Cumulative Bulletin) and are available 
from the Superintendent of Documents, U.S. Government Printing Office, 
Washington, DC 20402, or by visiting the IRS Web site at https://www.irs.gov.

[[Page 21801]]

Effect on Other Documents

    The IRS will modify, clarify, or obsolete publications as necessary 
to conform to these proposed regulations as of the date of publication 
of the Treasury decision adopting these rules as final regulations in 
the Federal Register. See, e.g., Rev. Rul. 75-513 (1975-2 CB 114) and 
Rev. Rul. 76-186 (1976-1 CB 186). The IRS solicits comments as to 
whether other publications should be modified, clarified, or obsoleted.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations.
    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that the proposed regulations under section 6045B 
in this document will not have a significant economic impact on a 
substantial number of small entities. Any effect on small entities by 
the rules in the proposed regulations flows directly from section 403 
of the Energy Improvement and Extension Act of 2008, Division B of 
Public Law 110-343 (122 Stat. 3765, 3854 (2008)) (the Act).
    Section 403(d) of the Act added section 6045B, which requires an 
issuer, including an issuer that is a small entity, to report certain 
information relating to any organizational action by the issuer that 
affects the basis of a specified security. In general, an issuer 
reports the information required under section 6045B to the IRS and to 
holders or nominees on Form 8937. The proposed regulations limit 
reporting to the information necessary to meet the Act's requirements. 
In addition, the proposed regulations retain the rule in the current 
regulations under section 6045B that permits an issuer to report each 
action publicly on its Web site instead of filing a return and 
furnishing each holder or nominee a statement about the action. The 
proposed regulations therefore do not add to the statutory impact on 
small entities but instead eases this impact to the extent the statute 
permits. Moreover, any economic impact on small entities is expected to 
be minimal.
    Therefore, because the proposed regulations in this document will 
not have a significant economic impact on a substantial number of small 
entities, a regulatory flexibility analysis is not required.
    Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Requests for Public Hearing

    Before the proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ``Addresses'' 
heading. The Treasury Department and the IRS request comments on all 
aspects of the proposed regulations. All comments will be available for 
public inspection and copying upon request, or at www.regulations.gov. 
A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal authors of these regulations are: With respect to the 
regulations under section 305, Maurice M. LaBrie of the Office of 
Associate Chief Counsel (Corporate); with respect to the regulations 
under sections 860G, 861, 1441, 1461, 1471, and 1473, Subin Seth of the 
Office of Associate Chief Counsel (International); and with respect to 
the regulations under section 6045B, Pamela Lew of the Office of 
Associate Chief Counsel (Financial Institutions and Products), all 
within the Office of Chief Counsel, IRS. Other personnel from the 
Treasury Department and the IRS participated in developing the 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAX REGULATIONS

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

0
Par. 2. Section 1.305-1 is amended by:
0
1. Revising paragraphs (b)(3) and (d).
0
2. Adding paragraph (e).
    The revisions and addition read as follows:


Sec.  1.305-1  Stock dividends.

* * * * *
    (b) * * *
    (3) For rules determining the amount of the distribution for 
certain transactions, such as periodic redemptions or applicable 
adjustments (as defined in Sec.  1.305-7(a)) of rights to acquire stock 
that are treated as distributions under section 305(b) and (c), see 
Sec.  1.305-7 and Examples 6, 7, 8, 9, and 15 of Sec.  1.305-3(e).
* * * * *
    (d) Definitions. For purposes of section 305, this section, and 
Sec. Sec.  1.305-2 through 1.305-7:
    (1) Stock. The term stock means actual stock or a right to acquire 
stock.
    (2) Actual stock. The term actual stock means stock issued by a 
corporation, excluding rights to acquire stock as defined in paragraph 
(d)(3) of this section.
    (3) Right to acquire stock. The term right to acquire stock means--
    (i) A right of a holder of a convertible instrument (including a 
debt instrument that is convertible into shares of stock and stock that 
is convertible into shares of another class of stock) to convert the 
instrument into one or more shares of stock of the corporation issuing 
the instrument;
    (ii) A warrant, subscription right, stock right, or other option to 
acquire shares of stock of the corporation issuing the instrument;
    (iii) A right to acquire stock of the corporation issuing such 
right similar to the rights described in paragraphs (d)(3)(i) and (ii) 
of this section; and
    (iv) A right to receive an amount of cash or other property 
determined in whole or in part by reference to the value of a specified 
number of shares of stock (whether or not in lieu of such stock) of the 
corporation issuing the right.
    (4) Shareholder. The term shareholder means a holder of actual 
stock or a holder of a right to acquire stock.
    (5) Actual shareholder. The term actual shareholder means a holder 
of actual stock.
    (6) Deemed shareholder. The term deemed shareholder means a holder 
of a right to acquire stock.
    (7) Deemed distribution. The term deemed distribution means a 
transaction or event, other than an actual distribution of cash or 
property, that constitutes a distribution under section 305(b) and (c). 
An applicable adjustment to a right to acquire stock is not and does 
not result in a deemed distribution if either--

[[Page 21802]]

    (i) The right to acquire stock is a nonqualified stock option 
without a readily ascertainable fair market value (see section 83(e) 
and Sec.  1.83-7), or
    (ii) Section 83(a) applies to the right to acquire stock or the 
stock to which the right relates or the stock is subject to a 
substantial risk of forfeiture, and the holder of the right has not 
made an election under section 83(b).
    (e) Effective/applicability date. Paragraphs (b)(3) and (d) of this 
section apply to deemed distributions under section 305(b) and (c) 
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 under section 305(c) that occur prior to such date. For 
purposes of determining the amount of a deemed distribution to a deemed 
shareholder occurring prior to such date, a taxpayer may determine the 
amount of the deemed distribution by treating such distribution either 
as a distribution of a right to acquire stock or as a distribution of 
the actual stock to which the right relates.
0
Par. 3. Section 1.305-3 is amended by:
0
1. Revising paragraph (e) introductory text,
0
Example (6)(ii),
0
Example (7)(ii) and (iii).
0
2. Adding paragraph (f).
    The revisions and addition read as follows:


Sec.  1.305-3  Disproportionate distributions.

