
[Federal Register Volume 81, Number 234 (Tuesday, December 6, 2016)]
[Notices]
[Pages 87984-87989]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-29163]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-79435; File No. SR-OCC-2016-014]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of Amendment No. 1 and Order Granting Accelerated 
Approval of a Proposed Rule Change, as Modified by Amendment No. 1, 
Related to Compliance With Section 871(m) of the Internal Revenue Code

November 30, 2016.
    On October 18, 2016, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') the 
proposed rule change SR-OCC-2016-014 pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder.\2\ On November 1, 2016, the proposed rule change was 
published for comment in the Federal Register.\3\ On November 28, 2016, 
OCC filed Amendment No. 1 to the proposal.\4\ The Commission did not 
receive any comments on the proposed rule change. The Commission is 
publishing this notice to solicit comment on Amendment No. 1 from 
interested persons and is approving the proposed rule change, as 
modified by Amendment No. 1, on an accelerated basis.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 79172 (Oct. 27, 2016), 
81 FR 75867 (Nov. 1, 2016) (SR-OCC-2016-014) (``Notice'').
    \4\ In Amendment No. 1, OCC amended the proposal by adjusting 
and clarifying the date by which an affected Clearing Member would 
need to demonstrate compliance with the proposed rule change, to 
allow additional time for the Internal Revenue Service (``IRS'') to 
finalize the form necessary to demonstrate such compliance. Whereas 
the original filing defined the ``Section 871(m) Implementation 
Date'' to mean ``December 1, 2016, or, if later, the date that is 30 
days before the Section 871(m) Effective Date'', Amendment No. 1 
defines ``Section 871(m) Implementation Date'' to mean ``such date 
on or after December 1, 2016 as [OCC] may designate in an 
Information Memo issued to its Clearing Members.''
---------------------------------------------------------------------------

I. Description of the Proposed Rule Change

    The following is a description of the proposed rule change as 
provided by OCC.\5\ All capitalized terms not defined herein have the 
same meaning as set forth in OCC's By-Laws and Rules.\6\
---------------------------------------------------------------------------

    \5\ The proposed amendments and OCC's By-Laws and Rules can be 
found on OCC's public Web site: http://optionsclearing.com/about/publications/bylaws.jsp.
    \6\ Id.
---------------------------------------------------------------------------

A. 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)'') \7\ 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.
---------------------------------------------------------------------------

    \7\ 26 U.S.C. 871(m).
---------------------------------------------------------------------------

    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.\8\
---------------------------------------------------------------------------

    \8\ See 26 U.S.C. 871(a)(1)(A) (30% tax on dividends paid to 
non-resident aliens).
---------------------------------------------------------------------------

    In September 2015, the Treasury Department adopted final 
regulations (the ``Final Section 871(m) Regulations'') \9\ 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.
---------------------------------------------------------------------------

    \9\ See T.D. 9734, 80 FR 56866 (Sept. 18, 2015).
---------------------------------------------------------------------------

    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.\10\

[[Page 87985]]

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.
---------------------------------------------------------------------------

    \10\ 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.
---------------------------------------------------------------------------

    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.\11\ The second regime, known as 
``FATCA,'' \12\ 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'').\13\
---------------------------------------------------------------------------

    \11\ See 26 U.S.C. 1441-1446.
    \12\ 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.
    \13\ See 26 CFR 1.1471-0 through 1.1474-1.1474-7.
---------------------------------------------------------------------------

    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'').\14\ The withholding tax is the mechanism by which the non-
U.S. person receiving the payment satisfies its tax liability to the 
United States.
---------------------------------------------------------------------------

    \14\ 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).
---------------------------------------------------------------------------

    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) \15\ 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.
---------------------------------------------------------------------------

    \15\ 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.
---------------------------------------------------------------------------

    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.
1. 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 non-U.S. customer.\16\ 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.\17\ Reporting by the U.S. 
Clearing Member with respect to such amounts on IRS Forms 1042 and 
1042-S would also be required.\18\
---------------------------------------------------------------------------

    \16\ 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.
    \17\ 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.
    \18\ See 26 CFR 1.1461-1(c)(2)(i)(L).
---------------------------------------------------------------------------

    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

[[Page 87986]]

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),\19\ (ii) to determine the 
amount of any dividend equivalents, and (iii) to effectuate 
withholding. Developing these systems will be challenging and costly.
---------------------------------------------------------------------------

    \19\ See supra note 9.
---------------------------------------------------------------------------

    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.\20\ 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.\21\ 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.
---------------------------------------------------------------------------

    \20\ See 26 CFR 1.1441-7(a)(3)(Example 7).
    \21\ 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.
---------------------------------------------------------------------------

    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:
    (1) 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.
    (2) 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.\22\ Entities entering into 
such agreements are referred to as ``Qualified Derivatives Dealers.''
---------------------------------------------------------------------------

