
[Federal Register Volume 81, Number 211 (Tuesday, November 1, 2016)]
[Notices]
[Pages 75867-75874]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-26382]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79172; File No. SR-OCC-2016-014]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Proposed Rule Change Related to Compliance With 
Section 871(m) of the Internal Revenue Code

October 27, 2016.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 18, 2016, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II and III below, which 
Items have been prepared by OCC. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Clearing Agency's Statement of the Terms of Substance of the 
Proposed Rule Change

    The purpose of this proposed rule change is to amend OCC's By-Laws 
and Rules to address the implementation of Section 871(m) of the 
Internal Revenue Code of 1986, as amended (``I.R.C.''),\3\ and the 
Treasury Regulations thereunder as they will apply to listed options 
transactions. The proposed amendments to OCC's By-Laws and Rules can be 
found on OCC's public Web site.\4\ All capitalized terms not defined 
herein have the same meaning as set forth in OCC's By-Laws and 
Rules.\5\
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    \3\ 26 U.S.C. 871(m).
    \4\ OCC's By-Laws and Rules can be found on OCC's public Web 
site: http://optionsclearing.com/about/publications/bylaws.jsp.
    \5\ Id.
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II. Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of these 
statements.

(A) Clearing Agency's Statement of the Purpose of, and Statutory Basis 
for, the Proposed Rule Change

(1) Purpose
Background
    OCC is proposing to modify its By-Laws and Rules to address the 
application of I.R.C. Section 871(m) (``Section 871(m)'') \6\ to listed 
options transactions commencing on January 1, 2017. The proposed 
modifications are designed to ensure that OCC will not be liable for 
U.S. withholding tax with respect to certain options transactions 
entered into by OCC's Clearing Members that are treated as non-U.S. 
persons for federal income tax purposes.
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    \6\ 26 U.S.C. 871(m).
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    Section 871(m), which was enacted in 2010, imposes a 30% 
withholding tax on ``dividend equivalent'' payments that are made or 
deemed to be made to non-U.S. persons with respect to certain 
derivatives (such as total return swaps) that reference equity of a 
U.S. issuer. In enacting Section 871(m), Congress was attempting to 
address the ability of foreign persons to obtain the economics of 
owning dividend-paying stock through a derivative while avoiding the 
withholding tax that would apply to dividends paid on the stock if the 
foreign person owned the stock directly.\7\
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    \7\ See 26 U.S.C. 871(a)(1)(A) (30% tax on dividends paid to 
non-resident aliens).
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    In September 2015, the Treasury Department adopted final 
regulations (the ``Final Section 871(m)

[[Page 75868]]

