IRS Notices on Basket Option Contracts

1 Jan

 

[DRAFT ONLY] The Treasury Department issued three Notices in 2015 concerning a structured financial transaction (a “basket option contract”), in which a taxpayer attempts to defer income recognition and convert short-term capital gain and ordinary income to long-term capital gain using a contract denominated as an option contract. IRS Notices 2015-47, 2015-73 and 2015-74.

 

The Treasury Department and the Internal Revenue Service believe that a basket option contract is a tax avoidance transaction. Transactions in effect on or after January 1, 2011, that are the same as, or substantially similar to, a basket option contract, are identified as “listed transactions” for purposes of § 1.6011 -4(b)(2) and §§ 6111 and 6112 as of October 21, 2015.

§ 1.6011-4 Requirement of statement disclosing participation in certain transactions by taxpayers.
(a)In general. Every taxpayer that has participated, as described in paragraph (c)(3) of this section, in a reportable transaction within the meaning of paragraph (b) of this section and who is required to file a tax return must file within the time prescribed in paragraph (e) of this section a disclosure statement in the form prescribed by paragraph (d) of this section. The fact that a transaction is a reportable transaction shall not affect the legal determination of whether the taxpayer’s treatment of the transaction is proper.

(b)Reportable transactions –

(1)In general. A reportable transaction is a transaction described in any of the paragraphs (b)(2) through (7) of this section. The term transaction includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of a plan.

(2)Listed transactions. A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.

(3)Confidential transactions –

(i)In general. A confidential transaction is a transaction that is offered to a taxpayer under conditions of confidentiality and for which the taxpayer has paid an advisor a minimum fee.

(ii)Conditions of confidentiality. A transaction is considered to be offered to a taxpayer under conditions of confidentiality if the advisor who is paid the minimum fee places a limitation on disclosure by the taxpayer of the tax treatment or tax structure of the transaction and the limitation on disclosure protects the confidentiality of that advisor’s tax strategies. A transaction is treated as confidential even if the conditions of confidentiality are not legally binding on the taxpayer. A claim that a transaction is proprietary or exclusive is not treated as a limitation on disclosure if the advisor confirms to the taxpayer that there is no limitation on disclosure of the tax treatment or tax structure of the transaction.

(iii)Minimum fee. For purposes of this paragraph (b)(3), the minimum fee is –

(A) $250,000 for a transaction if the taxpayer is a corporation;

(B) $50,000 for all other transactions unless the taxpayer is a partnership or trust, all of the owners or beneficiaries of which are corporations (looking through any partners or beneficiaries that are themselves partnerships or trusts), in which case the minimum fee is $250,000.

(iv)Determination of minimum fee. For purposes of this paragraph (b)(3), in determining the minimum fee, all fees for a tax strategy or for services for advice (whether or not tax advice) or for the implementation of a transaction are taken into account. Fees include consideration in whatever form paid, whether in cash or in kind, for services to analyze the transaction (whether or not related to the tax consequences of the transaction), for services to implement the transaction, for services to document the transaction, and for services to prepare tax returns to the extent return preparation fees are unreasonable in light of the facts and circumstances. For purposes of this paragraph (b)(3), a taxpayer also is treated as paying fees to an advisor if the taxpayer knows or should know that the amount it pays will be paid indirectly to the advisor, such as through a referral fee or fee-sharing arrangement. A fee does not include amounts paid to a person, including an advisor, in that person’s capacity as a party to the transaction. For example, a fee does not include reasonable charges for the use of capital or the sale or use of property. The IRS will scrutinize carefully all of the facts and circumstances in determining whether consideration received in connection with a confidential transaction constitutes fees.

(v)Related parties. For purposes of this paragraph (b)(3), persons who bear a relationship to each other as described in section 267(b) or 707(b) will be treated as the same person.

(4)Transactions with contractual protection –

(i)In general. A transaction with contractual protection is a transaction for which the taxpayer or a related party (as described in section 267(b) or 707(b)) has the right to a full or partial refund of fees (as described in paragraph (b)(4)(ii) of this section) if all or part of the intended tax consequences from the transaction are not sustained. A transaction with contractual protection also is a transaction for which fees (as described in paragraph (b)(4)(ii) of this section) are contingent on the taxpayer’s realization of tax benefits from the transaction. All the facts and circumstances relating to the transaction will be considered when determining whether a fee is refundable or contingent, including the right to reimbursements of amounts that the parties to the transaction have not designated as fees or any agreement to provide services without reasonable compensation.

(ii)Fees. Paragraph (b)(4)(i) of this section only applies with respect to fees paid by or on behalf of the taxpayer or a related party to any person who makes or provides a statement, oral or written, to the taxpayer or related party (or for whose benefit a statement is made or provided to the taxpayer or related party) as to the potential tax consequences that may result from the transaction.

(iii)Exceptions –

(A)Termination of transaction. A transaction is not considered to have contractual protection solely because a party to the transaction has the right to terminate the transaction upon the happening of an event affecting the taxation of one or more parties to the transaction.

(B)Previously reported transaction. If a person makes or provides a statement to a taxpayer as to the potential tax consequences that may result from a transaction only after the taxpayer has entered into the transaction and reported the consequences of the transaction on a filed tax return, and the person has not previously received fees from the taxpayer relating to the transaction, then any refundable or contingent fees are not taken into account in determining whether the transaction has contractual protection. This paragraph (b)(4) does not provide any substantive rules regarding when a person may charge refundable or contingent fees with respect to a transaction. See Circular 230, 31 CFR part 10, for the regulations governing practice before the IRS.

