Cat bond issuers may have to pay Money Market Fund withholding tax

Insurance-linked securities (ILS) specialist law firm Sidley Austin LLP warns that issuers of catastrophe bonds could become subject to payment of withholding tax on U.S. Money Market Fund dividends after an exception ceases to apply.

Catastrophe bond issuers, typically hold the proceeds of the sale of the notes in collateral accounts with the assets invested in U.S. Treasury Money Market Funds, considered about as safe an investment for reinsurance collateral assets as you can find.

Sidley Austin notes that U.S. money market fund dividends have recently been excepted from U.S. federal withholding tax, pursuant to Section 871(k) of the Internal Revenue Code. However, this exception no longer applies, with respect to taxable years of money market funds beginning after December 31, 2013, the lawfirm highlights.

The taxable year for money market funds often begins later in the year, notes Sidley Austin, adding that many begin their taxable year as of the 1st September.

As a result, even if a cat bond issuer has been receiving its dividends from a U.S. money market fund free of withholding taxes up to now, that could change as the new taxable year begins for the money market fund.

Sidley Austin explains:

It is not clear whether Congress will enact legislation to extend the applicability of Section 871(k) or whether any such legislation, if enacted, will be on a retroactive basis. Thus, cat bond issuers may be subject to a 30% U.S. federal withholding tax on dividends from U.S. money market funds beginning at some point in 2014.

Something for issuers of catastrophe bonds to bear in mind and to ensure they consult their lawyers about, as this could reduce the return the money market funds make from dividends, if they become subject to withholding tax.