Regulations'') \8\ based on a proposal issued in December 2013 
expanding the types of derivatives to which Section 871(m) applies to 
include certain listed options transactions with an effective date of 
January 1, 2017. While actual dividends paid to foreign owners of U.S. 
equities have been subject to withholding tax for over 80 years, 
transactions by foreign persons in listed options referencing U.S. 
equities have not previously given rise to withholding tax. The 
application of Section 871(m) to listed options, as provided in the 
Final Section 871(m) Regulations, thus introduces new tax obligations 
and associated risks for OCC and its Clearing Members.
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    \8\ See T.D. 9734, 80 FR 56866 (Sept. 18, 2015).
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    Under the Final Section 871(m) Regulations, any equity option 
entered into by a non-U.S. person with an initial delta of .8 or above 
is considered a ``Section 871(m) Transaction'' and can potentially give 
rise to a dividend equivalent subject to withholding tax.\9\ A dividend 
equivalent is deemed to arise if a dividend is paid on the underlying 
stock while such an option is outstanding even though no corresponding 
payment is made on the option. A complex set of rules and exceptions in 
the Final Section 871(m) Regulations must be followed in order for the 
withholding agent (as defined in 26 CFR 1.1441-7) to determine if the 
withholding tax in fact applies, and, if so, the amount of the dividend 
equivalent subject to withholding tax.
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    \9\ Under the regulations, ``delta'' refers to the ratio of the 
change in the fair market value of an option to a small change in 
the fair market value of the number of shares of the underlying 
security referenced by the option. See 26 CFR 1.871-15(g)(1). 
Individual options entered into ``in connection with each other'' 
must generally be combined and tested against the .8 delta threshold 
on a combined basis (the ``Combination Rule''). See 26 CFR 1.871-
15(n). For example, if a non-U.S. person buys a call option and 
writes a put option on the same stock, and the options are entered 
into in connection with each other, the delta of the call and the 
delta of the put are added together. If the sum is .8 or higher, the 
two transactions are treated as Section 871(m) Transactions.
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    Two separate but overlapping U.S. withholding tax regimes will 
apply to dividend equivalents on listed options that are Section 871(m) 
Transactions. The first regime, sometimes referred to as ``Chapter 3 
Withholding,'' is the basic U.S. income tax withholding regime under 
Chapter 3 subtitle A of the Internal Revenue Code (``Chapter 3''), 
which has existed for many years.\10\ The second regime, known as 
``FATCA,'' \11\ was enacted in 2010 and, subject to transition rules, 
first applied to withholdable payments (such as dividends and interest) 
made after June 30, 2014. The Treasury Department has issued extensive 
regulations under FATCA (the ``FATCA Regulations'').\12\
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    \10\ See 26 U.S.C. 1441-1446.
    \11\ See 26 U.S.C. 1471-1474. FATCA stands for the Foreign 
Account Tax Compliance Act, which is found in Chapter 4 of subtitle 
A of Title 26. References in this filing to ``Chapter 4'' are 
references to FATCA, and vice versa.
    \12\ See 26 CFR 1.1471-0 through 1.1474-1.1474-7.
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    The two withholding tax regimes serve very different purposes. 
Chapter 3 Withholding requires a withholding agent to withhold 30% of a 
withholdable payment and remit it to the Internal Revenue Service 
(``IRS'').\13\ The withholding tax is the mechanism by which the non-
U.S. person receiving the payment satisfies its tax liability to the 
United States.
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    \13\ Withholdable payments include U.S. source dividends, as 
defined in 26 U.S.C. 1441(b), and dividend equivalents are treated 
as U.S. source dividends for this purpose. 26 U.S.C. 871(m)(1).
