Group Co.
With The Introduction of QDD, Will Tax Compliance Get Even More Taxing?
Traders Magazine Online News, January 22, 2018
Just when banks may think they have met all of their fiscal and regulatory obligations for the New Year (including the hotly- debated IRS 871(m) requirements), yet a new one arises.
Cue QDD – a new set of requirements for broker dealers and banks that want to become Qualified Derivatives Dealers (QDD). The idea is great, as QDD status prevents the cascading of withholding taxes on implied and actual equity-linked income events. Becoming a QDD breaks the chain, as when a QDD is paying income to a fellow QDD, it can do so gross, whereas if it is paying a non-QDD it must do so net.
But QDD status means that the company must perform a self-assessment of what tax it must pay to the IRS. This may result in assessing hundreds or even thousands of U.S.-related derivative contracts, as well as the implied dividend on the underlying shares embedded in the contract where they will get taxed on the underlying income events. All of which could create substantial potential tax withholding processing issues.
Luckily, the IRS has recognized the potential complexity involved in QDD and granted a concession which states that firms can use risk system reporting to understand if their implied dividends on derivatives were fully offset by the tax due on a standard cash income event in a QDD self-assessment calculation. As a QDD, the company in question will need to report and pay tax on these events. This all sounds reasonably straightforward, right?
This is where things start to get even more complicated. The QDD regime acts so that, in return for complying with the requirements of the regime, the bank or broker dealer receives 100% of the dividend and can pass it on to other QDDs at that rate. Although when it is paying to a non-QDD, that party is taxed based upon their associated tax documentation. This scenario seems like it could be easily supported – but, multiply the transactions, positions and dividend events into hundreds of thousands of flows, and it is clear that attempting to comply with this regime manually without leveraging automation will lead to a plethora of problems.
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