(5)Loss transactions –

(i)In general. A loss transaction is any transaction resulting in the taxpayer claiming a loss under section 165 of at least –

(A) $10 million in any single taxable year or $20 million in any combination of taxable years for corporations;

(B) $10 million in any single taxable year or $20 million in any combination of taxable years for partnerships that have only corporations as partners (looking through any partners that are themselves partnerships), whether or not any losses flow through to one or more partners; or

(C) $2 million in any single taxable year or $4 million in any combination of taxable years for all other partnerships, whether or not any losses flow through to one or more partners;

(D) $2 million in any single taxable year or $4 million in any combination of taxable years for individuals, S corporations, or trusts, whether or not any losses flow through to one or more shareholders or beneficiaries; or

(E) $50,000 in any single taxable year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership, if the loss arises with respect to a section 988 transaction (as defined in section 988(c)(1) relating to foreign currency transactions).

(ii)Cumulative losses. In determining whether a transaction results in a taxpayer claiming a loss that meets the threshold amounts over a combination of taxable years as described in paragraph (b)(5)(i) of this section, only losses claimed in the taxable year that the transaction is entered into and the five succeeding taxable years are combined.

(iii)Section 165 loss – (A) For purposes of this section, in determining the thresholds in paragraph (b)(5)(i) of this section, the amount of a section 165 loss is adjusted for any salvage value and for any insurance or other compensation received. See § 1.165-1(c)(4). However, a section 165 loss does not take into account offsetting gains, or other income or limitations. For example, a section 165 loss does not take into account the limitation in section 165(d) (relating to wagering losses) or the limitations in sections 165(f), 1211, and 1212 (relating to capital losses). The full amount of a section 165 loss is taken into account for the year in which the loss is sustained, regardless of whether all or part of the loss enters into the computation of a net operating loss under section 172 or a net capital loss under section 1212 that is a carryback or carryover to another year. A section 165 loss does not include any portion of a loss, attributable to a capital loss carryback or carryover from another year, that is treated as a deemed capital loss under section 1212.

(B) For purposes of this section, a section 165 loss includes an amount deductible pursuant to a provision that treats a transaction as a sale or other disposition, or otherwise results in a deduction under section 165. A section 165 loss includes, for example, a loss resulting from a sale or exchange of a partnership interest under section 741 and a loss resulting from a section 988 transaction.

(6)Transactions of interest. A transaction of interest is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest.

(7) [Reserved]

(8)Exceptions –

(i)In general. A transaction will not be considered a reportable transaction, or will be excluded from any individual category of reportable transaction under paragraphs (b)(3) through (7) of this section, if the Commissioner makes a determination by published guidance that the transaction is not subject to the reporting requirements of this section. The Commissioner may make a determination by individual letter ruling under paragraph (f) of this section that an individual letter ruling request on a specific transaction satisfies the reporting requirements of this section with regard to that transaction for the taxpayer who requests the individual letter ruling.

(ii)Special rule for RICs. For purposes of this section, a regulated investment company (RIC) as defined in section 851 or an investment vehicle that is owned 95 percent or more by one or more RICs at all times during the course of the transaction is not required to disclose a transaction that is described in any of paragraphs (b)(3) through (5) and (b)(7) of this section unless the transaction is also a listed transaction or a transaction of interest.

(c)Definitions. For purposes of this section, the following definitions apply:

(1)Taxpayer. The term taxpayer means any person described in section 7701(a)(1), including S corporations. Except as otherwise specifically provided in this section, the term taxpayer also includes an affiliated group of corporations that joins in the filing of a consolidated return under section 1501.

(2)Corporation. When used specifically in this section, the term corporation means an entity that is required to file a return for a taxable year on any 1120 series form, or successor form, excluding S corporations.

(3)Participation –

(i)In general –

(A)Listed transactions. A taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance that lists the transaction under paragraph (b)(2) of this section. A taxpayer also has participated in a listed transaction if the taxpayer knows or has reason to know that the taxpayer’s tax benefits are derived directly or indirectly from tax consequences or a tax strategy described in published guidance that lists a transaction under paragraph (b)(2) of this section. Published guidance may identify other types or classes of persons that will be treated as participants in a listed transaction. Published guidance also may identify types or classes of persons that will not be treated as participants in a listed transaction.

(B)Confidential transactions. A taxpayer has participated in a confidential transaction if the taxpayer’s tax return reflects a tax benefit from the transaction and the taxpayer’s disclosure of the tax treatment or tax structure of the transaction is limited in the manner described in paragraph (b)(3) of this section. If a partnership’s, S corporation’s or trust’s disclosure is limited, and the partner’s, shareholder’s, or beneficiary’s disclosure is not limited, then the partnership, S corporation, or trust, and not the partner, shareholder, or beneficiary, has participated in the confidential transaction.

(C)Transactions with contractual protection. A taxpayer has participated in a transaction with contractual protection if the taxpayer’s tax return reflects a tax benefit from the transaction and, as described in paragraph (b)(4) of this section, the taxpayer has the right to the full or partial refund of fees or the fees are contingent. If a partnership, S corporation, or trust has the right to a full or partial refund of fees or has a contingent fee arrangement, and the partner, shareholder, or beneficiary does not individually have the right to the refund of fees or a contingent fee arrangement, then the partnership, S corporation, or trust, and not the partner, shareholder, or beneficiary, has participated in the transaction with contractual protection.

