Redemption payments: Proposed rules for US withholding tax under § 302

Abstract

Section 302 of the US Internal Revenue Code determines whether a payment in redemption of stock is treated as a dividend or as a sale or exchange, taxable as capital gain or loss. This provision applies in a wide variety of circumstances beyond simple calls for redemption or self-tenders. Aside from its general effect on US taxpayers, this provision has a direct bearing on whether or not redemption proceeds paid by US corporations to non-US shareholders are subject to US withholding tax. Regulations proposed by the Inland Revenue Service (IRS) seek to implement a new escrow procedure that insulates US withholding agents, but imposes reporting requirements on non-US shareholders, including qualified intermediaries. Essentially, non-US shareholders will have 60 days within which to establish that they are entitled to sale or exchange treatment on redemption payments and, as a result, are not subject to US withholding tax. This paper provides an overview of § 302 and outlines the key provisions of the proposed regulations, which are presently scheduled to go into effect at the beginning of 2009. With this information, the reader will be able to respond to enquiries from US withholding agents and understand the criteria under which redemption payments are properly treated as dividends, subject to withholding tax.