SECTION 3. SUBSTITUTE DIVIDEND

PAYMENTS

The final regulations were adopted to eliminate unjustifiable differences between the taxation of similar economic investments. It has been brought to the at

December 1, 1997 8 1997–48 I.R.B.

tention of the Treasury and the Service, however, that, in certain circumstances, the total U.S. withholding tax paid with respect to a securities loan or sale-repurchase transaction, or series of such transactions, could be excessive due to the application of the final regulations. The Treasury and the Service believe that taxpayers can avoid such excessive withholding taxes in the vast majority of cases by structuring their transactions appropriately. In some circumstances, however, such structuring may be difficult or impossible.

To address these concerns, under this Notice, the amount of U.S. withholding tax to be imposed under §§ 1.871–7(b)(2) and 1.881–2(b)(2) with respect to a foreign-toforeign payment will be the amount of the underlying dividend multiplied by a rate equal to the excess of the rate of U.S. withholding tax that would be applicable to U.S. source dividends paid by a U.S. person directly to the recipient of the substitute payment over the rate of U.S. withholding tax that would be applicable to U.S. source dividends paid by a U.S. person directly to the payor of the substitute payment. This amount may be reduced or eliminated to the extent that the total U.S. tax actually withheld on the underlying dividend and any previous substitute payments is greater than the amount of U.S. withholding tax that would be imposed on U.S. source dividends paid by a U.S. person directly to the payor of the substitute payment. The recipient of a substitute payment may not, however, disregard the form of its transaction in order to reduce the U.S. withholding tax. Therefore, a recipient of a foreign-to-foreign payment will not be entitled to a refund or tax credit against any other U.S. tax liability to reflect the fact that the rate of U.S. withholding tax that would be applicable to a U.S. source dividend paid by a U.S. person directly to such recipient is less than the rate of U.S. withholding tax that would be applicable to a U.S. source dividend paid by a U.S. person directly to the payor of the substitute payment (or any payor of a previous substitute payment or the underlying dividend).

As a result of this formula, substitute payments with respect to foreign-to-foreign securities loans and sale-repurchase transactions that do not reduce the overall U.S. withholding tax generally will not be subject to withholding tax. For

example, no withholding tax is required in situations where transactions are entered into between residents of the same country. The Treasury and the Service believe that this Notice adequately addresses the concerns of those foreign persons who are required by their local regulators to enter into transactions only with residents of the same country. Conversely, to the extent a foreign-toforeign securities loan or sale-repurchase transaction would reduce the overall U.S. withholding tax, an incremental amount of U.S. withholding tax is imposed on the substitute payment.