(D)Loss transactions. A taxpayer has participated in a loss transaction if the taxpayer’s tax return reflects a section 165 loss and the amount of the section 165 loss equals or exceeds the threshold amount applicable to the taxpayer as described in paragraph (b)(5)(i) of this section. If a taxpayer is a partner in a partnership, shareholder in an S corporation, or beneficiary of a trust and a section 165 loss as described in paragraph (b)(5) of this section flows through the entity to the taxpayer (disregarding netting at the entity level), the taxpayer has participated in a loss transaction if the taxpayer’s tax return reflects a section 165 loss and the amount of the section 165 loss that flows through to the taxpayer equals or exceeds the threshold amounts applicable to the taxpayer as described in paragraph (b)(5)(i) of this section. For this purpose, a tax return is deemed to reflect the full amount of a section 165 loss described in paragraph (b)(5) of this section allocable to the taxpayer under this paragraph (c)(3)(i)(D), regardless of whether all or part of the loss enters into the computation of a net operating loss under section 172 or net capital loss under section 1212 that the taxpayer may carry back or carry over to another year.

(E)Transactions of interest. A taxpayer has participated in a transaction of interest if the taxpayer is one of the types or classes of persons identified as participants in the transaction in the published guidance describing the transaction of interest.

(F) [Reserved]

(G)Shareholders of foreign corporations –

(1)In general. A reporting shareholder of a foreign corporation participates in a transaction described in paragraphs (b)(2) through (5) and (b)(7) of this section if the foreign corporation would be considered to participate in the transaction under the rules of this paragraph (c)(3) if it were a domestic corporation filing a tax return that reflects the items from the transaction. A reporting shareholder of a foreign corporation participates in a transaction described in paragraph (b)(6) of this section only if the published guidance identifying the transaction includes the reporting shareholder among the types or classes of persons identified as participants. A reporting shareholder (and any successor in interest) is considered to participate in a transaction under this paragraph (c)(3)(i)(G) only for its first taxable year with or within which ends the first taxable year of the foreign corporation in which the foreign corporation participates in the transaction, and for the reporting shareholder’s five succeeding taxable years.

(2)Reporting shareholder. The term reporting shareholder means a United States shareholder (as defined in section 951(b)) in a controlled foreign corporation (as defined in section 957) or a 10 percent shareholder (by vote or value) of a qualified electing fund (as defined in section 1295).

(ii)Examples. The following examples illustrate the provisions of paragraph (c)(3)(i) of this section:

Example 1.
Notice 2003-55 (2003-2 CB 395), which modified and superseded Notice 95-53 (1995-2 CB 334) (see § 601.601(d)(2) of this chapter), describes a lease stripping transaction in which one party (the transferor) assigns the right to receive future payments under a lease of tangible property and treats the amount realized from the assignment as its current income. The transferor later transfers the property subject to the lease in a transaction intended to qualify as a transferred basis transaction, for example, a transaction described in section 351. The transferee corporation claims the deductions associated with the high basis property subject to the lease. The transferor’s and transferee corporation’s tax returns reflect tax positions described in Notice 2003-55. Therefore, the transferor and transferee corporation have participated in the listed transaction. In the section 351 transaction, the transferor will have received stock with low value and high basis from the transferee corporation. If the transferor subsequently transfers the high basis/low value stock to a taxpayer in another transaction intended to qualify as a transferred basis transaction and the taxpayer uses the stock to generate a loss, and if the taxpayer knows or has reason to know that the tax loss claimed was derived indirectly from the lease stripping transaction, then the taxpayer has participated in the listed transaction. Accordingly, the taxpayer must disclose the transaction and the manner of the taxpayer’s participation in the transaction under the rules of this section. For purposes of this example, if a bank lends money to the transferor, transferee corporation, or taxpayer for use in their transactions, the bank has not participated in the listed transaction because the bank’s tax return does not reflect tax consequences or a tax strategy described in the listing notice (nor does the bank’s tax return reflect a tax benefit derived from tax consequences or a tax strategy described in the listing notice) nor is the bank described as a participant in the listing notice.
Example 2.
XYZ is a limited liability company treated as a partnership for tax purposes. X, Y, and Z are members of XYZ. X is an individual, Y is an S corporation, and Z is a partnership. XYZ enters into a confidential transaction under paragraph (b)(3) of this section. XYZ and X are bound by the confidentiality agreement, but Y and Z are not bound by the agreement. As a result of the transaction, XYZ, X, Y, and Z all reflect a tax benefit on their tax returns. Because XYZ’s and X’s disclosure of the tax treatment and tax structure are limited in the manner described in paragraph (b)(3) of this section and their tax returns reflect a tax benefit from the transaction, both XYZ and X have participated in the confidential transaction. Neither Y nor Z has participated in the confidential transaction because they are not subject to the confidentiality agreement.
Example 3.
P, a corporation, has an 80% partnership interest in PS, and S, an individual, has a 20% partnership interest in PS. P, S, and PS are calendar year taxpayers. In 2006, PS enters into a transaction and incurs a section 165 loss (that does not meet any of the exceptions to a section 165 loss identified in published guidance) of $12 million and offsetting gain of $3 million. On PS’ 2006 tax return, PS includes the section 165 loss and the corresponding gain. PS must disclose the transaction under this section because PS’ section 165 loss of $12 million is equal to or greater than $2 million. P is allocated $9.6 million of the section 165 loss and $2.4 million of the offsetting gain. P does not have to disclose the transaction under this section because P’s section 165 loss of $9.6 million is not equal to or greater than $10 million. S is allocated $2.4 million of the section 165 loss and $600,000 of the offsetting gain. S must disclose the transaction under this section because S’s section 165 loss of $2.4 million is equal to or greater than $2 million.
(4)Substantially similar. The term substantially similar includes any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy. Receipt of an opinion regarding the tax consequences of the transaction is not relevant to the determination of whether the transaction is the same as or substantially similar to another transaction. Further, the term substantially similar must be broadly construed in favor of disclosure. For example, a transaction may be substantially similar to a listed transaction even though it involves different entities or uses different Internal Revenue Code provisions. (See for example, Notice 2003-54 (2003-2 CB 363), describing a transaction substantially similar to the transactions in Notice 2002-50 (2002-2 CB 98), and Notice 2002-65 (2002-2 CB 690).) The following examples illustrate situations where a transaction is the same as or substantially similar to a listed transaction under paragraph (b)(2) of this section. (Such transactions may also be reportable transactions under paragraphs (b)(3) through (7) of this section.) See § 601.601(d)(2)(ii)(b) of this chapter. The following examples illustrate the provisions of this paragraph (c)(4):

