Tax News
CCA 20145102F: Three Years after CCA 201104031 Taxpayers Apparently Persist on Claiming Open Transaction on the “Short Sale” Unwind of a Variable Prepaid Forward
January 14, 2015
Administrative Actions
About 3 years ago we described a ruling, CCA 201104031, disagreeing with a strategy implemented by some taxpayers in closing variable prepaid forwards (VPFs). The strategy was based on a reading of PLR 200440005 and involved the borrowing of open market shares and delivering those shares at the VPF close (instead of delivering the originally pledged VPF shares). The taxpayer who delivers the borrowed shares claims that is taking a short position and that there should be no gain recognized when the VPF is closed (the original CCA coverage could be found here). In essence, the short position keeps the VPF open, thus, theoretically giving the taxpayer an indefinite open transaction as long as the taxpayer closes and re-delivers borrowed shares. At the same time the taxpayer locks in the gain on the VPF. This whole strategy, as stated above, faced the IRS’ disapproval. Apparently, taxpayers did not take heed from the CCA because in the very recent CCA 20145102F, the taxpayer did the same transaction and relied on the same old year 2004 ruling.

What did the IRS say? It said what one would expect it to say, i.e. that the taxpayer cannot rely on PLR 200440005 for support of its position. The rulings in PLR 200440005 failed to consider the economic substance of the transaction and that property was converted to cash for purposes of section 1001, and the ruling was withdrawn pursuant to the issuance of PLR 201109017. Moreover, the entire amount of cash paid to the taxpayer on the VPF should be recognized and included in the calculation of taxable gain under Section 1259. Presumably, this is not a transaction that is widespread in the industry, but hedge funds that are monetizing via VPFs and that might have dabbled in strategies for postponing their gain on the unwind of the VPF should look at this ruling here, and the old CCA here.
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Tags: section 1259, short sale, variable prepaid forward, VPF