IRS National Office Rules Adversely on Variable Prepaid Forward Contracts with Securities Loan
Author: Howard Barnet.
Source: Volume 19, Number 06, July/August 2006 , pp.31-36(6)
< previous article |next article > |return to table of contents
Abstract:
In late January the Internal Revenue Service formally released a highly anticipated technical advice memorandum on variable prepaid forward contracts (VPFCs). In it, the IRS National Office has taken the position on audit that the taxpayer, which had entered into several VPFCs with respect to shares of a publicly traded company, had sold such shares for tax purposes. TAM 200604033 relies primarily upon the fact (as determined by the IRS) that, as part of “one whole, continuous transaction,” the taxpayer also loaned the underlying shares to its counterparty under the VPFC. The risk arising from associated securities loans was well known, and not many transactions are as vulnerable as those in the TAM. However the fundamental pattern of the transaction at issue was not uncommon, and the issuance of the TAM—indeed, the earlier rumors of its impendency—has had a chilling effect on the use not only of VPFCs but also of related hedging transactions that are potentially subject to the same reasoning, such as equity collars. In the absence of further clarification from the IRS, the holder of a long position who engages in a derivative “short” transaction will wish to consider the tax risks very carefully before making a securities loan to the same (or a related) counterparty.Keywords:
Affiliations:
1: Carter Ledyard & Milburn LLP..