Example 1.
Notice 2000-44 (2000-2 CB 255) (see § 601.601(d)(2)(ii)(b) of this chapter), sets forth a listed transaction involving offsetting options transferred to a partnership where the taxpayer claims basis in the partnership for the cost of the purchased options but does not adjust basis under section 752 as a result of the partnership’s assumption of the taxpayer’s obligation with respect to the options. Transactions using short sales, futures, derivatives or any other type of offsetting obligations to inflate basis in a partnership interest would be the same as or substantially similar to the transaction described in Notice 2000-44. Moreover, use of the inflated basis in the partnership interest to diminish gain that would otherwise be recognized on the transfer of a partnership asset would also be the same as or substantially similar to the transaction described in Notice 2000-44. See § 601.601(d)(2)(ii)(b).
Example 2.
Notice 2001-16 (2001-1 CB 730) (see § 601.601(d)(2)(ii)(b) of this chapter), sets forth a listed transaction involving a seller (X) who desires to sell stock of a corporation (T), an intermediary corporation (M), and a buyer (Y) who desires to purchase the assets (and not the stock) of T. M agrees to facilitate the sale to prevent the recognition of the gain that T would otherwise report. Notice 2001-16 describes M as a member of a consolidated group that has a loss within the group or as a party not subject to tax. Transactions utilizing different intermediaries to prevent the recognition of gain would be the same as or substantially similar to the transaction described in Notice 2001-16. An example is a transaction in which M is a corporation that does not file a consolidated return but which buys T stock, liquidates T, sells assets of T to Y, and offsets the gain on the sale of those assets with currently generated losses. See § 601.601(d)(2)(ii)(b).
(5)Tax. The term tax means Federal income tax.

(6)Tax benefit. A tax benefit includes deductions, exclusions from gross income, nonrecognition of gain, tax credits, adjustments (or the absence of adjustments) to the basis of property, status as an entity exempt from Federal income taxation, and any other tax consequences that may reduce a taxpayer’s Federal income tax liability by affecting the amount, timing, character, or source of any item of income, gain, expense, loss, or credit.

(7)Tax return. The term tax return means a Federal income tax return and a Federal information return.

(8)Tax treatment. The tax treatment of a transaction is the purported or claimed Federal income tax treatment of the transaction.

(9)Tax structure. The tax structure of a transaction is any fact that may be relevant to understanding the purported or claimed Federal income tax treatment of the transaction.

(d)Form and content of disclosure statement. A taxpayer required to file a disclosure statement under this section must file a completed Form 8886, “Reportable Transaction Disclosure Statement” (or a successor form), in accordance with this paragraph (d) and the instructions to the form. The Form 8886 (or a successor form) is the disclosure statement required under this section. The form must be attached to the appropriate tax return(s) as provided in paragraph (e) of this section. If a copy of a disclosure statement is required to be sent to the Office of Tax Shelter Analysis (OTSA) under paragraph (e) of this section, it must be sent in accordance with the instructions to the form. To be considered complete, the information provided on the form must describe the expected tax treatment and all potential tax benefits expected to result from the transaction, describe any tax result protection (as defined in § 301.6111-3(c)(12) of this chapter) with respect to the transaction, and identify and describe the transaction in sufficient detail for the IRS to be able to understand the tax structure of the reportable transaction and the identity of all parties involved in the transaction. An incomplete Form 8886 (or a successor form) containing a statement that information will be provided upon request is not considered a complete disclosure statement. If the form is not completed in accordance with the provisions in this paragraph (d) and the instructions to the form, the taxpayer will not be considered to have complied with the disclosure requirements of this section. If a taxpayer receives one or more reportable transaction numbers for a reportable transaction, the taxpayer must include the reportable transaction number(s) on the Form 8886 (or a successor form). See § 301.6111-3(d)(2) of this chapter.

(e)Time of providing disclosure –

(1)In general. The disclosure statement for a reportable transaction must be attached to the taxpayer’s tax return for each taxable year for which a taxpayer participates in a reportable transaction. In addition, a disclosure statement for a reportable transaction must be attached to each amended return that reflects a taxpayer’s participation in a reportable transaction. A copy of the disclosure statement must be sent to OTSA at the same time that any disclosure statement is first filed by the taxpayer pertaining to a particular reportable transaction. If a reportable transaction results in a loss which is carried back to a prior year, the disclosure statement for the reportable transaction must be attached to the taxpayer’s application for tentative refund or amended tax return for that prior year. In the case of a taxpayer that is a partnership, an S corporation, or a trust, the disclosure statement for a reportable transaction must be attached to the partnership, S corporation, or trust’s tax return for each taxable year in which the partnership, S corporation, or trust participates in the transaction under the rules of paragraph (c)(3)(i) of this section. If a taxpayer who is a partner in a partnership, a shareholder in an S corporation, or a beneficiary of a trust receives a timely Schedule K-1 less than 10 calendar days before the due date of the taxpayer’s return (including extensions) and, based on receipt of the timely Schedule K-1, the taxpayer determines that the taxpayer participated in a reportable transaction within the meaning of paragraph (c)(3) of this section, the disclosure statement will not be considered late if the taxpayer discloses the reportable transaction by filing a disclosure statement with OTSA within 60 calendar days after the due date of the taxpayer’s return (including extensions). The Commissioner in his discretion may issue in published guidance other provisions for disclosure under § 1.6011-4.

