In April of 2016, the IRS published proposed regulations providing that conversion rate adjustments (CRAs) on convertible instruments are deemed dividends and are subject to withholding by withholding agents.  A comment period was scheduled ending 7/12/2016 in which seven comment letters were filed and posted to the docket on  On 7/5/2016, the IRS published some minor corrections to the Proposed Rule (corrections to code sections cited in examples in the original proposed rule) and then comment period closed.  And there has been no further comment or posting to the docket since.

Then in December, the status of the rule moved from “Proposed Rule” to “Final Rule” and the Final Action Date was changed to 12/00/2016.

What does that mean? 

It is hard to say, particularly in the current regulatory climate.  In the past I would have said that it means that the rule is about to become final in more or less its current form.  Perhaps a small change like the effective date, but no substantive changes.  Did I mention that the effective date in the proposed rule is 1/1/2016?

And now it is February and there have been no further changes to the docket.

Is the rule final?

Well, it has not been published in the Federal Register as a Final Rule.  On that basis, I would say no, the rule is not yet a Final Rule.  Will it become final in its current form?  I would say the chances are very good.  A change to the effective date is still possible, but by no means guaranteed.

The IRS position since this issue came to light in 2013 has been that existing regulations support the treatment of CRAs as deemed dividends.  And the subsequent reporting, withholding, and basis adjustment requirements for issuers and brokers are only an application of existing requirements for issuers and brokers to this particular type of income.  They were not persuaded that the argument that a CRA should be treated differently because it is a non-cash distribution.

So how should we proceed? 

One could hope that the current political climate, which is looking to reduce regulatory burdens on the financial services industry, will sweep away this new rule.  But I would not count on it.  305(c) impacts a pretty small universe of securities.  The last number I heard was in the low thousands.  Certainly not inconsequential, but the regulatory burden here is tiny by comparison to some aspects of Dodd Frank.  And the new requirements are only extensions of activities that issuers and brokers perform now – filing returns, withholding, adjusting basis and 1099 reporting.  If this rule does ever come up on the political “reduce the burden” radar, the impact on broker could significantly be reduced by some simple changes such as extending the withholding deadline and limiting the liability of the agent, as has been recommended by the industry.

If you accept the strong probability that this new rule will become final, then it is time to start planning for implementation.  Issuers generally announce these events today.  Some (not many) even issue 8937s as proscribed in the Proposed Rule.  DTCC has indicated that they follow-up on CRA announcements to obtain 8937s.  I expect other data vendors will follow suit.  So your Corporate Action data source is one place to start.  Withholding agents may also need to calculate FMV for the CRA if they are required to withhold prior to the issuance of the 8937.   That is another task to plan for.  Then cost basis systems will need to adjust basis for the amount of the deemed dividend.  So, that is a third task for which planning can start.  All three of these tasks may have to be applied to events retroactive to 1/1/2016.  So also a contingency that can be planned for now.

Time to get busy!

The IRS opinion is that current regulations now in effect require issuers and brokers to treat CRAs as deemed dividends.  The Proposed Rule defines the expected treatment.  The CRA announcements and even some 8937s are available today.  The rule may not become Final for days or even months, but I don’t see the expectations changing much.  Much of the planning if not the actual work necessary to identify the payments, calculate FMV, issue returns, adjust basis and report deemed dividends as income can be done by brokers now, even if they do not actually begin withholding or reporting until the rule becomes final.

Better to put it in the budget and resource plans now.


Blog contributed by Bob Linville, Director Tax and Cost Basis Product Management at Scivantage.  Bob is former co-chair of the FIF Back Office Committee and is currently Chairman of FIF’s Cost Basis Working Group and DTCC’s CBRS Steering Committee.