Notice 97-66

Part III. Administrative, Procedural, and Miscellaneous
Notice 97–61
The Internal Revenue Service has undertaken a large-scale effort to address
the year 2000 issue. The Year 2000 Conversion Project’s primary goal is to make
all current and future IRS information
systems year 2000 compliant. That is,
ensure that all computer systems function correctly before and after January 1,
2000.
The Internal Revenue Service has
adopted a standard for the year representation and date representation. This standard will be used in all data exchanges
with external trading partners (ETPs),
Federal, state and local governments as
well as the private sector. The standard
is:
—
an 8-position year when using
the Gregorian data format; the 8 characters (YYYYMMDD) must be contiguous
and the 4-position year field must be at
the beginning of the date field;
—
a four-position year when using
the Julian date format; the date field
would be represented as YYYYDDD;
—
a four-position year when using
the Epock/Offset date format where the
Epoch (year field) contains four characters and the Offset is a time element determined by the system owner; and,
—
a four-position year will be used
in conjunction with all other date formats and the other elements of the date
field.
The IRS said it will be contacting its
external trading partners to inform them
of the date by which data exchanges will
be converted. The trading partners will
be expected to certify that they will be
ready to receive the data and that they
will provide any related exchanges to the
IRS as specified in the standard.
External Trading Partners who provide data in accord with specifications
generally issued in Revenue Procedures
will continue to be informed of the date
requirements through Revenue Procedures. Others, with whom IRS has
agreements for specific exchanges, such
as with state revenue departments involved in tax administration, will be contacted individually by the IRS.

December 1, 1997

Certain Payments Made
Pursuant to a Securities
Lending Transaction

ments. The Treasury and the Service request comments on the treatment of foreign-to-foreign payments provided in this
Notice.

Notice 97–66

SECTION 2. SUBSTITUTE INTEREST
PAYMENTS

SECTION 1. SUMMARY
On October 14, 1997, final regulations
were published in the Federal Register
[T.D. 8735], RIN 1545-AP71, (the “final
regulations”) which source substitute interest and substitute dividend payments
that are made pursuant to a securities
lending or sale-repurchase transaction by
reference to the income that would be
earned with respect to the underlying
transferred debt security or stock. The
final regulations also provide that substitute interest and dividend payments that
are U.S. source under the regulations are
also characterized as interest and dividends for purposes of determining the
fixed or determinable annual or periodical
income of foreign resident individuals
and corporations subject to tax under sections 871, 881, 4948(a) and Chapter 3 of
the Internal Revenue Code and for purposes of granting tax treaty benefits with
respect to interest and dividends. As promulgated, the final regulations were made
applicable in all respects for substitute interest (as defined in § 1.861–2(a)(7) of
the income tax regulations) and substitute
dividend payments (as defined in §
1.861–3(a)(6)) made after November 13,
1997.
This Notice provides guidance on complying with the statement requirement of
section 871(h)(5) for substitute interest
payments made after November 13, 1997,
and before January 1, 1999. In addition,
the Treasury and the Service intend to
propose new regulations to provide specific guidance on how substitute dividend
payments made by one foreign person to
another foreign person (“foreign-to-foreign payments”) are to be treated. Until
the proposed regulations are promulgated,
this Notice clarifies how the amount of
the tax imposed under §§ 1.871–7(b)(2)
and 1.881–2(b)(2) will be determined
with respect to foreign-to-foreign pay-

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Substitute interest payments made by a
foreign person that are U.S. source interest under the final regulations must satisfy
the statement requirement of section
871(h)(5) to qualify as portfolio interest.
The final regulations refer taxpayers to §
1.871–14(c) for this purpose, but those
regulations are not generally applicable
until January 1, 1999. Under this Notice,
the statement requirement of section
871(h)(5) will be satisfied with respect to
substitute interest payments made after
November 13, 1997 and before January 1,
1999, if any written, electronic, or oral
statement that reasonably establishes that
the payee is a foreign person is given or
made to the payor prior to, or within a
reasonable period of time after, the payment. The statement requirement of the
preceding sentence is deemed to be satisfied if the payor is subject to, and satisfies
with respect to the payee, the regulatory
rules in the jurisdiction in which the payor
is operating regarding establishing the
identity of a customer (i.e., “know your
customer” rules). Also, if a taxpayer
makes an election under § 1.14411(f)(2)(ii), such election will be effective,
pursuant to this Notice, to allow a withholding agent to apply retroactively
the documentation requirements of
§ 1.871–14(c) with respect to one or more
substitute interest payments made
after November 13, 1997. Treas. Reg.
§ 1.871–14(c)(3) allows a withholding
agent to collect a certificate or documentary evidence at any time until the expiration of the beneficial owner’s period of
limitation for claiming a refund of tax
with respect to portfolio interest.
SECTION 3. SUBSTITUTE DIVIDEND
PAYMENTS
The final regulations were adopted to
eliminate unjustifiable differences between the taxation of similar economic investments. It has been brought to the at-