(2)Special rules –

(i)Listed transactions and transactions of interest. In general, if a transaction becomes a listed transaction or a transaction of interest after the filing of a taxpayer’s tax return (including an amended return) reflecting the taxpayer’s participation in the listed transaction or transaction of interest and before the end of the period of limitations for assessment of tax for any taxable year in which the taxpayer participated in the listed transaction or transaction of interest, then a disclosure statement must be filed, regardless of whether the taxpayer participated in the transaction in the year the transaction became a listed transaction or a transaction of interest, with OTSA within 90 calendar days after the date on which the transaction became a listed transaction or a transaction of interest. The Commissioner also may determine the time for disclosure of listed transactions and transactions of interest in the published guidance identifying the transaction.

(ii)Loss transactions. If a transaction becomes a loss transaction because the losses equal or exceed the threshold amounts as described in paragraph (b)(5)(i) of this section, a disclosure statement must be filed as an attachment to the taxpayer’s tax return for the first taxable year in which the threshold amount is reached and to any subsequent tax return that reflects any amount of section 165 loss from the transaction.

(3)Multiple disclosures. The taxpayer must disclose the transaction in the time and manner provided for under the provisions of this section regardless of whether the taxpayer also plans to disclose the transaction under other published guidance, for example, § 1.6662-3(c)(2).

(4)Example. The following example illustrates the application of this paragraph (e):

Example.
In January of 2008, F, a calendar year taxpayer, enters into a transaction that at the time is not a listed transaction and is not a transaction described in any of the paragraphs (b)(3) through (7) of this section. All the tax benefits from the transaction are reported on F’s 2008 tax return filed timely in April 2009. On May 2, 2011, the IRS publishes a notice identifying the transaction as a listed transaction described in paragraph (b)(2) of this section. Upon issuance of the May 2, 2011 notice, the transaction becomes a reportable transaction described in paragraph (b) of this section. The period of limitations on assessment for F’s 2008 taxable year is still open. F is required to file Form 8886 for the transaction with OTSA within 90 calendar days after May 2, 2011.
(f)Rulings and protective disclosures –

(1)Rulings. If a taxpayer requests a ruling on the merits of a specific transaction on or before the date that disclosure would otherwise be required under this section, and receives a favorable ruling as to the transaction, the disclosure rules under this section will be deemed to have been satisfied by that taxpayer with regard to that transaction, so long as the request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed under this section. If a taxpayer requests a ruling as to whether a specific transaction is a reportable transaction on or before the date that disclosure would otherwise be required under this section, the Commissioner in his discretion may determine that the submission satisfies the disclosure rules under this section for the taxpayer requesting the ruling for that transaction if the request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed under this section. The potential obligation of the taxpayer to disclose the transaction under this section will not be suspended during the period that the ruling request is pending.

(2)Protective disclosures. If a taxpayer is uncertain whether a transaction must be disclosed under this section, the taxpayer may disclose the transaction in accordance with the requirements of this section and comply with all the provisions of this section, and indicate on the disclosure statement that the disclosure statement is being filed on a protective basis. The IRS will not treat disclosure statements filed on a protective basis any differently than other disclosure statements filed under this section. For a protective disclosure to be effective, the taxpayer must comply with these disclosure regulations by providing to the IRS all information requested by the IRS under this section.

(g)Retention of documents.

(1) In accordance with the instructions to Form 8886 (or a successor form), the taxpayer must retain a copy of all documents and other records related to a transaction subject to disclosure under this section that are material to an understanding of the tax treatment or tax structure of the transaction. The documents must be retained until the expiration of the statute of limitations applicable to the final taxable year for which disclosure of the transaction was required under this section. (This document retention requirement is in addition to any document retention requirements that section 6001 generally imposes on the taxpayer.) The documents may include the following:

(i) Marketing materials related to the transaction;

(ii) Written analyses used in decision-making related to the transaction;

(iii) Correspondence and agreements between the taxpayer and any advisor, lender, or other party to the reportable transaction that relate to the transaction;

(iv) Documents discussing, referring to, or demonstrating the purported or claimed tax benefits arising from the reportable transaction; and documents, if any, referring to the business purposes for the reportable transaction.

(2) A taxpayer is not required to retain earlier drafts of a document if the taxpayer retains a copy of the final document (or, if there is no final document, the most recent draft of the document) and the final document (or most recent draft) contains all the information in the earlier drafts of the document that is material to an understanding of the purported tax treatment or tax structure of the transaction.

(h)Effective/applicability date –

(1)In general. This section applies to transactions entered into on or after August 3, 2007. However, this section applies to transactions of interest entered into on or after November 2, 2006. Paragraph (f)(1) of this section applies to ruling requests received on or after November 1, 2006. Otherwise, the rules that apply with respect to transactions entered into before August 3, 2007, are contained in § 1.6011-4 in effect prior to August 3, 2007 (see 26 CFR part 1 revised as of April 1, 2007).

(2) [Reserved]

[T.D. 9350, 72 FR 43149, Aug. 3, 2007, as amended at 75 FR 26061, May 11, 2010]

 

Notice 2015-47 also alerted taxpayers about responsibilities from involvement with these transactions.

 

Commenters complained that difficulty in similar transactions could cause taxpayers to file disclosure unnecessarily.

Notice 2015-73 revokes the earlier Notice, and provides additional details on the types of transactions intended. The new Notice describes the tax benefits that identify the transaction as a listed transaction, i.e., a deferral of income into a later taxable year, or a conversion of ordinary income or short-term capital gain or loss into long-term capital gain or loss.

The Service may also challenge these transactions under other tax provisions and general tax principles.