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    FATCA, on the other hand, was enacted with the purpose of curbing 
tax evasion by U.S. citizens and residents through the use of offshore 
bank accounts. FATCA imposes a 30% withholding tax (``FATCA 
Withholding'') on U.S.-source dividends and other withholdable payments 
(including dividend equivalents) \14\ made by a U.S. withholding agent 
to a foreign financial institution (``FFI''), such as a bank or 
brokerage firm, unless the financial institution agrees to provide 
information to the IRS about its U.S. account holders. The purpose of 
FATCA Withholding is thus to force FFIs to provide the required 
information about U.S. account holders to the IRS. FFIs that enter into 
the required agreement with the IRS are referred to as ``Participating 
FFIs,'' and those that do not are referred to as ``Nonparticipating 
FFIs.'' The 30% FATCA Withholding applies to withholdable payments made 
to a Nonparticipating FFI whether the Nonparticipating FFI is the 
beneficial owner of the payment or acting as a broker, custodian or 
other intermediary with respect to the payment. To the extent that 
withholdable payments are made to a Nonparticipating FFI in any 
capacity, a U.S. withholding agent, such as OCC or its U.S. Clearing 
Members, transmitting these payments to the Nonparticipating FFI will 
be liable to the IRS for any amounts of FATCA Withholding that the U.S. 
withholding agent should, but does not, withhold and remit to the IRS.
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    \14\ The types of payments subject to FATCA Withholding are 
generally the same as those subject to Chapter 3 Withholding, 
although FATCA Withholding also applies to gross proceeds from the 
sale or other disposition of any instrument that gives rise to such 
payments. See 26 U.S.C. 1473(1). Gross proceeds withholding under 
FATCA is scheduled to become effective in 2019.
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    The Treasury Department has provided alternative means of complying 
with FATCA for FFIs that are resident in foreign jurisdictions that 
enter into an intergovernmental agreement (``IGA'') with the United 
States (each such foreign jurisdiction being referred to as a ``FATCA 
Partner''). An FFI resident in a FATCA Partner jurisdiction must either 
transmit the information required by FATCA to its local tax authority, 
which in turn would transmit the information to the IRS pursuant to a 
tax treaty or information exchange agreement (referred to as a ``Model 
1 IGA''), or the FFI must be authorized or required by FATCA Partner 
law to enter into an FFI agreement and to transmit FATCA reporting 
directly to the IRS (referred to as a ``Model 2 IGA''). Under both IGA 
models, payments to such FFIs would not be subject to FATCA Withholding 
so long as the FFI complies with the FATCA Partner's laws as mandated 
in the IGA. OCC currently has eight non-U.S. Clearing Members, all of 
which are Canadian firms. Canada entered into a Model 1 IGA with the 
United States on February 5, 2014, as a result of which OCC's Canadian 
Clearing Members that comply with the Canadian laws mandated in such 
Model 1 IGA are ``Reporting Model 1 FFIs'' and are exempt from FATCA 
Withholding.
    Because OCC does not make payments of U.S.-source interest and 
dividends to its Clearing Members, OCC's transactions with its Clearing 
Members have not to date given rise to payments subject to Chapter 3 
Withholding or to FATCA Withholding. Both Chapter 3 Withholding and 
FATCA Withholding will become applicable to OCC and its Clearing 
Members, however, once Section 871(m) applies to listed options 
commencing January 1, 2017.
Impact on OCC and its Clearing Members
    The application of Section 871(m) to listed options transactions 
that are Section 871(m) Transactions in combination with Chapter 3 
Withholding and FATCA Withholding will have significant implications 
for OCC and its Clearing Members. These implications differ depending 
upon whether the Clearing Member involved in the transaction is a U.S. 
firm or a non-U.S. firm. When a U.S. Clearing Member is involved, 
Section 871(m) is relevant if the Clearing Member is acting (directly 
or indirectly) on behalf of a