* * * * *
    (e) Examples. The following examples illustrate the application of 
section 305(b)(2) to distributions of stock and rights to acquire stock 
and the application of section 305(c) to deemed distributions of stock 
and rights to acquire stock. * * *

    Example 6. * * *
    (ii) M pays an annual cash dividend on the class A stock. At the 
beginning of the second year, when the conversion ratio is increased 
to 1.05 shares of class A stock for each share of class B stock, an 
applicable adjustment occurs, as defined in Sec.  1.305-7(a), and a 
distribution of rights to acquire 0.05 shares of class A stock is 
deemed made under section 305(c) and Sec.  1.305-7(c)(1) with 
respect to each share of class B stock. The proportionate interests 
of the class B shareholders in the assets or earnings and profits of 
M are increased, and the transaction has the effect described in 
section 305(b)(2). Accordingly, sections 305(b)(2) and 301 apply to 
the transaction. The amount of the deemed distribution is determined 
in accordance with Sec.  1.305-7(c)(4)(ii), and the date and time of 
the deemed distribution are determined in accordance with Sec.  
1.305-7(c)(5).
    Example 7.  * * *
    (ii) In 2017, a $1 cash dividend per share is declared and paid 
on the class B stock. Pursuant to the terms of the class B stock, on 
the date of payment, the conversion ratio of the class B stock is 
reduced. The reduction in conversion ratio is an applicable 
adjustment, as defined in Sec.  1.305-7(a). Under section 305(c) and 
Sec.  1.305-7(c)(2), the reduction is a deemed distribution of stock 
to the class A shareholders, since their proportionate interest in 
the assets or earnings and profits of the corporation is increased, 
and the transaction has the effect described in section 305(b)(2). 
Accordingly, sections 305(b)(2) and 301 apply to the transaction. 
The amount of the distribution is determined in accordance with 
Sec.  1.305-7(c)(4)(ii), and the date and time of the deemed 
distribution are determined in accordance with Sec.  1.305-7(c)(5).
    (iii) In the following year a cash dividend is paid on the class 
A stock but not on the class B stock, and the conversion ratio of 
the class B stock increases. The increase in the conversion ratio of 
the class B shares is an applicable adjustment. Under section 305(c) 
and Sec.  1.305-7(c)(1), the adjustment is a deemed distribution of 
rights to acquire stock to the class B shareholders since their 
proportionate interest in the assets or earnings and profits of the 
corporation is increased, and the transaction has the effect 
described in section 305(b)(2). Accordingly, sections 305(b)(2) and 
301 apply to the transaction. The amount of the distribution is 
determined in accordance with Sec.  1.305-7(c)(4)(i), and the date 
and time of the deemed distribution are determined in accordance 
with Sec.  1.305-7(c)(5).
* * * * *
    (f) Effective/applicability date. The first sentence of paragraph 
(e) of this section and Examples 6 and 7 of paragraph (e) of this 
section apply to deemed distributions under section 305(c) 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 under section 305(c) that occur prior to such date. For 
purposes of determining the amount of a deemed distribution to a deemed 
shareholder occurring prior to the date of publication, a taxpayer may 
determine the amount of the deemed distribution by treating such 
distribution either as a distribution of a right to acquire stock or as 
a distribution of the actual stock to which the right relates.
0
Par. 4. Section 1.305-7 is revised to read as follows:


Sec.  1.305-7  Certain transactions treated as distributions.

    (a) Applicable adjustment. For purposes of section 305, Sec. Sec.  
1.305-1 through 1.305-6, and this section, the term applicable 
adjustment means an adjustment to a right to acquire stock (as defined 
in Sec.  1.305-1(d)(3)), including--
    (1) With respect to a convertible instrument and a holder thereof, 
an increase in the conversion ratio or a reduction in the conversion 
price of such instrument;
    (2) With respect to a warrant, subscription right, stock right, 
option, or other similar right and a holder thereof, an increase in the 
number of shares to be received by the holder upon exercise or a 
reduction in exercise price;
    (3) With respect to a convertible instrument and a holder of actual 
stock into which such instrument may be converted, an increase in the 
conversion price or a reduction in the conversion ratio of such 
instrument;
    (4) With respect to a warrant, subscription right, stock right, 
option, or similar right and a holder of actual stock into which such 
instrument is exercisable, an increase in the exercise price or a 
reduction in the number of shares to be received by the holder upon 
exercise; and
    (5) An adjustment in the terms of a right to acquire stock having 
an effect similar to the effects of the adjustments described in 
paragraphs (a)(1) through (a)(4) of this section, including, for 
example, an extension or reduction of the term during which a right to 
acquire stock may be exercised.
    (b) Transactions treated as distributions--(1) In general. Under 
section 305(c), an applicable adjustment, a change in redemption price, 
a difference between redemption price and issue price, a redemption 
that is treated as a distribution to which section 301 applies, or any 
transaction (including a recapitalization) having a similar effect on 
the interest of any shareholder is treated as a distribution of stock 
to which sections 305(b) and 301 apply if such transaction increases a 
shareholder's proportionate interest in the assets or earnings and 
profits of the corporation deemed to make such distribution, and the 
distribution has the result described in section 305(b)(2), (3), (4), 
or (5). Depending upon the facts presented, the distribution may be 
deemed to be made in shares of actual stock or in additional rights to 
acquire stock (which, in either case, may be common or preferred 
stock).
    (c) Applicable adjustment to right to acquire stock--(1) Increase 
in deemed shareholder's proportionate interest. Under section 305(c), 
if an applicable adjustment has the effect of increasing a deemed 
shareholder's proportionate interest in the assets or earnings and 
profits of the corporation, and if such increase has the effect 
described in section 305(b)(2), (3), (4) or (5), the

