Recently, the Internal Revenue Service (“IRS”) released proposed regulations on the treatment of certain basket contracts, potentially classifying them as listed transactions. The term “basket” is defined by the proposed regulations under 1.6011-16(b)(6) as “a notional basket of assets that may include: actively traded personal property as defined under § 1.1092(d)-1(a); interests in entities that trade securities, commodities, foreign currency, digital assets as defined in section 6045(g)(3)(D), or similar property; securities; commodities; foreign currency; digital assets as defined in section 6045(g)(3)(D); or similar property (or positions in such property).”
The proposed regulations would expand upon IRS Notices 2015-73 & 2015-74, and as a result, basket contracts may now potentially be considered listed transactions.
Why is this important? Listed transactions are generally designated by the IRS as “reportable transactions.” They are considered tax avoidance transactions that every taxpayer is required to disclose to the IRS.
A basket contract would fall under the proposed regulations §1.6011-16(c) if certain conditions are met. The five conditions that need to be met under the proposed regulations include:
- The taxpayer and its counterparty enter into a contract to receive a return based on performance. These contracts include forwards, notional principal contracts, options, as well as other derivative contracts.
- The contract has a stated term of greater than 1 year or if the contract overlaps two of the taxpayer’s taxable years.
- The taxpayer or their designee has exercised discretion to change (directly or indirectly through its counterparty) the assets referenced by the basket or trading algorithm.
- The taxpayer’s taxable years on or after January 1, 2011 reflect a tax benefit in regard to the transaction under the proposed regulations (§ 1.6011-16(b)(5)).
- The transactions do not fall into one of the exceptions provided in proposed regulations § 1.6011-16(d).
§ 1.6011-16(d) provides a few exceptions as to whether a basket contract is considered a listed transaction. These exceptions are met if the contract is traded on a national exchange or domestic board of trade that is regulated by the Securities and Exchange Commission or Commodity Futures Trading Commission, respectively. The next exception is satisfied if the contracts are treated as a “contingent payment debt instrument under § 1.1275-4 (including a short-term contingent payment debt instrument) or a variable rate debt instrument under § 1.1275-5.” Lastly, the final exception applies to the counterparty. This can be met in one of two ways:
- The taxpayer certifies in writing that none of their taxable income on their tax returns since 2011 has or will reflect a tax benefit under the proposed regulations.
- The counterparty has established, via a valid withholding form (W-8), that the taxpayer is a non-resident alien or foreign corporation that is not engaged in a U.S. trade or business within the United States.
Depending on your trading strategy, you may meet one of these exceptions under the proposed regulations.
At Withum, our team of dedicated tax professionals serves a wide range of financial service vehicles. To learn more about these proposed regulations, please reach out to your engagement partner or team member.
Author: Matthew Magliano, Principal | [email protected]
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