[[Page 75869]]

non-U.S. customer.\15\ When a U.S. Clearing Member is acting for a 
foreign customer, the U.S. Clearing Member will need to determine 
whether the transaction is a Section 871(m) Transaction, and, if so, 
the amount of any dividend equivalents subject to withholding. Under 
Chapter 3 and Chapter 4, withholding tax will need to be collected by 
the U.S. Clearing Member on any such dividend equivalent and remitted 
to the IRS.\16\ Reporting by the U.S. Clearing Member with respect to 
such amounts on IRS Forms 1042 and 1042-S would also be required.\17\
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    \15\ Section 871(m) is not relevant if the U.S. Clearing Member 
is acting on behalf of a U.S. customer or for its own account.
    \16\ The obligation to withhold arises under both Chapter 3 and 
Chapter 4 (i.e., FATCA), but duplicate withholding is not required. 
Under Section 1474(d) and 26 CFR 1.1474-6T(b)(1), amounts withheld 
under FATCA are credited against amounts required to be withheld 
under chapter 3.
    \17\ See 26 CFR 1.1461-1(c)(2)(i)(L).
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    OCC will not be obligated to withhold on any dividend equivalents 
associated with listed options that are Section 871(m) Transactions 
when the Clearing Member involved is a U.S. firm. Under the applicable 
Treasury Regulations, because OCC is treated as making such payments to 
a U.S. financial institution, OCC is not required to withhold. Rather, 
the withholding obligation falls on the U.S. Clearing Member if the 
member is acting directly for a non-U.S. person, or potentially on 
another broker or custodian with a closer connection to the non-U.S. 
person. Similarly, OCC will not have any tax reporting obligations. 
Those obligations will typically fall on the broker that has the 
obligation to withhold. In general terms, OCC is relieved of the 
obligation to withhold and to report dividend equivalents in this 
situation because the U.S. Clearing Member, and not OCC, is the last 
U.S. person with custody or control over the relevant payment or funds 
before they leave the United States. Without regard to the proposed 
rule change described herein, therefore, Section 871(m) will require 
OCC's U.S. Clearing Members with foreign customers to develop and 
maintain systems (i) to identify options transactions that are Section 
871(m) Transactions (including under the Combination Rule),\18\ (ii) to 
determine the amount of any dividend equivalents, and (iii) to 
effectuate withholding. Developing these systems will be challenging 
and costly.
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    \18\ See supra note 9.
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    The situation is very different when the Clearing Member involved 
is a non-U.S. firm. (As noted above, OCC currently has eight non-U.S. 
clearing members, all of which are Canadian firms.) Under the Final 
Section 871(m) Regulations, OCC itself is a withholding agent when a 
non-U.S. Clearing Member enters into a transaction on behalf of a 
customer or for its own account.\19\ In this situation, OCC is the last 
U.S. person treated as having custody or control over the payment or 
funds before they leave the United States. Unless the non-U.S. Clearing 
Members enter into certain agreements with the IRS (described below), 
under which they assume primary responsibility for Chapter 3 
Withholding tax and are FATCA Compliant, OCC would be required to 
withhold on dividend equivalents with respect to transactions that are 
Section 871(m) Transactions.\20\ In order to carry out these 
responsibilities, OCC would need to develop and maintain systems (i) to 
identify transactions that are Section 871(m) Transactions, (ii) to 
determine the amount of any dividend equivalents, (iii) to effectuate 
withholding, and (iv) to remit the withheld tax to the IRS. The non-
U.S. Clearing Members in this situation generally would not be required 
to withhold or to report because they already would have been subject 
to withholding by OCC. Without the proposed rule change, therefore, 
Section 871(m) by default would impose on the U.S. Clearing Members and 
OCC--but not on the non-U.S. Clearing Members--the responsibility for 
withholding and reporting on dividend equivalents. The proposed rule 
change would transfer OCC's obligations with respect to the non-U.S. 
Clearing Members to those members, so that they would be treated in a 
manner analogous to the U.S. Clearing Members, who themselves will be 
required to withhold and report on dividend equivalents when Section 
871(m) becomes effective with respect to listed options.
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    \19\ See 26 CFR 1.1441-7(a)(3) (Example 7).
    \20\ As proposed, the term ``FACTA [sic] Compliant'' would mean 
that a FFI Clearing Member has qualified under such procedures 
promulgated by the IRS as are in effect from time to time to 
establish an exemption from withholding under FATCA such that OCC 
will not be required to withhold any amount with respect to any 
payment or deemed payment to such FFI Clearing Member under FATCA.
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    To address OCC's potential Chapter 3 Withholding and reporting 
obligations, the agreements that non-U.S. Clearing Members can enter 
into with the IRS to relieve OCC of these obligations are as follows:
     With respect to transactions that the Clearing Member 
enters into on behalf of customers (that is, as an intermediary), the 
Clearing Member can enter into a ``qualified intermediary agreement'' 
with the IRS under which the Clearing Member assumes primary 
withholding responsibility. If a Clearing Member has such an agreement 
in place (such member being a ``Qualified Intermediary Assuming Primary 
Withholding Responsibility''), OCC is relieved of its obligation to 
withhold under Chapter 3 with respect to the Clearing Member's customer 
transactions.
     With respect to transactions the Clearing Member enters 
into for its own account (that is, as a principal), the Clearing Member 
will be able to enter into a qualified intermediary agreement with the 
IRS (as described above) in which it further agrees, inter alia, to 
assume primary withholding responsibility with respect to all dividends 
and dividend equivalents it receives and makes.\21\ Entities entering 
into such agreements are referred to as ``Qualified Derivatives 
Dealers.''
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    \21\ See 26 CFR 1.1441-1T(e)(6); Notice 2016-42, 2016-29 I.R.B. 
(July 1, 2016).
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    The Treasury Regulations regarding Qualified Derivatives Dealers 
are currently in temporary form and are subject to change. Treasury and 
the IRS recently issued Notice 2016-42, which has proposed changes to 
the ``qualified intermediary agreement'' necessary to expand the 
Qualified Derivatives Dealer exception to include all transactions in 
which a Qualified Derivatives Dealer acts as a principal for its own 
account, regardless of whether it does so in its dealer capacity.\22\ 
If these changes are incorporated into the final qualified intermediary 
agreement, and if the Clearing Members timely enter into such 
agreements, OCC does not believe, based on IRS Notice 2016-42, that OCC 
will be obligated to withhold under Chapter 3 on any transactions 
entered into by the Clearing Member for its own account.
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    \22\ The concept of dealer in the tax context is different than 
in the securities regulatory context, where dealer activity would 
include both principal trading to facilitate customer activity as 
well as principal trading solely on behalf of the firm.
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    With respect to FATCA Withholding, OCC would not be required to 
withhold if the non-U.S. Clearing Member has entered into an agreement 
with the IRS to provide information about its U.S. account holders or 
if the Clearing Member is a resident of a country that has entered into 
an IGA and the member complies with its reporting responsibilities 
under the local legislation implementing the IGA.
    Even if OCC's non-U.S. Clearing Members enter into the agreements 
with the IRS described above (or with respect to FATCA are resident in 
a country with

