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The United States Department of the Treasury is proposing new regulations, which, when finalized, should close a tax "loophole" that currently enables non-American investors, like offshore hedge funds, to avoid taxes on dividends paid by US equities.
Currently, many non-US investors, including foreign hedge funds, enter into swaps or other derivative contracts that pay dividend equivalents, instead of directly holding the dividend-paying equities on which they are based. These foreign investors are therefore able to avoid the US's 30 percent withholding tax on a dividend, by receiving instead a dividend equivalent, which is not currently subject to US tax.
The proposed regulations should ensure that foreign taxpayers receiving "dividend equivalents," which are amounts directly or indirectly measured by reference to US dividends, are taxed in the same way as a foreign taxpayer receiving an actual dividend.
Treasury's regulations would align the taxation of dividend equivalents with the taxation of dividends from sources within the US when the underlying security that generates the dividend equivalent is a US equity. When finalized, the new rules would eliminate the incentive for non-US persons to use financial products like swap transactions, forwards and futures "to escape US tax obligations."
In addition, final regulations, released at the same time as the proposed regulations, continue the statutory regime that imposes a withholding tax on the dividend equivalent component of certain US equity-linked swap contracts.
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