1997–48 I.R.B.

tention of the Treasury and the Service,
however, that, in certain circumstances,
the total U.S. withholding tax paid with
respect to a securities loan or sale-repurchase transaction, or series of such transactions, could be excessive due to the application of the final regulations. The
Treasury and the Service believe that taxpayers can avoid such excessive withholding taxes in the vast majority of cases
by structuring their transactions appropriately. In some circumstances, however,
such structuring may be difficult or impossible.
To address these concerns, under this
Notice, the amount of U.S. withholding tax
to be imposed under §§ 1.871–7(b)(2) and
1.881–2(b)(2) with respect to a foreign-toforeign payment will be the amount of the
underlying dividend multiplied by a rate
equal to the excess of the rate of U.S. withholding tax that would be applicable to
U.S. source dividends paid by a U.S. person directly to the recipient of the substitute
payment over the rate of U.S. withholding
tax that would be applicable to U.S. source
dividends paid by a U.S. person directly to
the payor of the substitute payment. This
amount may be reduced or eliminated to
the extent that the total U.S. tax actually
withheld on the underlying dividend and
any previous substitute payments is greater
than the amount of U.S. withholding tax
that would be imposed on U.S. source dividends paid by a U.S. person directly to the
payor of the substitute payment. The recipient of a substitute payment may not, however, disregard the form of its transaction in
order to reduce the U.S. withholding tax.
Therefore, a recipient of a foreign-to-foreign payment will not be entitled to a refund or tax credit against any other U.S. tax
liability to reflect the fact that the rate of
U.S. withholding tax that would be applicable to a U.S. source dividend paid by a U.S.
person directly to such recipient is less than
the rate of U.S. withholding tax that would
be applicable to a U.S. source dividend
paid by a U.S. person directly to the payor
of the substitute payment (or any payor of a
previous substitute payment or the underlying dividend).
As a result of this formula, substitute
payments with respect to foreign-to-foreign securities loans and sale-repurchase
transactions that do not reduce the overall U.S. withholding tax generally will
not be subject to withholding tax. For

1997–48 I.R.B.

example, no withholding tax is required
in situations where transactions are entered into between residents of the same
country. The Treasury and the Service
believe that this Notice adequately addresses the concerns of those foreign
persons who are required by their local
regulators to enter into transactions only
with residents of the same country.
Conversely, to the extent a foreign-toforeign securities loan or sale-repurchase
transaction would reduce the overall
U.S. withholding tax, an incremental
amount of U.S. withholding tax is imposed on the substitute payment.
SECTION 4. LIABILITY OF
WITHHOLDING AGENTS
Each person who makes a foreign-toforeign payment shall be treated as a
withholding agent under section 1.1441–7
with respect to such payment. If a U.S.
withholding agent withholds the highest
rate of tax which would be imposed on all
foreign recipients of dividends and substitute payments in a chain of such payments, each foreign withholding agent
will be treated as having satisfied its withholding obligation under §1.1441–7.
SECTION 5. EXAMPLES
The following examples illustrate the
principles of this Notice:
Example 1. Same Country Securities Loan. FP, a
pension fund resident in Country X, owns stock issued by USCo, a corporation resident in the United
States. An income tax treaty between Country X
and the United States limits the U.S. withholding tax
on gross dividends to 15 percent. USBroker, a U.S.
broker-dealer, needs to borrow the stock owned by
FP. Under Country X rules intended to safeguard
the interests of workers, however, FP is required to
deal only with Country X residents in connection
with its investment activities. Accordingly, FP enters into a securities loan with FBroker, a brokerdealer also resident in Country X. FBroker then enters into a securities loan with USBroker. USCo
pays a dividend of $100 on March 15, 1998. USBroker is the shareholder of record with respect to
the dividend. Since USBroker is a U.S. person,
USCo does not withhold on the dividend. USBroker
makes a substitute payment of $100 to FBroker from
which USBroker withholds $15. The rate of withholding tax that would be applicable to a U.S. source
dividend payment made by a U.S. person directly to
FP is the same as the rate of withholding tax that
would be applicable to a U.S. source dividend payment made by a U.S. person directly to FBroker.
Accordingly, no U.S. withholding tax is imposed
under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the
substitute payments made by FBroker to FP.
Example 2. Non-Same Country Securities Loan.