[[Page 75870]]

an IGA), OCC would still be required to report to the IRS the amounts 
of dividend equivalents it is treated as paying to those Clearing 
Members.\23\
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    \23\ See 26 CFR 1.1461-1(c)(2)(i)(L).
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Preparing for Implementation of Section 871(m) as Applied to Listed 
Options
    Beginning on January 1, 2017, the Final Section 871(m) Regulations 
would treat OCC as paying dividend equivalents subject to both Chapter 
3 Withholding and FATCA Withholding--even though no actual payments are 
made--when a non-U.S. Clearing Member enters into a listed equity 
option with an initial delta of .8 or higher. OCC has evaluated its 
existing systems and services to determine whether and how it may 
comply with such withholding obligations. As a result of this 
evaluation, OCC has determined that its existing systems are not 
capable of effectuating withholding with regard to the transactions 
processed by OCC. OCC does not have access to the necessary 
transaction-specific information to determine whether a particular 
transaction triggers withholding, nor the systems to obtain such 
information. For example, OCC cannot associate options transactions in 
a Clearing Member's customer account with any particular customer. 
Similarly, when an option contract in a Clearing Member's customer 
account is closed out, OCC cannot determine the specific contract that 
is closed out when there are multiple identical contracts in the 
Clearing Member's customer account.\24\
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    \24\ Contracts with identical terms but entered into on 
different days or at different times will have different initial 
deltas. As a result, some (those with initial deltas above .8) may 
be Section 871(m) Transactions, while others may not be. It is thus 
critical to know which specific contract is closed out for purposes 
of determining if dividend equivalents arise with respect to a 
particular contract that is a Section 871(m) Transaction.
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    Even if OCC had access to all necessary information, the daily net 
settlement process in which OCC engages would not permit OCC to 
effectuate withholding without introducing significant settlement and 
liquidity risk, particularly since dividend equivalents on listed 
options do not involve an actual cash payment to the Clearing Member 
from which amounts could be withheld. OCC nets credits and debits per 
Clearing Member for daily settlement. Given OCC's netting, effectuating 
withholding could require OCC in certain circumstances to apply its own 
funds in order to remit withholding taxes to the IRS whenever the net 
credit owed to a non-U.S. Clearing Member is less than the withholding 
tax. In addition, if a non-U.S. Clearing Member has dividend equivalent 
payments aggregating $50 million, but the member is in a net debit 
settlement position for that day because of OCC's daily net crediting 
and debiting, there would be no payment to this Clearing Member from 
which OCC could withhold. In this example, OCC would likely need to 
fund the $15 million withholding tax (30% of $50 million) until such 
time as the Clearing Member could reimburse OCC. Furthermore, the cost 
of implementing a withholding system for the small number of Clearing 
Members that are non-U.S. firms (currently eight out of 115 Clearing 
Members) would be substantial and disproportionate to the related 
benefit. Since the cost of developing and maintaining a complex 
withholding system would be passed on to OCC's Clearing Members at 
large, it would burden both U.S. Clearing Members and non-U.S. Clearing 
Members that have entered into the requisite agreements with the IRS 
and are FATCA Compliant.
    Section 871(m) requires OCC's U.S. Clearing Members with foreign 
customers to build and maintain systems in order to carry out their 
withholding responsibilities under Chapter 3 and Chapter 4 for dividend 
equivalents in connection with transactions with their foreign 
customers. Absent the proposed rule change, OCC's non-U.S. Clearing 
Members could decide not to develop similarly appropriate systems. Such 
a decision would force OCC to be in a position to comply with 
withholding obligations on Section 871(m) Transactions under Chapter 3 
and Chapter 4 with regard to its non-U.S. Clearing Members, which, as 
noted above, OCC cannot do based on the way its settlement process and 
systems work. If such a situation were to theoretically occur, the 
resulting compliance costs would be shifted from the non-U.S. Clearing 
Members to OCC, and would cause such costs to be borne indirectly by 
OCC's U.S. Clearing Members, which already would be bearing their own 
compliance costs with regard to Section 871(m) Transactions. Moreover, 
as noted, the non-U.S. Clearing Members are in a better position than 
OCC to comply with Chapter 3 and Chapter 4 reporting and withholding 
requirements for Section 871(m) Transactions because they have customer 
information that OCC lacks. Under the proposed rule change, the costs 
associated with developing and maintaining the required systems would 
be moved back to the non-U.S. Clearing Members, who would essentially 
be placed in the same position as U.S. Clearing Members in terms of 
having to incur their own U.S. tax compliance costs.
    For the reasons explained above, OCC is proposing amendments to its 
Rules, as described below, to implement prudent, preventive measures 
that would require all of OCC's non-U.S. Clearing Members to enter into 
agreements with the IRS under which they assume primary withholding 
responsibility, to become Qualified Derivatives Dealers, and to be 
FATCA Compliant, so as to permit OCC to make payments (and deemed 
payments of dividend equivalents) to such Clearing Members free from 
U.S. withholding tax. In preparation for the proposed rule change and 
the implementation of Section 871(m) as applied to listed options, OCC 
has asked its non-U.S. Clearing Members to provide OCC with tax 
documentation certifying their tax status for purposes of both FATCA 
and Chapter 3 Withholding. All of these Clearing Members are Canadian 
firms and, in response to OCC's request, each of them has provided 
documentation certifying that it is a Reporting Model 1 FFI under the 
IGA with Canada, and therefore FATCA Compliant. Each has also certified 
that for Chapter 3 Withholding purposes, it is a Qualified Intermediary 
Assuming Primary Withholding Responsibility. None of these Clearing 
Members are currently Qualified Derivatives Dealers because the IRS has 
not yet finalized the relevant regulations and the associated agreement 
that must be entered into with the IRS. The IRS is expected to finalize 
the regulations and provide the agreement language before January 1, 
2017. If the IRS does not take any further action before January 1, 
2017, then the regulations will go into effect, as they are currently 
written, on January 1, 2017. In that case, FFI Clearing Members would 
become subject to withholding by OCC with respect to Section 871(m) 
Transactions in which the FFI Clearing Members are acting as a 
principal (i.e., transactions for the member's own account). Because of 
the practical difficulty OCC would encounter in attempting to 
distinguish dealer transactions in which the FFI Clearing Member is 
acting as an intermediary versus those in which it is acting as a 
principal, OCC will not allow the FFI Clearing Members to clear any 
dealer trades in the absence of final guidance or the ability of OCC's 
FFI Clearing Members to distinguish intermediary versus principal 
transactions in a manner that would allow OCC to process intermediary 
transactions free of any withholding obligations under Section 871(m). 
As

