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NEWS ANALYSIS


Trump one year on: why banks can’t wait for the 871(m)-review outcome


It may be hard to believe, but 20 January marked one year since Donald Trump’s inauguration. Away from all the media furore surrounding his Presidency to date, actions he has taken so far will have long-term repercussions


Head of regulation, Meritsoft Daniel Carpenter


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n 18 January, Russ Mould, AJ Bell investment director, said: “If the Dow Jones Industrials rises by a further 1.3% to 26,450 by the close on Friday, the headline US index


will have generated its best return ever in the first year of any post-war President.” At Wednesday’s close of 26,116, the Dow had recorded a gain of 31.7% since President Trump’s inauguration on 20 January 2017. Since Harry S. Truman’s accession to power in January 1949, only Barack Obama, in his first term, has been welcomed by a better return during a President’s first year in office.


One of his less well publicised reforms to the US tax code is perhaps best summed up by one of his political predecessors: “You may delay but time will not.” The words of none other than Benjamin Franklin perfectly explain the situation surrounding one particular tax reform currently under review – 871(m). This very specific – not to mention very complicated rule – is a tax on the value of dividends a financial institution receives on a US equity derivatives position.


There is a need for banks to comply with the first part of 871(m) in the here and now, particularly given that there is absolutely no indication that the 871(m) legislation will be dropped. While many banks may be inclined to wait for the outcome of the review, this mentality will only open up a whole world of problems further down the line and is preventing operational teams strategically addressing pressing tax and compliance issues today.


Not straightforward


The current rule establishes up to a 30% withholding tax on foreign investors on dividend-equivalent payments under equity derivatives, covering a number of product types including swaps, options, futures, MLPs, Structured Notes and convertible debt. And this is where things start to get tricky. A firm’s equity linked derivative instruments will face a tax withholding if the ratio of change to the fair market value is .08, as of January 2019 – currently


this is Delta 1, or greater to the corresponding change in the price of its derivative. Banks have no choice but to enhance their systems and processes in order to monitor which equity derivatives underlying constituents fall under 871(m) and know exactly when to calculate and enforce withholding on dividend equivalents.


In order to do this, a careful assessment of intricate calculations based on a set of highly convoluted rules and scenarios needs to be carried out; for example, required Combination Rule logic. In order to do this, firms need to pull together vast amounts of data, ranging from relevant trades (positions alone are insufficient for combination rule tracking), as well as Deltas and Dividends across many instrument types. This would not be so problematic if it was the only issue banks had to contend with. However, with so many other IT initiatives for other Tax and Regulatory mandatory projects also in the works, 871(m) is by no means the only significant compliance requirement currently on a financial institution’s plate.


Other challenges


Different, albeit similar, challenges also arise from other transaction tax legislation. With this in mind, firms should ensure they minimise multiple interface creation and support costs that result from linking to separate systems managing individual tax rules. Instead, firms should look to feed into a single Transaction Tax system that it is flexible enough to support ever changing global tax reforms down the line.


It is important to address the 871(m) conundrum now to get ahead of the game. It is not the first – and certainly will not be the last – transaction tax headache banks are having to overcome under this particular presidential regime. After all, we are in the midst of perhaps the biggest ever shake up of the US tax code, so who knows what is in store for financial institutions come the end of Trump’s first term?


www.ibsintelligence.com | © IBS Intelligence 2018


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