Providers of listed structured products in the Netherlands have decided to make turbos long on American stocks bid-only as of January 1, 2017. The move comes after the US Internal Revenue Service (IRS) issued the final regulations under Section 871(m) which imposes a withholding tax of 30% on dividend equivalent amounts (DEA). The new legislation is designed to tax foreign investors on derivatives and structured notes linked to US securities purchased after January 1, 2017. The tax applies only to non-US counterparties and therefore to all issuers of leverage products in the Dutch market.
In 2010 the US Congress approved the Hire Act which has the objective to offer tax breaks to companies which employ non skilled workers, according to Christophe Cox, assistant vice president, derivatives public distribution Belgium and the Netherlands, Commerzbank. "To finance these measures the US tax code was changed," said Cox. "The introduction of the so called Foreign Account Tax Compliance Act (Fatca) regulation for instance aims to tax the income of American citizens living abroad. The adjustment of the section 871m regulation has also consequences for Dutch or Belgian investors who invest in US stocks."
Commerzbank, together with other issuers of listed investment products such as turbos and factors, has now decided to make listed products on US underlyings bid-only, according to Cox. "We wanted to prevent that investors who buy these products, directly from Commerzbank as an issuer, have tax obligations towards the US tax authorities," said Cox. "We are talking about genuine US stocks. Not Alibaba for example, which is listed in the US, but stocks such as Alphabet, Apple, Facebook and the like which are used as underlying for listed products."
The new tax applies when the dividend is paid during the term of the derivative. Qualified equity indices such as the S&P 500, DJ Industrial Average and Nasdaq 100 are not in-scope. Technically, this is a challenge, according to Robin Said (pictured), head of turbos for the Netherlands at Citi. "A turbo, for example, replicates the underlying 100% (delta of 100%), but the payment of the dividend on the underlying asset won't generate a cash payment on the account of the investor," he said. "Therefore, practically, the deduction of a tax is a complicated matter."
Issuers of leveraged products, in collaboration with the IRS and other market participants, are looking at ways to facilitate the withholding of the tax on dividends, according to Said. "Until such a solution is implemented, Citi and other leveraged products issuers will take a number of precautionary measures to prevent risks for investors," said Said. "We are not going to issue new turbo long products on US stocks from January 1, 2017 onwards while at the same time we will no longer provide offer prices for existing in-scope turbos."
Commerzbank too is awaiting an automated solution for the settlement of the turbos, for the dividend tax to be paid automatically, according to Cox. "This solution has to be developed at market level, likely by Euroclear, the Dutch CSD, it's not in the hands of Commerzbank," he said. "Once the solution is found we will again start offering turbos on US equities. We collaborate with various parties, which, in Germany are different from the parties we work with in the Dutch market. However, pending a solution, products remain bid-only."
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