In a basket option contract, a taxpayer (“T”) enters into a contract denominated as an option with a counterparty (“C”), to receive a return based on the performance of a notional basket of actively traded personal property (the “reference basket”). T either determines the assets that comprise the reference basket, or designs or selects a trading algorithm that determines the assets.

While the basket option contract remains open, T has discretion to change the assets in the reference basket or the trading algorithm, or to request that C do so. C may reject certain changes, but generally accepts nearly all changes requested by T.

T typically makes an upfront cash payment to C of between 10 and 40 percent of the value of the assets in the reference basket. To manage risk, C typically acquires substantially all of the assets in the reference basket at the inception of the contract, and acquires and disposes of assets during the term of the contract when T changes the assets in the reference basket or the trading algorithm provides for such changes.

C generally supplies the additional cash required to purchase the assets in the reference basket.

The assets in the reference basket would typically generate ordinary income if held directly by T, and short-term gains and losses if purchases and sales of the assets were carried out directly by T. The basket option contract has a stated term of more than one year but contains provisions that in effect allow either party to terminate the contract at any time during the stated contract term with proper notice. The amount that T receives upon settlement of the basket option contract is based on the performance of the assets in the reference basket, plus the upfront payment. The net basket gain or loss includes net changes in the values of the assets, together with periodic income, reduced by C’s fee.

The basket option contract terminates if the net basket loss reaches the amount of the upfront payment, giving T a cash settlement amount of zero. The contract may permit or require T to provide additional collateral or otherwise reduce risk if a specified level of risk is reached. The typically contains other safeguards to minimize the economic risk to C.

C holds the rights associated with legal title to the assets and positions in the reference basket, including voting rights and the right to pledge, transfer, or otherwise use the assets in the basket without notice to T.

T takes the position that T’s short-term trading gains and interest, dividend, and other ordinary periodic income from the performance of the reference basket are deferred until the basket option contract terminates. If the contract is held for more than one year, the entire gain is expected to be treated as long-term capital gain.

The Treasury Department and the Service are concerned that taxpayers are using a basket option contract to inappropriately defer income recognition or convert ordinary income or short-term capital gain into long-term capital gain. The government believes taxpayers are also mischaracterizing a transaction as an option to avoid application of Code section 1260. Section 1260 []

Therefore, Treasury and the Service identify transactions in the two Notices as listed transactions. The Service may assert one or more arguments to challenge the parties’ tax characterization, including: (1) that C, in substance, holds the assets in the reference basket as an agent of T and that T is the beneficial owner of the assets for tax purposes; (2) that the basket option contract is not an option for tax purposes; (3) that changes to the assets in the reference basket during the year materially modify the basket option contract and result in taxable dispositions of the contract under Code section 1001 throughout the term of the contract; and (4) that T actually owns separate contractual rights with respect to each asset in the reference basket, such that each change to the assets in the basket results in a taxable disposition of a contractual right under section 1001 with respect to the asset affected by the change. The Service may assert other arguments supporting the conclusion that T is the beneficial owner of the assets in the reference basket for tax purposes.

Notice 2015-73 specifies minimum conditions for a transaction to be treated as a basket option contract. A transaction is the same as, or substantially similar to, a basket option contract, only if:

(1) T enters into a transaction with C that is denominated as an option contract;

(2) T receives a return based on the performance of the reference basket;

(3) substantially all of the assets in the reference basket primarily consist of actively traded personal property as defined under Treas. Reg. § 1.1092(d)-1(a); Actively traded personal property includes any personal property for which there is an established financial market.

(4) the contract is not fully settled at intervals of one year or less;

(5) T or T’s designee has exercised discretion to change (either directly or through a request to C) the assets in the reference basket or the trading algorithm; and

(6) T’s tax return for a taxable year ending on or after January 1, 2011 reflects a tax benefit described above.

Any reference to T having the right to request changes to the assets in the reference basket or the trading algorithm includes T’s designee, defined as any person who is: (1) T’s agent under principles of agency law; (2) compensated by T for suggesting, requesting, or determining changes in the assets in the reference basket or the trading algorithm; or (3) selected by T to suggest or determine such changes.

A person will not be treated as compensated or selected by T as a result of: (1) the person’s position as an investment advisor or employee of an entity, such as a mutual fund, when the entity’s publicly offered securities are included in the reference basket; or (2) the person’s use of, or the person’s authority to suggest or determine changes in the assets included in, (a) a widely used and publicly quoted index that is based on objective financial information, or (b) an index that tracks a broad market or a market segment.

T will not be treated as having discretion to change the assets in the reference basket or the trading algorithm, if the changes are made according to objective operations that are disclosed at the inception of the transaction (the rules), and T does not have the right to amend the rules, or the assets or trading algorithm selected thereunder.

T will not be treated as having authority to amend the rules, solely because T has the authority to: (1) exercise routine judgment in the administration of the rules, not including amendments designed to improve the financial performance of the reference basket; (2) correct errors in rules implementation; or (3) respond to an unanticipated event outside of T’s control, such as a merger, insolvency, regulatory compliance requirement, or force majeure.

A transaction is not the same as, or substantially similar to, a basket option contract, if: (1) the contract is publicly traded, as defined; or 2) the contract is treated as a contingent payment debt instrument under § 1.1275-4 or a variable rate debt instrument under § 1.1275-5. With respect to C, a transaction is not the same as, or substantially similar to, a basket option contract, if: (1) T represents to C in writing under penalties of perjury that T’s tax return will not reflect a tax benefit described above, in any taxable year ending on or after January 1, 2011, or (2) C has established that T is a nonresident alien or foreign corporation, not engaged in a U.S. business, by obtaining a withholding certificate from the beneficial owner of the payments under the basket option contract, or, in the case of payments made outside of the United States on offshore obligations, by obtaining documentary evidence as described in Treas. Reg. §1.1441 -1(c)(17).
The terms documentary evidence or other appropriate documentation refer to documentary evidence that may be provided for payments made outside the United States with respect to offshore obligations in accordance with § 1.6049-5(c)(1) or any other evidence that under the Code or regulations certifies or establishes the status of a payee or beneficial owner as a U.S. or foreign person. See §§ 1.1441-6(b)(2), (c)(3) and (4) (relating to treaty benefits), and 1.6049-5(c)(1) and (4) (relating to chapter 61 reporting). Also see § 1.1441-4(a)(3)(ii) regarding documentary evidence for notional principal contracts.