[[Page 21803]]

applicable adjustment is a deemed distribution to the deemed 
shareholder of a right to acquire stock, and section 301 applies to the 
deemed distribution. Applicable adjustments that can have this effect 
include, with respect to a convertible instrument, an increase in the 
conversion ratio or the number of shares of stock to be received upon 
conversion or a reduction in the conversion price.
    (2) Increase in actual shareholder's proportionate interest. If an 
applicable adjustment has the effect of reducing a deemed shareholder's 
proportionate interest in the assets or earnings and profits of the 
corporation and thereby increasing an actual shareholder's 
proportionate interest, and if such increase has the effect described 
in section 305(b)(2), (3), (4), or (5), then the applicable adjustment 
is a deemed distribution of stock to the actual shareholder, and 
section 301 applies to the deemed distribution. Applicable adjustments 
that can have this effect include, with respect to a convertible 
instrument, a reduction in the conversion ratio or in the number of 
shares to be received upon conversion, or an increase in the conversion 
price.
    (3) Exception. For purposes of applying section 305(c) in 
conjunction with section 305(b), an applicable adjustment that is made 
pursuant to a bona fide, reasonable adjustment formula (including but 
not limited to an applicable adjustment made to compensate for a 
distribution of stock to another shareholder) and that has the effect 
of preventing dilution of the proportionate interest of the holders of 
actual stock or rights to acquire stock does not result in a deemed 
distribution of stock. An applicable adjustment that is made to 
compensate for a cash or property distribution to another shareholder 
and that is taxable under section 301, 356(a)(2), 871(a)(1)(A), 
881(a)(1), 852(b), or 857(b) is not made pursuant to a bona fide 
adjustment formula described in the preceding sentence.
    (4) Amount of deemed distribution--(i) Deemed distribution to 
deemed shareholder. For a deemed distribution under section 305(b) and 
(c) that is made to a deemed shareholder and is an applicable 
adjustment, the amount of the deemed distribution is the excess of--
    (A) The fair market value of the right to acquire stock held by the 
deemed shareholder immediately after the applicable adjustment, over
    (B) The fair market value, determined immediately after the 
applicable adjustment, of such right to acquire stock as if no 
applicable adjustment had occurred.
    (ii) Deemed distribution to actual shareholder. For a deemed 
distribution under section 305(b) and (c) that is made to an actual 
shareholder and results from an applicable adjustment, the amount of 
the deemed distribution is the fair market value of the stock deemed 
distributed, determined in accordance with the methodology set forth in 
Sec.  1.305-3(e), Examples 8 and 9.
    (iii) Fair market value standard. In determining the fair market 
value of a right to acquire stock for purposes of this paragraph 
(c)(4),
    (A) Any particular facts pertaining to the deemed shareholder, 
including the number of rights or shares such deemed shareholder owns, 
will be disregarded, and
    (B) Any value or reduction in value attributable to the possibility 
of future applicable adjustments that may result from actual or deemed 
distributions will not be taken into account.
    (5) Date and time of deemed distribution. When an applicable 
adjustment is a deemed distribution under paragraphs (c)(1) or (2) of 
this section, 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 (taking into account Sec.  1.305-3(b)). For 
such 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 time the applicable adjustment occurs, the 
deemed distribution occurs immediately prior to the opening of business 
on the ex-dividend date for the distribution of the 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 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.
    (6) Examples. The following examples and the examples in Sec. Sec.  
1.305-3(e) and 1.305-5(d) illustrate the application of section 305(c) 
and paragraphs (a), (b) and (c) of this section.

    Example 1.  (i) Facts. Corporation U has two classes of actual 
stock outstanding, class A and class B. Each class B share is 
convertible into class A stock. In accordance with a bona fide, 
reasonable antidilution provision, the conversion price is adjusted 
downward if the corporation transfers class A stock to anyone for 
consideration below the conversion price. The corporation sells 
class A stock to the public at the current market price, which is 
below the conversion price. Pursuant to the antidilution provision, 
the conversion price is adjusted downward.
    (ii) Analysis. Although such a reduction in conversion price is 
an applicable adjustment, under paragraph (c)(3) of this section the 
reduction is not a distribution under section 305(c) for the 
purposes of section 305(b).
    Example 2. (i) Facts. Corporation X has outstanding one class of 
actual common stock and convertible debt securities. The convertible 
securities have a bona fide, reasonable antidilution provision that 
provides for an increase in conversion ratio in the event stock 
dividends or rights to acquire stock are distributed to the common 
shareholders. Corporation X distributes to the common shareholders 
an actual stock dividend that results in an increase in the 
conversion ratio of the convertible securities. Pursuant to the 
antidilution provision, the conversion ratio is increased.
    (ii) Analysis. Under section 305(d) and Sec.  1.305-1(d)(4), the 
holders of convertible securities are shareholders for purposes of 
section 305(b) and (c). The convertible securities are rights to 
acquire stock and are stock for purposes of section 305. The 
increase in conversion ratio caused by the distribution of the stock 
dividend to the common shareholders is an applicable adjustment. 
Because the applicable adjustment is made pursuant to a bona fide, 
reasonable adjustment formula within the meaning of paragraph (c)(3) 
of this section, the applicable adjustment is not a deemed 
distribution under section 305(c) of rights to acquire stock.
    Example 3.  (i) Facts. Corporation X has outstanding one class 
of publicly-traded common stock and convertible debt securities. The 
terms of the convertible securities provide for an increase in the 
conversion ratio in the event stock, cash, or property is 
distributed to the holders of the common stock. Corporation X 
distributes cash to the holders of the common stock, and the 
distribution results in an increase in the conversion ratio of the 
convertible securities.
    (ii) Analysis. Under section 305(d) and Sec.  1.305-1(d)(5), the 
holders of the convertible securities are shareholders for purposes 
of section 305(b) and (c). The conversion rights in the convertible 
securities are rights to acquire stock (as defined in Sec.  1.305-
1(d)(3)) and is stock for purposes of section 305. The increase in 
conversion ratio resulting from the cash distribution to the holders 
of common stock is an applicable adjustment. Because the applicable 
adjustment is not made pursuant to a bona fide, reasonable 
adjustment formula within the meaning of paragraph (c)(3) of this 
section, it is a deemed distribution to the holders of the 
convertible securities of rights to acquire stock under section 
305(c) and paragraph (c)(1) of this section. Because the 
proportionate interests of these deemed shareholders in the assets 
or earnings and profits of Corporation X are increased by the change 
in conversion ratio, the distribution has the result described in 
section 305(b)(2) and is treated as a

[[Page 21804]]

distribution to which section 301 applies. The amount of the deemed 
distribution is determined in accordance with paragraph (c)(4)(i) of 
this section, and the date and time of the deemed distribution are 
determined in accordance with paragraph (c)(5) of this section.

