Proposed Regulations Regarding the Scope of Swap Exclusion for Contracts Marked to Market and Expanded Definition of Notional Principal Contract: IRS and Treasury Department Issue Proposed Regulations on Swap Exclusion for Section 1256 Contracts and on Definition of Notional Principal Contract

Sullivan & Cromwell LLP - September 20, 2011

On September 16, 2011, the Internal Revenue Service (the “IRS”) and Treasury Department proposed regulations (the “Proposed Regulations”) that would (1) clarify and expand a Dodd-Frank Act exclusion from the definition of contracts that are marked to market under Section 1256 of the Internal Revenue Code, and (2) expand the definition of a “notional principal contract” (i.e., a “swap”) within the meaning of Treasury Regulation Section 1.446-3.  The latter would expand the definition of a “notional principal contract” so that it includes (a) credit default swaps, (b) certain “bullet swaps” (i.e., swaps that provide for a single net payment at maturity), and (c) certain swaps based on a specified non-financial index (e.g., weather-related swaps).  Characterization as a “notional principal contract” can affect the timing or character of payments under the contract or whether certain payments received by foreign persons are subject to U.S. withholding tax.  The regulations are proposed to be effective for contracts entered into on or after the date final regulations are published in the Federal Register.