[[Page 75871]]

discussed above, however, OCC expects the IRS to finalize the 
regulations and to provide the relevant agreement language before 
January 1, 2017.
Proposed Amendments to OCC's By-Laws and Rules
    For the reasons discussed above, OCC is proposing a number of 
amendments to its By-Laws and Rules designed to require that, as a 
general requirement for membership, all existing and future Clearing 
Members that are treated as non-U.S. entities for U.S. federal income 
tax purposes must enter into appropriate agreements with the IRS and be 
FATCA Compliant, such that OCC will not be responsible for withholding 
on dividend equivalents under Section 871(m). Specifically, OCC 
proposes to amend Article I of its By-Laws to include the following 
defined terms. The term ``FFI Clearing Member'' would mean any Clearing 
Member that is treated as a non-U.S. entity for U.S. federal income tax 
purposes. The term ``Dividend Equivalent'' would be defined as having 
the meaning provided in Section 871(m) of the I.R.C. and related 
Treasury Regulations and other official interpretations thereof. The 
term ``FATCA'' would be defined as meaning: (i) the provisions of 
Sections 1471 through 1474 of the Internal Revenue Code of 1986, as 
amended, which were enacted as part of The Foreign Account Tax 
Compliance Act (or any amendment thereto or successor sections 
thereof), and related Treasury Regulations and other official 
interpretations thereof, as in effect from time to time, and (ii) the 
provisions of any intergovernmental agreement to implement The Foreign 
Account Tax Compliance Act as in effect from time to time between the 
United States and the jurisdiction of the FFI Clearing Member's 
residency. The term ``FATCA Compliant'' would mean, with respect to an 
FFI Clearing Member, that such FFI Clearing Member has qualified under 
such procedures promulgated by the IRS as are in effect from time to 
time to establish exemption from withholding under FATCA such that OCC 
will not be required to withhold any amount with respect to any payment 
or deemed payment to such FFI Clearing Member under FATCA. The term 
``Qualified Intermediary Assuming Primary Withholding Responsibility'' 
would mean an FFI Clearing Member that has entered into an agreement 
with the IRS to be a qualified intermediary and to assume primary 
responsibility for reporting and for collecting and remitting 
withholding tax under Chapter 3 and Chapter 4 of subtitle A, and 
Chapter 61 and Section 3406, of the I.R.C. with respect to any income 
(including Dividend Equivalents) arising from transactions entered into 
by the Clearing Member with OCC as an intermediary, including 
transactions entered into on behalf of such Clearing Member's 
customers. The term ``Qualified Derivatives Dealer'' would be defined 
as an FFI Clearing Member that has entered into an agreement with IRS 
that permits OCC to make Dividend Equivalent payments to such clearing 
member free from U.S. withholding tax under Chapter 3 and Chapter 4 of 
subtitle A, and Chapter 61 and Section 3406, of the I.R.C. with respect 
to transactions entered into by such clearing member with OCC as a 
principal for such Clearing Member's own account. ``Section 871(m) 
Effective Date'' would be defined as meaning January 1, 2017, or, if 
later, the date on which Section 871(m) and related Treasury 
Regulations and other official interpretations thereof, first apply to 
listed options transactions. Finally, ``Section 871(m) Implementation 
Date'' would mean December 1, 2016, or, if later, the date that is 30 
days before the Section 871(m) Effective Date.\25\
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    \25\ Although withholding with regard to Dividend Equivalent 
payments to non-U.S. clearing members is scheduled take effect 
beginning January 1, 2017, the proposed amendments to the By-Laws 
and Rules would require existing non-U.S. clearing members to 
provide documentation certifying their compliance with the 
requirements of Rule 310(d) 30 days prior to January 1, 2017, in 
order for OCC to review the certification materials and to address 
in a timely manner any potential non-compliance, in accordance with 
its Rules.
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    The proposed rule change also would add Section 1(e) to Article V 
of OCC's By-Laws, which would require any applicant, that if admitted 
to membership would be an FFI Clearing Member, to be a Qualified 
Intermediary Assuming Primary Withholding Responsibility and to be 
FATCA Compliant beginning on the Section 871(m) Implementation Date. In 
addition, if the applicant intends to trade for its own account, the 
applicant would be required to be a Qualified Derivatives Dealer.
    Furthermore, the proposed rule change would impose additional 
requirements on FFI Clearing Members. Specifically, proposed Rule 
310(d)(1) would prohibit FFI Clearing Members from conducting any 
transaction or activity through OCC unless the Clearing Member is a 
Qualified Intermediary Assuming Primary Withholding Responsibility and 
FATCA Compliant, beginning on the Section 871(m) Effective Date. In 
addition, FFI Clearing Members would not be permitted to enter into a 
transaction for their own accounts unless such Clearing Member is a 
Qualified Derivatives Dealer and such transaction is within the scope 
of the exemption from withholding tax for Dividend Equivalents paid to 
Qualified Derivatives Dealers.
    Proposed Rule 310(d)(2) would require each FFI Clearing Member to 
certify annually to OCC, beginning on the Section 871(m) Implementation 
Date, that it satisfies the above requirements and also to update its 
certification to OCC (viz., a completed Form W-8IMY electing primary 
withholding responsibility and Qualified Derivatives Dealer status) if 
required by applicable law or administrative guidance or if its 
certification is no longer accurate. Proposed Rule 310(d)(3) also would 
require each FFI Clearing Member to provide OCC with the information it 
needs relating to Dividend Equivalents, in sufficient detail and in a 
sufficiently timely manner, for OCC to comply with its obligation under 
Chapters 3 and 4 to make required reports to the IRS regarding Dividend 
Equivalents and the transactions giving rise to same between OCC and 
the FFI Clearing Member.
    Additionally, proposed Rule 310(d)(4) would require each FFI 
Clearing Member to inform OCC promptly if it is not, or has reason to 
know that it will not be, in compliance with Rule 310(d) within 2 days 
of knowledge thereof This rule ensures that OCC will be notified in a 
timely manner in the event that an FFI Clearing Member no longer 
maintains the appropriate arrangements described above to ensure that 
all withholding and reporting obligations with respect to Dividend 
Equivalents under Section 871(m) and Chapter 3 and 4 are being 
fulfilled.
    Finally, proposed Rule 310(d)(5) would require each FFI Clearing 
Member to indemnify OCC for any loss, liability, or expense sustained 
by OCC resulting from such member's failure to comply with proposed 
Rule 310(d). As discussed above, a Dividend Equivalent is deemed to 
arise if a dividend is paid on the underlying stock while an option is 
outstanding, even though no corresponding payment is made on the 
option. Due to the nature of OCC's settlement process, there may be no 
actual payments to the FFI Clearing Member from which OCC could 
withhold in order to address a liability or expense incurred by OCC 
arising from a member's failure to comply with the proposed rules. As a 
result, if OCC were required to satisfy any liability or expense caused 
by such member's failure to comply out of OCC's own funds, OCC would 
look to the FFI

[[Page 75872]]