    (d) Recapitalizations--(1) In general. A recapitalization (whether 
or not an isolated transaction) will be deemed to result in a 
distribution to which section 305(c) and this section apply if--
    (i) It is pursuant to a plan to periodically increase a 
shareholder's proportionate interest in the assets or earnings and 
profits of the corporation, or
    (ii) A shareholder owning preferred stock with dividends in arrears 
exchanges his stock for other stock and, as a result, increases his 
proportionate interest in the assets or earnings and profits of the 
corporation. An increase in a preferred shareholder's proportionate 
interest occurs in any case where the fair market value or the 
liquidation preference, whichever is greater, of the stock received in 
the exchange (determined immediately following the recapitalization), 
exceeds the issue price of the preferred stock surrendered.
    (2) Amount of distribution. In a case to which paragraph (d)(1)(ii) 
of this section applies, the amount of the distribution deemed under 
section 305(c) to result from the recapitalization is the lesser of--
    (i) The amount by which the fair market value or the liquidation 
preference, whichever is greater, of the stock received in the exchange 
(determined immediately following the recapitalization) exceeds the 
issue price of the preferred stock surrendered, or
    (ii) The amount of the dividends in arrears.
    (3) Definition. For purposes of applying paragraphs (d)(1) and (2) 
of this section with respect to stock issued before July 12, 1973, the 
term issue price of the preferred stock surrendered shall mean the 
greater of the issue price or the liquidation preference (not including 
dividends in arrears) of the stock surrendered.
    (4) Examples. For an illustration of the application of this 
paragraph (d), see Example 12 of Sec.  1.305-3(e) and Examples 1, 2, 3, 
and 6 of Sec.  1.305-5(d).
    (e) Redemption premiums with respect to preferred stock. Under 
section 305(c), if a redemption premium exists with respect to a class 
of preferred stock under the circumstances described in Sec.  1.305-
5(b) and the other requirements of this section are met, the 
distribution will be deemed made with respect to such preferred stock, 
in stock of the same class. Accordingly, the preferred shareholders are 
considered under section 305(b)(4) and (c) to have received a deemed 
distribution of preferred stock to which section 301 applies.
    (f) Coordination with section 871(m). For coordination of sections 
305 and 871(m), see Sec.  1.871-15(c)(2)(ii).
    (g) Effective date. This section applies to deemed distributions 
under section 305(c) 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 under section 305(c) that occur 
prior to such date. For purposes of determining the amount of a deemed 
distribution to a deemed shareholder occurring prior to the date of 
publication, a taxpayer may determine the amount of the deemed 
distribution by treating such distribution either as a distribution of 
a right to acquire stock or as a distribution of the actual stock to 
which the right relates.


Sec.  1.860G-3  [Amended]

0
Par. 5. Section 1.860G-3(b)(1) is amended by removing the language 
``1.1441-2(d)(4)'' in the last sentence, and adding the language 
``1.1441-2(d)(1)(ii)(C)'' in its place, and by removing the language 
``1.1441-5(b)(2)(i)(A), and'' and adding the language ``1.1441-
5(b)(2)(i)(A), 1.1471-2(a)(4)(i)(B)(4), and'' in its place.
0
Par. 6. Section 1.861-3 is amended by:
0
1. In paragraph (a)(6), removing ``A substitute dividend payment is a 
payment'' in the first sentence and adding ``A substitute dividend 
payment is a payment or a deemed payment'' in its place, and adding a 
new second sentence.
0
2. In paragraph (d), replacing the third sentence with a new sentence.
    The additions read as follows:


Sec.  1.861-3.  Dividends.

    (a) * * * * *
    (6) Substitute dividend payments. * * * A deemed payment is a 
payment deemed to have been made in the amount (as determined under 
Sec.  1.305-7(c)(4)) of a deemed distribution (as defined in Sec.  
1.305-1(d)(7)) that the owner of the transferred security is entitled 
to during the term of the transaction. * * *
* * * * *
    (d) Effective/applicability date. * * * Paragraph (a)(6) of this 
section applies to payments made on or after the date of publication of 
the Treasury decision adopting these rules as final regulations in the 
Federal Register; however, a taxpayer may rely on the rule in the 
second sentence of paragraph (a)(6) of this section for all deemed 
distributions (as defined in Sec.  1.305-1(d)(7)) occurring on or after 
January 1, 2016, until the date of publication of a Treasury decision 
adopting these rules as final regulations in the Federal Register. * * 
*
0
Par. 7. Section 1.1441-2 is amended by:
0
1. Revising paragraphs (d)(1) and (4).
0
2. Amending paragraph (f) by removing the language ``(d)(4)'' in the 
second sentence and adding in its place ``(d)(1)(ii)(C),'' and adding a 
fourth and fifth sentence.
    The revisions and addition read as follows:


Sec.  1.1441-2  Amounts subject to withholding.

* * * * *
    (d) * * *
    (1) General rule--(i) Control or custody and knowledge. Except as 
provided in paragraph (d)(1)(ii) of this section, a withholding agent 
has an obligation to withhold under section 1441 only to the extent 
that, at any time between the date that the obligation to withhold 
would arise (but for the provisions of this paragraph (d)) and the due 
date (including extensions) for filing Form 1042 with respect to the 
calendar year in which the payment occurs, it has--
    (A) Control over, or custody of, money or property owned by the 
recipient or beneficial owner from which to withhold an amount; and
    (B) Knowledge of the facts that give rise to the payment.
    (ii) Exception not available. The exception from the obligation to 
withhold under paragraph (d)(1)(i) of this section does not apply if--
    (A) The withholding agent is related (within the meaning of section 
482) to the recipient or the beneficial owner of the payment;
    (B) The payment is a distribution with respect to stock (including 
a deemed distribution (as defined in Sec.  1.305-1(d)(7)) of stock or a 
right to acquire stock); see, however, paragraph (d)(4) of this 
section, which provides a limited exception from the obligation to 
withhold on a deemed distribution;
    (C) The amounts are described in Sec.  1.860G-3(b)(1) (regarding 
certain partnership allocations of REMIC net income with respect to a 
REMIC residual interest);
    (D) The lack of control over or custody of money or property from 
which to withhold is part of a pre-arranged plan known to the 
withholding

