New Disclosure Requirement for Derivatives Over “Basket Positions” That Are Controlled by the Counterparty: Financial Institutions and Counterparties Must Retroactively Disclose Participation in Derivative Transactions that Effectively Provide a Counterparty with a Return Based on a Basket of Positions that the Counterparty Itself Trades and Controls

Sullivan & Cromwell LLP - July 9, 2015

In Notices issued yesterday (Notices 2015-47 and 2015-48), the IRS implemented disclosure requirements for derivative transactions (including swap and forward transactions, in addition to call options) that effectively provide a counterparty with a return based on a basket of positions that the counterparty itself trades and controls.  (This includes a case where the positions are varied pursuant to a trading algorithm controlled by the counterparty, or where the positions are interests in a hedge fund that itself trades financial positions.)  The IRS is concerned that some counterparties might be using such transactions to defer income, to convert what would otherwise be ordinary income and short-term capital gain from the underlying positions into long-term capital gain and/or to avoid U.S. withholding tax on outbound dividends.

Securities dealers and counterparties that were engaged in such transactions after 2010 (provided, in the case of non-option transactions, they were entered into after November 2, 2006) must disclose their participation in such transactions to the IRS Office of Tax Shelter Analysis under the reportable transactions rules of Treasury Regulations Section 1.6011-4 for each taxable year of their participation.   This must be done within 120 days. Moreover, participants in such transactions must retain a copy of all material documents and other records relating to such transactions.

Transactions involving swaps or forward contracts are currently reportable as “transactions of interest” to the IRS.  However, transactions involving call options are now “listed transactions” under those regulations.

The Notices are attached to this publication as Annex A and B.