Clearing Member to indemnify OCC for such losses.
(2) Statutory Basis
    OCC believes the proposed rule change is consistent with Section 
17A of the Securities Exchange Act of 1934, as amended (``Act''),\26\ 
and the rules thereunder applicable to OCC. Section 17A(b)(3)(F) of the 
Act \27\ requires, among other things, that the rules of a clearing 
agency: (i) Promote the prompt and accurate clearance and settlement of 
securities transactions and, to the extent applicable, derivative 
agreements, contracts, and transactions; (ii) assure the safeguarding 
of securities and funds which are in the custody or control of the 
clearing agency or for which it is responsible; (iii) in general, 
protect investors and the public interest; and (iv) are not designed to 
permit unfair discrimination among participants in the use of the 
clearing agency. OCC believes that the proposed rule change is designed 
to promote the prompt and accurate clearance and settlement of 
securities and derivatives transactions, assure the safeguarding of 
securities and funds at OCC, and protect investors and the public 
interest because it would eliminate the uncertainty in funds settlement 
that otherwise would arise if OCC were subject to withholding 
obligations with respect to Dividend Equivalents under Section 871(m). 
As noted above, the daily net settlement process in which OCC engages 
would not permit OCC to effectuate the necessary withholdings, 
particularly since Dividend Equivalents on listed options do not 
involve an actual cash payment to the Clearing Member from which 
amounts could be withheld. In addition, OCC lacks the customer 
information necessary determine the correct amounts subject to 
withholding. The introduction of withholding responsibilities on OCC 
therefore would introduce new complications and risks into OCC's 
clearance and settlement process and could create uncertainty around 
the settlement of funds at OCC. For these reasons, OCC does not believe 
that it is situated to accept the liability associated with Dividend 
Equivalent withholding responsibilities.
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78q-1.
    \27\ 15 U.S.C. 78q-1(b)(3)(F).
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    The proposed rule change would implement prudent, preventive 
measures to protect OCC against the obligation for any such withholding 
(and any resulting liability) by requiring FFI Clearing Members to 
enter into certain agreements with the IRS under which the FFI Clearing 
Member assumes primary withholding responsibilities with respect to 
transactions that it enters into on behalf of customers (i.e., as an 
intermediary) or for its own account (i.e., as a principal) and to be 
FATCA Compliant. The proposed rule change would eliminate potential 
risks and uncertainty in the daily settlement of funds at OCC otherwise 
imposed by Section 871(m)'s new mandate. Thus, OCC believes the 
proposed rule change is designed to promote the prompt and accurate 
clearance and settlement of securities and derivatives transactions, 
the safeguarding of securities and funds at OCC, and the protection of 
securities investors and the public interest in accordance with Section 
17A(b)(3)(F) of the Act.\28\
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    \28\ 15 U.S.C. 78q-1(b)(3)(F).
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    Moreover, OCC believes that the proposed rule change does not 
unfairly discriminate among participants in the use of the clearing 
agency. While the proposed rule change would impose additional 
requirements and/or restrictions on FFI Clearing Members, the proposed 
rules are intended to address specific issues and potential risks to 
OCC arising from those FFI Clearing Members whose membership creates 
potential withholding obligations for OCC. Additionally, as described 
above, Section 871(m) will impose similar withholding and reporting 
obligations on OCC's U.S. Clearing Members with respect to their 
foreign customers. Once Section 871(m) withholding becomes effective, 
OCC's U.S. Clearing Members will be subject to similar withholding and 
reporting requirements under Chapters 3 and 4, and they would need to 
develop and maintain appropriate systems to effectuate the required 
withholdings. The proposed rule change by OCC would require OCC's non-
U.S. Clearing Members to develop and maintain similar systems to 
effectuate the necessary U.S. tax withholding.
    OCC believes it is appropriate to impose these additional 
requirements on FFI Clearing Members because providing clearing 
services for these FFI Clearing Members would subject OCC to the 
additional withholding obligations discussed above, which do not arise 
when OCC performs clearing services for its U.S. Clearing Members. In 
the absence of the proposed rules, OCC would need to be in a position 
to comply with withholding obligations on Section 871(m) Transactions 
under Chapter 3 and Chapter 4 with regard to its FFI Clearing Members, 
which as noted above OCC cannot do based on the way its settlement 
process and systems work. If such a situation were to theoretically 
occur, the resulting compliance costs would be shifted from the non-
U.S. Clearing Members to OCC, and would cause such costs to be borne 
indirectly by OCC's U.S. Clearing Members, which already would be 
bearing their own compliance costs with regard to Section 871(m) 
Transactions. Since the cost of developing and maintaining a complex 
withholding system would be passed on to OCC's Clearing Members at 
large, OCC believes it would be an unfair burden on U.S. Clearing 
Members, as well as any non-U.S. Clearing Members that have entered 
into the requisite agreements with the IRS and are FATCA Compliant. 
Finally, OCC understands that its non-U.S. Clearing Members already 
have agreed to act as Qualified Intermediaries that accept primary 
withholding responsibility for Chapter 3 and Chapter 4 purposes more 
generally, which may limit to some degree the incremental burden they 
would be required to undertake as Qualified Derivatives Dealers once 
the Section 871(m) withholding rules take effect. Therefore, OCC 
believes that the proposed rule change is not unfairly discriminatory 
among participants in the use of the clearing agency and is therefore 
consistent with Section 17A(b)(3)(F) of the Act.\29\ The proposed rule 
change is not inconsistent with any rules of OCC, including those rules 
proposed to be amended.
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    \29\ 15 U.S.C. 78q-1(b)(3)(F).
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(B) Clearing Agency's Statement on Burden on Competition

    Section 17A(b)(3)(I) of the Act requires that the rules of a 
clearing agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act.\30\ The proposed 
rule change could potentially impact or burden competition by requiring 
any applicant for clearing membership or existing Clearing Member that 
would be an FFI Clearing Member to be a Qualified Intermediary Assuming 
Primary Withholding Responsibility in order to conduct any transaction 
or activity through OCC. This requirement could impose burdens on such 
an applicant or member because it would require them to develop systems 
and processes to collect the information necessary to determine which 
of its cleared options transactions are Section 871(m) Transactions and 
to calculate and effectuate the required withholdings and reporting. 
Additionally, the proposed rule change would require such an applicant 
or