[[Page 21805]]

agent to avoid withholding under section 1441, 1442, or 1443; or
    (E) The payment is a deemed payment (as defined in Sec.  1.861-
3(a)(6)); see, however, paragraph (d)(4) of this section, which 
provides a limited exception from the obligation to withhold on a 
deemed payment.
    (iii) Documentation. Any exception from withholding pursuant to 
paragraph (d)(1)(i) of this section applies without a requirement that 
documentation be furnished to the withholding agent. However, 
documentation may have to be furnished for purposes of the information 
reporting provisions under chapter 61 of the Code and backup 
withholding under section 3406.
    (iv) Scope of exception. The exception from withholding under this 
paragraph (d) is not a determination that the amounts are not fixed or 
determinable annual or periodical income, nor is it an exception from 
reporting the amount under Sec.  1.1461-1(b) and (c).
    (v) Lack of money or property or lack of knowledge. A withholding 
agent does not lack control over money or property for purposes of this 
paragraph (d)(1) if the withholding agent directs another party to make 
the payment. Thus, for example, a principal does not cease to have 
control over a payment when it contracts with a paying agent to make 
the payments to its account holders in lieu of paying the account 
holders directly. Further, a withholding agent does not lack knowledge 
of the facts that give rise to a payment merely because the withholding 
agent does not know the character or source of the payment for U.S. tax 
purposes. See Sec.  1.1441-3(d)(1) for rules addressing a withholding 
agent's obligations when the withholding agent has knowledge of the 
facts that give rise to the payment, but the character or source of the 
payment is not known.

    (vi) Example.  A, an individual, owns stock in DC, a domestic 
corporation, through a custodian, Bank 1. A also has a money market 
account at Bank 2. DC pays a dividend of $1,000 that is deposited in 
A's custodial account at Bank 1. A then directs Bank 1 to transfer 
$1,000 to A's money market account at Bank 2. With respect to the 
payment of the dividend into A's custodial account with Bank 1, both 
DC and Bank 1 are withholding agents making a payment of an amount 
subject to withholding for which they have custody, control, and 
knowledge. See Sec. Sec.  1.1441-2(b)(1) and 1.1441-7(a)(1). 
Therefore, both DC and Bank 1 have an obligation to withhold on the 
payment unless they can reliably associate the payment with 
documentation sufficient to treat the respective payees as not 
subject to withholding under chapter 3. With respect to the wire 
transfer of $1,000 from A's account at Bank 1 to A's account at Bank 
2, neither Bank 1 nor Bank 2 is required to withhold on the transfer 
because neither bank has knowledge of the facts that gave rise to 
the payment. Even though Bank 1 is a custodian for A's stock in DC 
and has knowledge regarding the $1,000 dividend paid to A, once Bank 
1 credits the $1,000 dividend to A's account, the $1,000 becomes A's 
property. When A transfers the $1,000 to its account at Bank 2, this 
is a separate transfer about which Bank 1 has no knowledge regarding 
the type of payment made. Further, Bank 2 only has knowledge that it 
receives $1,000 to be credited to A's account but has no knowledge 
regarding the type of payment made. Accordingly, Bank 1 and Bank 2 
have no withholding obligation with respect to the transfer from A's 
custodial account at Bank 1 to A's money market account at Bank 2.
* * * * *
    (4) Deemed distributions under section 305(c) and deemed payments--
(i) General rule. Subject to the rules in this paragraph (d)(4)(i) and 
paragraph (d)(4)(iii) of this section, and any other exception to 
withholding (for example, under Sec.  1.1441-4), a withholding agent 
has an obligation to withhold on a deemed distribution (as defined in 
Sec.  1.305-1(d)(7)) or a deemed payment (as defined in Sec.  1.861-
3(a)(6)) on a security. However, a withholding agent other than the 
issuer of a specified security (as defined in Sec.  1.6045-1(a)(14)) 
has an obligation to withhold on a deemed distribution (as defined in 
Sec.  1.305-1(d)(7)) on a specified security or a deemed payment (as 
defined in Sec.  1.861-3(a)(6)) that is determined with respect to a 
deemed distribution on a specified security only if:
    (A) The issuer of the specified security reports the information 
required under Sec.  1.6045B-1 regarding the deemed distribution before 
the due date (not including extensions) for the withholding agent to 
file Form 1042 for the calendar year in which the deemed distribution 
or the deemed payment occurred; or
    (B) The withholding agent has actual knowledge of the deemed 
distribution before the due date (not including extensions) for it to 
file Form 1042 for the calendar year in which the deemed distribution 
or the deemed payment occurred, but in such case the requirements of 
this paragraph (d)(4)(i) will not be considered to be met until January 
15 of the year following the calendar year in which the deemed 
distribution or the deemed payment occurred.
    (ii) Time to withhold on a deemed distribution or deemed payment. 
After the requirements of paragraph (d)(4)(i) of this section have been 
met, except as provided in Sec.  1.1441-5 regarding the time to 
withhold for partnerships and trusts, a withholding agent must withhold 
on a deemed distribution (as defined in Sec.  1.305-1(d)(7)) or a 
deemed payment (as defined in Sec.  1.861-3(a)(6)) on the earliest of:
    (A) The date on which a payment of cash is made with respect to the 
security or the securities lending or sales-repurchase transaction;
    (B) The date on which the security is sold, exchanged, or otherwise 
disposed of (including a transfer of the security to a separate account 
not maintained by the withholding agent or a termination of the account 
relationship); or
    (C) The due date (not including extensions) for the withholding 
agent to file Form 1042 for the calendar year in which the deemed 
distribution or the deemed payment occurred.
    (iii) Treatment of foreign entities assuming withholding 
responsibilities. Notwithstanding Sec.  1.1441-1(b)(1), a withholding 
agent may not treat a foreign entity as having assumed primary 
withholding responsibility under Sec.  1.1441-1(e)(5), Sec.  1.1441-
1(b)(2)(iv), Sec.  1.1441-5(c)(2)(i), or Sec.  1.1441-5(e)(5)(v) for a 
deemed distribution (as defined in Sec.  1.305-1(d)(7)) on a specified 
security (as defined in Sec.  1.6045-1(a)(14)) or a deemed payment (as 
defined in Sec.  1.861-3(a)(6)) that is determined with respect to a 
deemed distribution on a specified security unless the withholding 
agent has provided the foreign entity a copy of the issuer statement 
described in Sec.  1.6045B-1(b)(1) 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 described in Sec.  
1.6045B-1(a)(3). A foreign entity described in the preceding sentence 
has an obligation to withhold on the deemed distribution or the deemed 
payment (unless an exception to withholding under section 1441 applies) 
if it receives a copy of the statement described in Sec.  1.6045B-
1(b)(1) or the issuer has met the public reporting requirements 
described in Sec.  1.6045B-1(a)(3) by the due date (not including 
extensions) for filing Form 1042 with respect to the calendar year in 
which the deemed distribution or the deemed payment occurred. See Sec.  
1.1441-3(c)(5)(i) for when the foreign entity may rely on the copy of 
the issuer statement that it receives to determine the amount to 
withhold.
    (iv) Examples. The following examples illustrate when a withholding 
agent must satisfy its obligation to withhold under paragraph (d)(4) of 
this section on a deemed distribution.