    \22\ See 26 CFR 1.1441-1T(e)(6); Notice 2016-42, 2016-29 I.R.B. 
(July 1, 2016).
---------------------------------------------------------------------------

    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.\23\ 
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.
---------------------------------------------------------------------------

    \23\ 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.
---------------------------------------------------------------------------

    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 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.\24\
---------------------------------------------------------------------------

    \24\ See 26 CFR 1.1461-1(c)(2)(i)(L).
---------------------------------------------------------------------------

2. 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

[[Page 87987]]

out, OCC cannot determine the specific contract that is closed out when 
there are multiple identical contracts in the Clearing Member's 
customer account.\25\
---------------------------------------------------------------------------

    \25\ 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.
---------------------------------------------------------------------------

    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 discussed above, however, OCC expects the IRS to finalize the 
regulations and to provide the relevant agreement language before 
January 1, 2017.

B. 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

[[Page 87988]]

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.\26\
---------------------------------------------------------------------------

    \26\ 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.
---------------------------------------------------------------------------

    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 Clearing Member to indemnify OCC for such losses.

II. Discussion and Commission Findings

    Section 19(b)(2)(C) of the Act \27\ directs the Commission to 
approve a proposed rule change of a self-regulatory organization if it 
finds that the rule change, as proposed, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to such organization. The Commission finds that the proposed 
rule change is consistent with Section 17A(b)(3)(F) of the Act,\28\ 
which 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; and (iii) are not 
designed to permit unfair discrimination among participants in the use 
of the clearing agency.
---------------------------------------------------------------------------

    \27\ 15 U.S.C. 78s(b)(2)(C).
    \28\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

    According to OCC, the proposed rule change is needed to eliminate 
the uncertainty in funds settlement that

[[Page 87989]]

otherwise would arise if OCC were subject to withholding obligations 
with respect to Dividend Equivalents under Section 871(m). As noted 
above in Section I.A.2, given OCC's daily net settlement process, OCC 
may be required to apply its own funds if it were obligated to 
effectuate withholdings to the IRS pursuant to Section 871(m). The 
assumption of withholding responsibilities by OCC would introduce 
uncertainty and risks around the settlement of funds at OCC. The 
proposed rule change would transfer the obligation for any such 
withholding (and any resulting liability) to FFI Clearing Members 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 therefore would eliminate the potential uncertainty and risks in 
the daily settlement of funds at OCC that otherwise would be imposed by 
Section 871(m)'s new mandate. Thus, the Commission finds that the 
proposed rule change is designed to promote the prompt and accurate 
clearance and settlement of securities and derivatives transactions, 
and the safeguarding of securities and funds at OCC. While the proposed 
rule change would impose additional requirements and/or restrictions on 
FFI Clearing Members, the proposed rules are designed to address in a 
targeted and proportionate manner specific issues and potential risks 
to OCC arising from those FFI Clearing Members whose membership creates 
potential withholding obligations for OCC under the revised tax 
provisions. The Commission therefore finds that the proposed rule 
change does not unfairly discriminate among participants in the use of 
the clearing agency. Based on the above, the Commission finds that the 
proposed rule change is consistent with Section 17A(b)(3)(F) of the 
Act.\29\
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78q-1(b)(3)(F).
---------------------------------------------------------------------------

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as modified by Amendment No. 1, 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 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 December 27, 2016.

IV. Accelerated Approval of Proposed Rule Change, as Modified by 
Amendment No. 1

    As discussed above, OCC submitted Amendment No. 1 in order to 
adjust and clarify the date by which affected Clearing Members would 
need to demonstrate compliance with the proposed rule change. Amendment 
No. 1 does not raise any novel issues, and the filing has been designed 
to facilitate OCC's compliance with the requirements of another 
applicable regulatory regime. Accordingly, the Commission finds good 
cause, pursuant to Section 19(b)(2) of the Act,\30\ to approve the 
filing, as modified by Amendment No. 1, on an accelerated basis prior 
to the 30th day after the date of the publication in the Federal 
Register of the Notice and the notice of Amendment No. 1 to the filing.
---------------------------------------------------------------------------

    \30\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposal is consistent with the requirements of the Act, and in 
particular, with the requirements of Section 17A of the Act \31\ and 
the rules and regulations thereunder.
---------------------------------------------------------------------------

    \31\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\32\ that the proposed rule change (SR-OCC-2016-014), as modified 
by Amendment No. 1, be, and it hereby is, approved on an accelerated 
basis.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 78s(b)(2).
    \33\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\33\
Eduardo A. Aleman,
Assistant Secretary.
[FR Doc. 2016-29163 Filed 12-5-16; 8:45 am]
 BILLING CODE 8011-01-P