SECTION 3. RULES OF APPLICATION.01 Effective Date

 

Persons engaged in transactions in effect on or after January 1, 2011, must disclose the transactions as described in § 1.6011 -4 for each taxable year in which thetaxpayer participated in the transactions, provided that the period of limitations forassessment of tax had not ended on or before October 21, 2015.
Every taxpayer that has participated, as described in paragraph (c)(3) of this section, in a reportable transaction within the meaning of paragraph (b) of this section and who is required to file a tax return must file within the time prescribed in paragraph (e) of this section a disclosure statement in the form prescribed by paragraph (d) of this section. The fact that a transaction is a reportable transaction shall not affect the legal determination of whether the taxpayer’s treatment of the transaction is proper.

Material advisors whomake a tax statement on or after January 1, 2011, with respect to transactions in effecton or after January 1, 2011, have disclosure and list maintenance obligations under§§ 6111 and 6112. See §§ 301.6111 -3, 301.6112-1.

Independent of their classification as listed transactions, transactions that are thesame as, or substantially similar to, the transaction described in this notice may alreadybe subject to the requirements of §§ 6011, 6111, or 6112, or the regulations thereunder.

If a transaction is identified as a listed transaction under section 2.01 of this notice andas a transaction of interest in Notice 2015-74, the transaction is identified as a listed10transaction.

Persons satisfying the disclosure requirements for a listed transactionunder this notice are deemed to have satisfied the disclosure requirements under Notice2015-74..

03 Time for Disclosure For rules regarding the time for providing disclosure of a transaction described inthis notice, see § 1.6011 -4(e) and § 301.6111 -3(e). However, if, under § 1.6011 -4(e), ataxpayer is required to file a disclosure statement with respect to the listed transactiondescribed in this notice after October 21, 2015, and prior to January 19, 2016, thatdisclosure statement will be considered to be timely filed if the taxpayer alternativelyfiles the disclosure with the Office of Tax Shelter Analysis by January 19, 2016..04

Material Advisor Threshold AmountFor the threshold amounts necessary to become a material advisor to a listedtransaction, see § 301.6111 -3(b)(3)(i)(B).11.05

Penalties and Period of LimitationsPersons required to disclose these transactions under § 1.6011 -4 who fail to doso may be subject to the penalty under § 6707A.

(a) Imposition of penalty
Any person who fails to include on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay a penalty in the amount determined under subsection (b).

(b) Amount of penalty
(1) In general
Except as otherwise provided in this subsection, the amount of the penalty under subsection (a) with respect to any reportable transaction shall be 75 percent of the decrease in tax shown on the return as a result of such transaction (or which would have resulted from such transaction if such transaction were respected for Federal tax purposes).

(2) Maximum penaltyThe amount of the penalty under subsection (a) with respect to any reportable transaction shall not exceed—
(A) in the case of a listed transaction, $200,000 ($100,000 in the case of a natural person), or
(B) in the case of any other reportable transaction, $50,000 ($10,000 in the case of a natural person).
(3) Minimum penalty
The amount of the penalty under subsection (a) with respect to any transaction shall not be less than $10,000 ($5,000 in the case of a natural person).

(c) DefinitionsFor purposes of this section:
(1) Reportable transaction
The term “reportable transaction” means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion.

(2) Listed transaction
The term “listed transaction” means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.

(d) Authority to rescind penalty
(1) In generalThe Commissioner of Internal Revenue may rescind all or any portion of any penalty imposed by this section with respect to any violation if—
(A) the violation is with respect to a reportable transaction other than a listed transaction, and
(B) rescinding the penalty would promote compliance with the requirements of this title and effective tax administration.
(2) No judicial appeal
Notwithstanding any other provision of law, any determination under this subsection may not be reviewed in any judicial proceeding.

(3) RecordsIf a penalty is rescinded under paragraph (1), the Commissioner shall place in the file in the Office of the Commissioner the opinion of the Commissioner with respect to the determination, including—
(A) a statement of the facts and circumstances relating to the violation,
(B) the reasons for the rescission, and
(C) the amount of the penalty rescinded.
(e) Penalty reported to SECIn the case of a person—
(1) which is required to file periodic reports under section 13 or 15(d) of the Securities Exchange Act of 1934 or is required to be consolidated with another person for purposes of such reports, and
(2) which—
(A) is required to pay a penalty under this section with respect to a listed transaction,
(B) is required to pay a penalty under section 6662A with respect to any reportable transaction at a rate prescribed under section 6662A(c), or
(C) is required to pay a penalty under section 6662(h) with respect to any reportable transaction and would (but for section 6662A(e)(2)(B)) have been subject to penalty under section 6662A at a rate prescribed under section 6662A(c),
the requirement to pay such penalty shall be disclosed in such reports filed by such person for such periods as the Secretary shall specify. Failure to make a disclosure in accordance with the preceding sentence shall be treated as a failure to which the penalty under subsection (b)(2) applies.
(f) Coordination with other penalties
The penalty imposed by this section shall be in addition to any other penalty imposed by this title.

 

Persons required to disclose thesetransactions under § 6111 who fail to do so may be subject to the penalty under§ 6707(a).