    Example 1  (i) Facts. WA is a U.S. custodian that holds a 
convertible debt instrument (CDI) of Corporation X that is a 
specified security (as defined in Sec.  1.6045-

[[Page 21806]]

1(a)(14)) on behalf of A, a foreign person. On March 1 of Year 1, 
there is a change in the conversion ratio of the CDI that is treated 
as a deemed distribution under Sec.  1.305-7(b) and (c). On March 15 
of Year 1, Corporation X makes an interest payment on the CDI to WA 
as custodian for A. On April 1 of Year 1, Corporation X reports the 
information required under Sec.  1.6045B-1 regarding the deemed 
distribution on its public Web site. On April 15 of Year 1, 
Corporation X makes another interest payment on the CDI to WA as 
custodian for A.
    (ii) Analysis. Under paragraph (d)(4)(i) of this section, WA 
does not have an obligation to withhold on the deemed distribution 
on the CDI that it holds on behalf of A until April 1 of Year 1, the 
date on which Corporation X satisfied its reporting requirements 
under Sec.  1.6045B-1 regarding the deemed distribution. WA must 
withhold on the April 15 cash payment, which is the earliest of the 
dates specified in paragraph (d)(4)(ii) of this section for 
withholding on the deemed distribution.
    Example 2 (i) Facts. The facts are the same as in Example 1, 
except that an interest payment is not made on the Corporation X CDI 
on April 15 of Year 1, and the CDI is transferred to a separate 
account of A that is not maintained by WA on April 15 of Year 1.
    (ii) Analysis. Because WA is a withholding agent under Sec.  
1.1441-7(a)(4) with respect to the deemed distribution on March 1 of 
Year 1 and Corporation X reports the information required under 
Sec.  1.6045B-1, WA is required to satisfy the withholding 
obligation even though the CDI was transferred before a cash payment 
is made with respect to the CDI. WA does not have an obligation to 
withhold on the deemed distribution until April 1 of Year 1, the 
date on which Corporation X reported the conversion ratio adjustment 
as required by Sec.  1.6045B-1 regarding the deemed distribution. WA 
must withhold upon the transfer of the CDI to an account not 
maintained by WA on April 15 of Year 1, which is the earliest of the 
dates specified in paragraph (d)(4)(ii) of this section for 
withholding.
    Example 3  (i) Facts. The facts are the same as in Example 2, 
except that the CDI is transferred to a separate account of A that 
is not maintained by WA on March 30 of Year 1.
    (ii) Analysis. Because WA is a withholding agent under Sec.  
1.1441-7(a)(4) with respect to the deemed distribution on March 1 of 
Year 1 and Corporation X has satisfied its reporting requirements 
with respect to the deemed distribution, WA is required to satisfy 
the withholding obligation even though the CDI was transferred 
before WA received the issuer reporting from Corporation X under 
Sec.  1.6045B-1 regarding the deemed distribution. WA does not have 
an obligation to withhold on the deemed distribution until April 1 
of Year 1, the date on which Corporation X satisfied its reporting 
requirements under Sec.  1.6045B-1 regarding the deemed 
distribution. Because neither of the events specified in paragraphs 
(d)(4)(ii)(A) and (B) of this section occurred after April 1 of Year 
1, WA must satisfy its withholding obligation by the due date (not 
including extensions) for filing Form 1042 (that is, by March 15 of 
Year 2), as provided in paragraph (d)(4)(ii)(C) of this section. WA 
may apply Sec.  1.1461-2(b) in order to collect the underwithheld 
amount.
* * * * *
    (f) Effective/applicability date. * * * Paragraphs (d)(1) and 
(d)(4) of this section apply to payments made on or after the date of 
publication of the Treasury decision adopting these rules as final 
regulations in the Federal Register. A withholding agent may, however, 
rely on the rules in paragraphs (d)(1) and (d)(4) of this section for 
all deemed distributions (as defined in Sec.  1.305-1(d)(7)) or deemed 
payments (as defined in Sec.  1.861-3(a)(6)) occurring on or after 
January 1, 2016, until the date of publication of a Treasury decision 
adopting these rules as final regulations in the Federal Register.
0
Par. 8. Section 1.1441-3 is amended by:
0
1. Adding paragraph (c)(5).
0
2. Amending paragraph (i) by removing the language ``paragraphs (g) and 
(h)'' and adding in its place ``paragraphs (c)(5), (g), and (h)''.
    The addition reads as follows:


Sec.  1.1441-3  Determination of amounts to be withheld.

* * * * *
    (c) * * *
    (5) Reliance rule for applicable adjustments--(i) In general. For 
purposes of determining the amount of a deemed distribution (as defined 
in Sec.  1.305-1(d)(7)) on a specified security (as defined in Sec.  
1.6045-1(a)(14)) or a deemed payment (as defined in Sec.  1.861-
3(a)(6)) that is determined with respect to a deemed distribution on a 
specified security, a withholding agent other than the issuer of the 
specified security (as defined in Sec.  1.6045-1(a)(14)) may rely on 
the information provided by the issuer under Sec.  1.6045B-1 (or a copy 
of the issuer statement in the circumstances described in Sec.  1.1441-
2(d)(4)(iii)) unless it knows that such information is incorrect or 
unreliable. See Sec.  1.1441-2(d)(4) for a withholding agent's 
obligation to withhold on a deemed distribution or a deemed payment.
    (ii) Effective/applicability date. Paragraph (c)(5)(i) of this 
section applies to payments made on or after the date of publication of 
the Treasury decision adopting these rules as final regulations in the 
Federal Register. A withholding agent may, however, rely on the rules 
in paragraph (c)(5)(i) of this section for all deemed distributions (as 
defined in Sec.  1.305-1(d)(7)) or deemed payments (as defined in Sec.  
1.861-3(a)(6)) occurring on or after January 1, 2016, until the date of 
publication of a Treasury decision adopting these rules as final 
regulations in the Federal Register.
* * * * *
0
Par. 9. Section 1.1441-7 is amended by:
0
1. Redesignating paragraph (a)(4) as (a)(5) and adding a second and 
third sentence to newly redesignated (a)(5).
0
2. Adding a new paragraph (a)(4).
0
3. Amending paragraph (g) by removing the language ``paragraphs 
(a)(4)'' and adding in its place ``paragraphs (a)(5).''
    The addition reads as follows:


Sec.  1.1441-7  General provisions relating to withholding agents.