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A, a resident of Country X, owns shares of USCo, a
U.S. resident corporation. Country X has a treaty
with the United States which limits the United States
tax on gross dividends to 15 percent. A enters into a
securities loan with B, a resident of Country Y,
whose treaty with the United States also limits the
United States tax on gross dividends to 15 percent.
USCo pays a dividend of $100 on March 15, 1998.
B is the shareholder of record with respect to the
dividend. USCo withholds $15 and pays B a net
dividend of $85. B makes a substitute payment of
$85 to A. The rate of withholding tax that would be
applicable to a U.S. source dividend payment made
by a U.S. person directly to A is the same as the rate
of withholding tax that would be applicable to a U.S.
source dividend payment made by a U.S. person directly to B. Accordingly, no U.S. withholding tax is
imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)
on the substitute payments made by B to A.
Example 3. Increased Treaty Benefits. The facts
are the same as in example 2, except that Country X
has no treaty with the United States. Since a dividend payment made by a U.S. person directly to A
would have been subject to a 30-percent withholding tax, B must withhold an additional $15 ((30 percent - 15 percent) x $100) on the substitute payment
it makes to A. Alternatively, USCo could have withheld 30 percent from the dividend payment made to
B, thereby satisfying B’s withholding liability under
§ 1.1441–7.
Example 4. Multiple Country Securities Loans.
A, a resident of Country W, owns shares of USCo, a
U.S. resident corporation. Country W has an income tax treaty with the United States that limits the
United States tax on gross dividends to 15 percent.
B, a resident of Country X, enters into a securities
loan with A. Country X does not have an income tax
treaty with the United States. C, a resident of Country Y, enters into a securities loan with B. Country Y
has an income tax treaty with the United States
which limits the United States tax on gross dividends to 10 percent. D, a resident of country Z, enters into a securities loan with C. Country Z has an
income tax treaty with the United States which limits the United States tax on gross dividends to 15
percent.
USCo pays a dividend of $100 on March 15,
1998. D is the shareholder of record with respect to
the dividend. USCo withholds $15 and pays D a net
dividend of $85. D makes a substitute payment of
$85 to C. The rate of withholding tax that would be
applicable to a U.S. source dividend payment made
by a U.S. person directly to C is less than the rate of
withholding tax that would be applicable to a U.S.
source dividend payment made by a U.S. person directly to D. Accordingly, no U.S. withholding tax is
imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)
on the substitute payments received by C. However,
C is not entitled to a refund or tax credit against any
other U.S. tax liability for the additional 5-percent
tax reflected in its substitute payment from D over
the amount to which C would have been subject had
C received a dividend directly from USCo.
C makes a substitute payment of $85 to B from
which C withholds $15. Since a dividend payment
made by a U.S. person directly to B would have
been subject to a 30-percent withholding tax, C generally would be required to withhold an additional
$20 ((30 percent - 10 percent) x $100) on the substitute payment it makes to B. However, because $15

December 1, 1997

actually was withheld with respect to a $100 gross
dividend paid to D, C may reduce by $5 ((15 percent
- 10 percent) x $100) the $20 withholding obligation
on its substitute payment to B.
B makes a substitute payment of $70 to A. The
rate of withholding tax that would be applicable to a
U.S. source dividend payment made by a U.S. person directly to A is less than the rate of withholding
tax that would be applicable to a U.S. source dividend payment made by a U.S. person directly to B.
Accordingly, no U.S. withholding tax is imposed
under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the
substitute payment received by A. However, A is
not entitled to a refund or tax credit against any
other U.S. tax liability for the additional 15-percent
tax reflected in its substitute payment from B over
the amount to which A would have been subject had
A received a dividend directly from USCo.
Alternatively, USCo could have withheld 30 percent from the dividend payment made to D, thereby
satisfying C’s withholding obligation under §
1.1441–7.

