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Tax News
Notice 2015-47 makes “basket options” a listed transaction
July 10, 2015
Administrative Actions
The IRS has decided to lay the hammer on “basket option” strategies utilized by some hedge funds to convert short term capital gain and ordinary income into long term capital gain. The strategy became notorious after an investigation by the U.S. Senate Permanent Subcommittee on Investigations into Renaissance's operations (original story could be found here). In the strategy, a hedge fund will enter into a contract with a third party, for example a bank, to receive a return based on the performance of a notional basket of referenced actively traded securities. The contract will be structured as an option with an expiration period of over a year. The hedge fund would typically hedge the risk on the basket option and would take the position that is not the tax owner of the underlying securities in the basket. After the contract expires, the hedge fund is paid a net amount based on the net gain of the securities in the basket during the option period.

The IRS has decided to classify this strategy as a tax shelter. It said that it will use various litigation approaches to combat the shelter, including challenge the tax ownership, or take the position that the “basket option” is not an option for tax purposes. Hedge funds engaged in transactions in effect on or after January 1, 2011, must disclose the transactions to the IRS for each taxable year in which they participated in the transactions.  In addition, lawyers and accountants who make a tax statement on or after January 1, 2011 with respect to transactions will have disclosure and list maintenance obligations under §§ 6111 and 6112.

The Notice could be found here.
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Tags: Notice 2015-47, basket options, hedge funds