    (a) * * *
    (4) Withholding agent with respect to deemed distributions under 
section 305(c). Any person that issues or holds directly or indirectly 
(for example, through an account maintained for another intermediary) 
on behalf of a beneficial owner, or a flow through entity that owns 
directly or indirectly (through another flow-through entity), a 
security upon which a deemed distribution (as defined in Sec.  1.305-
1(d)(7)) is made has custody of or control over the deemed 
distribution. See Sec.  1.1441-2(d)(4) for a withholding agent's 
obligation to withhold on the deemed distribution and Sec.  1.1441-
3(c)(5)(i) for when a withholding agent may rely on the information 
reported by the issuer under Sec.  1.6045B-1 to determine the amount to 
withhold.
    (5) * * * Paragraph (a)(4) of this section applies to payments made 
on or after the date of publication of the Treasury decision adopting 
these rules as final regulations in the Federal Register. A withholding 
agent may, however, rely on the rules in paragraph (a)(4) of this 
section for all deemed distributions (as defined in Sec.  1.305-
1(d)(7)) occurring on or after January 1, 2016, until the date of 
publication of a Treasury decision adopting these rules as final 
regulations in the Federal Register.
0
Par. 10. Section 1.1461-2 is amended by revising the second sentence to 
paragraph (b), adding a fourth sentence to paragraph (b), and adding a 
second and third sentence to paragraph (d) to read as follows:


Sec.  1.1461-2  Adjustments for overwithholding or underwithholding of 
tax.

* * * * *
    (b) Withholding of additional tax when underwithholding occurs. * * 
* In the alternative, the withholding agent may satisfy the tax from 
property that it holds in custody for the beneficial owner, property 
over which it has

[[Page 21807]]

control, or additional contributions of property obtained directly or 
indirectly from the beneficial owner. * * * A withholding agent that 
adjusts its underwithholding under the procedure described in this 
paragraph (b) will not be subject to any penalties or additions to tax 
described in Sec.  1.1461-1(a)(2) if it timely deposits the amounts 
that it withholds from future payments, proceeds from the liquidation 
of property, or additional contributions of property obtained directly 
or indirectly from the beneficial owner. * * *
    (d) * * * Paragraph (b) of this section applies to payments made on 
or after the date of publication of the Treasury decision adopting 
these rules as final regulations in the Federal Register. A withholding 
agent may, however, rely on the rules in paragraph (b) of this section 
for payments occurring on or after January 1, 2016, until the date of 
publication of a Treasury decision adopting these rules as final 
regulations in the Federal Register.
0
Par. 11. Section 1.1471-2 is amended by:
0
1. Revising paragraph (a)(4)(i)(A), redesignating paragraph (B) as new 
paragraph (E), and adding new paragraphs (B) through (D).
0
2. Amending paragraph (c) by adding a third and fourth sentence.
    The revisions and addition read as follows:


Sec.  1.1471-2  Requirement to deduct and withhold tax on withholdable 
payments to certain FFIs.

* * * * *
    (a) * * *
    (4) * * *
    (i) * * *
    (A) In general. Except as provided in paragraph (a)(4)(i)(B) of 
this section, a withholding agent has an obligation to withhold under 
chapter 4 only to the extent that, at any time between the date that 
the obligation to withhold would arise (but for the provisions of this 
paragraph (a)(4)(i)(A)) and the due date (including extensions) for 
filing Form 1042 (including extensions) with respect to the calendar 
year in which the payment occurs, it has--
    (1) Control over, or custody of, money or property owned by the 
recipient or beneficial owner from which to withhold an amount, and
    (2) Knowledge of the facts that give rise to the payment.
    (B) Exception not available. The exception from the obligation to 
withhold under paragraph (a)(4)(i)(A) of this section does not apply 
if--
    (1) The withholding agent is related (within the meaning of section 
482) to the recipient or the beneficial owner of the payment;
    (2) The payment is with respect to stock (including a deemed 
distribution (as defined in Sec.  1.305-1(d)(7)) of stock or a right to 
acquire stock) or other securities; however, the limited exception from 
the obligation to withhold on a deemed distribution provided in Sec.  
1.1441-2(d)(4) also applies to a deemed distribution that is a 
withholdable payment under chapter 4;
    (3) The lack of control over or custody of money or property from 
which to withhold is part of a pre-arranged plan known to the 
withholding agent to avoid withholding under section 1471 or 1472;
    (4) The amounts are described in Sec.  1.860G-3(b)(1) (regarding 
certain partnership allocations of REMIC net income with respect to a 
REMIC residual interest);
    (5) Any of the special rules described in Sec.  1.1441-2(d)(2) or 
(3), regarding the obligation of a withholding agent with respect to 
cancellation of debt or the satisfaction of tax liability following 
underwithholding by a withholding agent, apply with respect to the 
payment (by applying such rules to payments that are withholdable 
payments under chapter 4); or
    (6) The payment is a deemed payment (as defined in Sec.  1.861-
3(a)(6)); however, the limited exception from the obligation to 
withhold on a deemed payment provided in Sec.  1.1441-2(d)(4) also 
applies to a deemed payment that is determined with respect to a deemed 
distribution on a specified security and that is a withholdable payment 
under chapter 4.
    (C) Documentation. Any exception from withholding pursuant to 
paragraph (a)(4)(i)(A) of this section applies without a requirement 
that documentation be furnished to the withholding agent. However, 
documentation may have to be furnished for purposes of the information 
reporting provisions under chapter 61 of the Code and backup 
withholding under section 3406.
    (D) Lack of money or property or lack of knowledge. A withholding 
agent does not lack control over money or property for purposes of this 
paragraph (a)(4)(i)(A) if the withholding agent directs another party 
to make the payment. Thus, for example, a principal does not cease to 
have control over a payment when it contracts with a paying agent to 
make the payments to its account holders in lieu of paying the account 
holders directly. Further, a withholding agent does not lack knowledge 
of the facts that give rise to a payment merely because the withholding 
agent does not know the character or source of the payment for U.S. tax 
purposes. See paragraph (a)(5) of this section for rules addressing a 
withholding agent's obligations when the withholding agent has 
knowledge of the facts that give rise to the payment, but the character 
or source of the payment is not known.
* * * * *
    (c) * * * Paragraph (a)(4)(i) of this section applies to payments 
made on or after the date of publication of the Treasury decision 
adopting these rules as final regulations in the Federal Register. A 
withholding agent may, however, rely on the rules in paragraph 
(a)(4)(i) of this section (together with the rules in Sec.  1.1441-
2(d)(4)), for all deemed distributions (as defined in Sec.  1.305-
1(d)(7)) or deemed payments (as defined in Sec.  1.861-3(a)(6)) that 
are withholdable payments occurring on or after January 1, 2016, until 
the date of publication of a Treasury decision adopting these rules as 
final regulations in the Federal Register.
0
Par. 12. Section 1.1473-1 is amended by:
0
1. Amending paragraph (a)(2)(vii)(A) by adding a sentence to the end of 
the paragraph.
0
2. Adding paragraph (d)(7).
0
3. Amending paragraph (f) by adding a third and fourth sentence.
    The additions read as follows:


Sec.  1.1473-1  Section 1473 definitions.

    (a) * * *
    (2) * * *
    (vii) * * *
    (A) * * * For purposes of determining the amount of a deemed 
distribution (as defined in Sec.  1.305-1(d)(7)) on a specified 
security (as defined in Sec.  1.6045-1(a)(14)) or a deemed payment (as 
defined in Sec.  1.861-3(a)(6)) that is determined with respect to a 
deemed distribution on a specified security, a withholding agent other 
than the issuer of the specified security may rely on issuer reporting 
by applying the rule under Sec.  1.1441-3(c)(5)(i) to deemed 
distributions or deemed payments that are withholdable payments under 
chapter 4.
* * * * *
    (d) * * *
    (7) Withholding agent with respect to deemed distributions under 
section 305(c). Any person that issues or holds directly or indirectly 
(for example, through an account maintained for another intermediary) 
on behalf of a beneficial owner or a flow through entity that owns 
directly or indirectly (through another flow-through entity), a 
security upon which a deemed distribution (as defined in Sec.  1.305-

[[Page 21808]]

1(d)(7)) is made has custody of or control over the deemed 
distribution.
* * * * *
    (f) * * * Paragraphs (a)(2)(vii) and (d)(7) of this section apply 
to payments made on or after the date of publication of the Treasury 
decision adopting these rules as final regulations in the Federal 
Register. A withholding agent may, however, rely on the rules in 
paragraphs (a)(2)(vii) and (d)(7) of this section for all deemed 
distributions (as defined in Sec.  1.305-1(d)(7)) or deemed payments 
(as defined in Sec.  1.861-3(a)(6)) that are withholdable payments 
occurring on or after January 1, 2016, until the date of publication of 
a Treasury decision adopting these rules as final regulations in the 
Federal Register.
0
Par. 13. Section 1.6045B-1 is amended by adding paragraph (i) to read 
as follows:


Sec.  1.6045B-1  Returns relating to actions affecting basis of 
securities.

* * * * *
    (i) Deemed distribution under section 305(c)--(1) In general. This 
paragraph (i) provides special rules for an organizational action 
resulting in a deemed distribution under section 305(c) that affects 
the basis of a specified security, including a deemed distribution 
resulting from an applicable adjustment (for example, a conversion 
ratio adjustment). See paragraph (j) of this section to determine when 
this section applies to an organizational action that affects the basis 
of a specified security. For example, under paragraph (j)(4) of this 
section, this section applies to a deemed distribution under section 
305(c) resulting from an applicable adjustment to a convertible debt 
instrument if the deemed distribution occurs on or after January 1, 
2016, and the deemed distribution could affect the basis of the 
convertible debt instrument.
    (2) Mandatory reporting. Notwithstanding any other provision in 
this section (including the reporting exceptions for exempt recipients 
in paragraphs (a)(4) and (b)(5) of this section), for an organizational 
action described in paragraph (i)(1) of this section the issuer must 
file an issuer return in accordance with paragraphs (a)(1) and (2) of 
this section and issuer statements in accordance with paragraphs 
(b)(1), (2), and (3) of this section. However, the requirement to file 
an issuer return and issuer statement in accordance with the preceding 
sentence does not apply if the issuer satisfies the public reporting 
requirements of paragraph (a)(3) of this section.
    (3) Information required to be reported. For purposes of paragraph 
(i)(2) of this section, an issuer must provide the information required 
under paragraph (a)(1) of this section, including--
    (i) The date of the deemed distribution under section 305(c) as 
determined in accordance with Sec.  1.305-7(c)(5) (pursuant to 
paragraph (a)(1)(iv) of this section); and
    (ii) The amount of the deemed distribution under section 305(c) as 
determined in accordance with Sec.  1.305-7(c)(4) (pursuant to 
paragraph (a)(1)(v) of this section).
    (4) Effective/applicability date. Paragraph (i)(2) of this section 
applies to a deemed distribution under section 305(c) occurring on or 
after the date of publication of the Treasury decision adopting these 
rules as final regulations in the Federal Register. For purposes of 
paragraphs (a)(1)(v) and (i)(3)(ii) of this section, an issuer must 
determine the amount of a deemed distribution under section 305(c) in 
accordance with Sec.  1.305-7(c)(4) for a deemed distribution occurring 
on or after the date of publication. For purposes of reporting the 
amount of a deemed distribution occurring prior to the date of 
publication, an issuer may determine the amount of the deemed 
distribution by treating such distribution either as a distribution of 
a right to acquire stock in accordance with Sec.  1.305-7(c)(4), or as 
a distribution of the shares of stock that would be received upon 
exercise of the right. For purposes of paragraphs (a)(1)(iv) and 
(i)(3)(i) of this section, an issuer must determine the date of a 
deemed distribution under section 305(c) occurring on or after the date 
of publication in accordance with Sec.  1.305-7(c)(5). An issuer, 
however, may rely on Sec.  1.305-7(c)(5) to determine the date of a 
deemed distribution that occurs prior to the date of publication.
* * * * *

John M. Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-08248 Filed 4-12-16; 8:45 am]
 BILLING CODE 4830-01-P