[[Page 75873]]

member to be FATCA Compliant, which would require it to develop 
processes and procedures to gather information from clients necessary 
to fulfill its reporting obligations under FATCA. Moreover, in order to 
engage in activity for its own account, such applicant or member would 
need to be a Qualified Derivatives Dealer, which would entail the 
development of additional systems and processes for identifying any 
residual Section 871(m) Transactions it has entered into for its own 
account. The development of these systems and processes remain subject 
to some uncertainty, due to remaining questions regarding regulatory 
guidance under Section 871(m).\31\ In the absence of the proposed rule 
change, however, the non-U.S. Clearing Members themselves would become 
subject to withholding by OCC on dividend equivalents. The proposed 
rule thus reduces a direct economic burden on transactions between OCC 
and its non-U.S. Clearing Members that would apply absent compliance 
with the proposed rules.
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    \30\ 15 U.S.C. 78q-1(b)(3)(I).
    \31\ OCC believes, however, that theses burdens will be 
alleviated when the Treasury Department and IRS issue further 
guidance and provide additional clarity around outstanding questions 
and issues concerning the Final Section 871(m) Regulations. See 
generally Letter to the U.S. Department of the Treasury and IRS from 
Craig S. Donohue, Executive Chairman, OCC, on behalf of the U.S. 
Securities Markets Coalition regarding Final Section 871(m) 
Regulations Effective Date available at http://www.optionsclearing.com/components/docs/about/newsroom/comment-letters/August-16-OCC-Request-for-Postponement-871(m)-2016.pdf.
---------------------------------------------------------------------------

    Furthermore, OCC does not believe the proposed rule change would 
impose a significant burden on competition for FFI Clearing Members as 
compared to OCC's U.S. Clearing Members. As described above, Section 
871(m) imposes similar withholding and reporting obligations on OCC's 
U.S. Clearing Members with foreign customers. OCC's U.S. Clearing 
Members also will need to develop and maintain appropriate systems to 
identify Section 871(m) Transactions and to effectuate the required 
withholding. The proposed rule change by OCC would impose comparable 
requirements on OCC's non-U.S. Clearing Members.
    The proposed rule change also is narrowly tailored. It addresses 
the specific issues and potential risks to OCC arising from those firms 
whose membership creates potential withholding obligations for OCC. The 
proposed requirements for FFI Clearing Members are designed to 
eliminate any uncertainty in funds settlement that would arise if OCC 
were subject to withholding obligations with respect to Dividend 
Equivalents under Section 871(m). As discussed further above, OCC 
believes that the proposed rule change is necessary to eliminate 
potential complications and risk to its clearance and settlement 
process that would be presented by OCC's potential withholding 
responsibilities under Chapter 3 and Chapter 4 (and which would be a 
direct consequence of providing its clearance and settlement services 
for these FFI Clearing Members). OCC believes the proposed rule change 
is necessary to promote the prompt and accurate clearance and 
settlement of securities and derivatives transactions, to assure the 
safeguarding of securities and funds in the custody or control of OCC 
or for which it is responsible, and in general, to protect investors 
and the public interest in accordance with Section 17A(b)(3)(F) of the 
Act.\32\ Any burden on competition that this proposed change could be 
regarded as imposing would not be unreasonable or inappropriate under 
the Act. Furthermore, as stated above, all of OCC's current non-U.S. 
Clearing Members are already Qualified Intermediaries Assuming Primary 
Withholding Responsibility and FATCA Compliant.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    OCC does not believe that the ongoing certification and reporting 
provisions of proposed Rules 310(d)(2)-(4) would have any impact on 
competition. As a matter of standard practice, Clearing Members are 
required to inform OCC of material changes in, for example, their 
formal organization, ownership structure, or financial condition \33\ 
and are subject to ongoing financial reporting requirements.\34\ OCC 
believes the proposed rule change would impose reasonable reporting and 
notification requirements with respect to FFI Clearing Members' tax 
compliance status similar to those rules referenced above. Moreover, 
OCC does not believe the indemnification provision in proposed Rule 
301(d)(5) would present a burden on competition as it would only be 
imposed in the event that an FFI Clearing Member failed to comply with 
the proposed rule change and such failure resulted in a loss or expense 
to OCC.
---------------------------------------------------------------------------

    \33\ See, e.g., OCC Rules 201 and 303.
    \34\ See OCC Rule 306.
---------------------------------------------------------------------------

    For the foregoing reasons, OCC believes that the proposed rule 
change is in the public interest, would be consistent with the 
requirements of the Act applicable to registered clearing agencies, and 
would not impose a burden on competition that is unnecessary or 
inappropriate in furtherance of the purposes of the Act.

(C) Clearing Agency's Statement on Comments on the Proposed Rule Change 
Received from Members, Participants or Others

    Written comments on the proposed rule change were not and are not 
intended to be solicited with respect to the proposed rule change and 
none have been received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 days of the date of publication of this notice in the 
Federal Register or within such longer period up to 90 days (i) as the 
Commission may designate if it finds such longer period to be 
appropriate and publishes its reasons for so finding or (ii) as to 
which the self- regulatory organization consents, the Commission will:
    (A) by order approve or disapprove the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-OCC-2016-014 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number SR-OCC-2016-014. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than

[[Page 75874]]

those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. Copies of such filings also will be available 
for inspection and copying at the principal office of OCC and on OCC's 
Web site at http://www.theocc.com/components/docs/legal/rules_and_bylaws/sr_occ_16_014.pdf.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly.
    All submissions should refer to File Number SR-OCC-2016-014 and 
should be submitted on or before November 22, 2016.
    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\35\
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    \35\ 17 CFR 200.30-3(a)(12).

Brent J. Fields,
Secretary.
[FR Doc. 2016-26382 Filed 10-31-16; 8:45 am]
 BILLING CODE 8011-01-P