SECTION 6. EFFECTIVE DATE OF
REGULATIONS
The provisions of this Notice are effective for purposes of applying the final
regulations as of November 14, 1997, the
effective date of those regulations. Because some withholding agents may require additional time to adjust their business practices to implement the
provisions of the final regulations and
this Notice, a withholding agent can
elect to defer the application of the final
regulations, other than Treas. Reg. §
1.864–5(b)(2)(ii), and this Notice until
January 1, 1998. A withholding agent
makes such an election by attaching a
statement to such effect to a timely filed
tax return (Form 1042) for the period
that includes November 14, 1997, or if
no such return is otherwise required for
the period including that date, on a
timely filed return (Form 1042) for the
period that includes January 1, 1998.
Withholding agents making this election
must apply the provisions of the final
regulations and this Notice for substitute
payments made after December 31,
1997.
SECTION 7. REQUEST FOR
COMMENTS
Treasury and the Service invite
comments on the guidance provided
by this Notice. Written comments should
be submitted by January 12, 1998,
to the Internal Revenue Service, P.O.
Box 7604 Ben Franklin Station, Atten-

December 1, 1997

tion: CC:CORP:T:R: (Notice 97-66)
Room 5228, Washington, DC 20044. Alternatively, comments may be
submitted via the internet at:
http://www.irs.ustreas.gov/prod/tax_regs/
comments.html. The comments submitted
will be available for public inspection and
copying.
SECTION 8. PAPERWORK
REDUCTION ACT
The collections of information contained in this Notice have been reviewed
and approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545–1566.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
control number.
The collections of information contained in this Notice are in Sections 2 and
6. The information is required to qualify
substitute interest payments as portfolio
interest and to defer, on election by the
taxpayer, the effective date of this Notice
and the final securities lending regulations (T.D. 8735, 62 FR 53498) for substitute payments made after December 31,
1997. The information will be used for
the same purpose described in the preceding sentence. The collections of information are required to obtain a benefit. The
likely respondents are businesses or other
for-profit institutions.
The estimated total annual reporting
and/or recordkeeping burden is 61,750
hours.
The estimated annual burden per respondent/recordkeeper varies from 1
minute to 15 minutes, depending on individual circumstances, with an estimated
average of 10 minutes. The estimated
number of respondents and/or recordkeepers is 377,500.
The estimated frequency of responses
(used for reporting requirements only) is
once.
Books or records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.

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SECTION 9. CONTACT
INFORMATION
The principal author of this Notice is
Paul Epstein of the Office of the Associate Chief Counsel (International) within
the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue,
NW, Washington, DC 20224. For further
information regarding this Notice contact
Milton Cahn or Paul Epstein at 202-6223870 (not a toll-free call).

Grace Period Interest
Notice 97–67
Many credit card agreements provide
for a grace period during which the credit
card issuer does not charge interest for a
billing cycle if the credit card holder pays
off its account balance by a specified date.
Under section 1004 of the Taxpayer Relief
Act of 1997 (the “Act”), Pub. L. No.
105–34, 111 Stat. 788, 911, if a taxpayer
holds a pool of credit card receivables, the
taxpayer must accrue interest and original
issue discount on the receivables based on
a reasonable assumption regarding the
timing of the payments by the obligors of
the receivables in the pool. Thus, the taxpayer is not permitted to assume that all of
its credit card holders will pay their balances by the date specified in the grace period provision of the credit card agreement
and, based on this assumption, defer the
inclusion of grace period interest. Section
1004 of the Act is effective for taxable
years beginning after August 5, 1997. The
Internal Revenue Service will issue guidance that provides the procedures for a
taxpayer to automatically change its
method of accounting to comply with section 1004 for the taxpayer’s first taxable
year beginning after August 5, 1997.
The Service will process requests by
taxpayers to change their methods of accounting for grace period interest that
were pending with the Service on August
4, 1997. For any requests filed on or
after August 5, 1997 (the date of enactment of the Act), the Service will exercise its discretion to deny requests to
change to a method of accounting for
grace period interest other than the
method required by section 1004 of the
Act. See § 446(e) of the Internal Revenue Code. See also H.R. Conf. Rep. No.

1997–48 I.R.B.