Persons required to maintain lists of advisees under § 6112 who fail to do so(or who fail to provide such lists when requested by the Service) may be subject to thepenalty under § 6708(a). (a) Imposition of penalty
(1) In general
If any person who is required to maintain a list under section 6112(a) fails to make such list available upon written request to the Secretary in accordance with section 6112(b) within 20 business days after the date of such request, such person shall pay a penalty of $10,000 for each day of such failure after such 20th day.

(2) Reasonable cause exception
No penalty shall be imposed by paragraph (1) with respect to the failure on any day if such failure is due to reasonable cause.

(b) Penalty in addition to other penalties
The penalty imposed by this section shall be in addition to any other penalty provided by law.

In addition, the Service may impose other penalties on partiesinvolved in these transactions or substantially similar transactions, including theaccuracy-related penalty under §§ 6662 or 6662A.

Persons required to disclose thesetransactions under § 1.6011 -4 who fail to do so may be subject to an extended period oflimitations on assessment under § 6501 (c)(10).
(10) Listed transactionsIf a taxpayer fails to include on any return or statement for any taxable year any information with respect to a listed transaction (as defined in section 6707A(c)(2)) which is required under section 6011 to be included with such return or statement, the time for assessment of any tax imposed by this title with respect to such transaction shall not expire before the date which is 1 year after the earlier of—
(A) the date on which the Secretary is furnished the information so required, or
(B) the date that a material advisor meets the requirements of section 6112 with respect to a request by the Secretary under section 6112(b) relating to such transaction with respect to such taxpayer.

The Treasury Department and the Service recognize that some taxpayers may havefiled tax returns taking the position that they were entitled to the purported tax benefitsof the type of transaction described in this notice. These taxpayers should takeappropriate corrective action and ensure that their transactions are disclosed properly..

06 Requests for a Change in Method of Accounting(1) Background. Section 446(e) and § 1.446-1(e) provide that, except asotherwise provided, a taxpayer must secure the consent of the Commissioner beforechanging a method of accounting for federal income tax purposes.

Section 1.446-1(e)(3)(i) provides that, to obtain the Commissioner’s consent to an accounting methodchange, a taxpayer must file a Form 3115, Application for Change in AccountingMethod, during the taxable year in which the taxpayer desires to make the proposedchange.

Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe12administrative procedures setting forth the limitations, terms, and conditions deemednecessary to permit a taxpayer to obtain consent to change a method of accounting inaccordance with § 446(e).

Rev. Proc. 2015-13, 2015-5 I.R.B. 419, as clarified and modified by Rev. Proc.2015-33, 2015-24 I.R.B. 1067, provides the procedures for obtaining the consent of theCommissioner to change a method of accounting for federal income tax purposes.

Under the non-automatic change procedures of Rev. Proc. 2015-13, a taxpayergenerally must file a Form 3115 during the year of change. When a taxpayer computesits taxable income using a method of accounting that differs from the method ofaccounting used during the preceding taxable year, a § 481(a) adjustment is required toprevent the duplication or omission of taxable income. See § 1.446-1(e)(3)(ii).

Section 11.02 of Rev. Proc. 2015-13 states that the national office will deny anyForm 3115 requesting consent to make a change in method of accounting in anysituation in which the national office determines that permitting the requested change inmethod of accounting would not clearly reflect income or would otherwise not be in theinterest of sound tax administration. As part of this determination, the national office willconsider whether the change in method of accounting would clearly and directlyfrustrate compliance efforts of the Service in administering the income tax laws. Thenational office will consider all the facts and circumstances and exercise discretionunder §§ 446(e) and 481(c) in a manner that generally minimizes distortions of incomeacross taxable years, as well as on an annual basis.Rev. Rul. 90-38, 1990-1 C.B. 57, provides that, if a taxpayer uses an erroneousmethod of accounting for two or more consecutive taxable years, the taxpayer has13adopted a method of accounting. The ruling further provides that a taxpayer may not,without the Commissioner’s consent, retroactively change from an erroneous to apermissible method of accounting by filing an amended return. See also Rev. Proc.2015-13, section 2.03(1).

(2) In general. The Service has determined that it is not in the interest of sound taxadministration to permit a prospective change in method of accounting6 for a transactionwithin the scope of this notice. Accordingly, the Service will not process applications for anychanges in method of accounting filed under the non-automatic change procedures ofRev. Proc. 2015-13 for a transaction within the scope of this notice. A taxpayer may,however, change its method of accounting for a transaction within the scope of thisnotice by filing an amended return in accordance with section 3.06(3) of this notice.

(3) Change in method of accounting by filing amended returns.(a) In general. In accordance with § 1.446-1(e)(3)(ii) and Rev. Rul. 90-38,consent is hereby granted for any taxpayer that has engaged in a transaction within thescope this notice to file amended returns to retroactively change from an impermissiblemethod of accounting to a permissible method of accounting for the transaction. Thisconsent is granted only if the taxpayer files such amended returns using a permissiblemethod of accounting for such transactions for the fServicet taxable year in which thetaxpayer used the impermissible method of accounting for any such transaction (or ifthe period of limitations has expired for such taxable year, for the fServicet taxable year for

6 Nothing in this notice may be construed as identifying whether the taxpayer’s treatment of any
particular aspect of a transaction described in this notice is a method of accounting.14

which the period of limitations has not expired) and for each subsequent taxable year inwhich the taxpayer’s use of the impermissible method of accounting for thesetransactions affected the taxpayer’s taxable income. If the period of limitations hasexpired for the fServicet taxable year in which a taxpayer used the impermissible method ofaccounting for these transactions and the taxpayer files amended returns pursuant tothis notice, the amended return for the fServicet taxable year for which the period oflimitations has not expired must include the entire amount of the § 481(a) adjustment,whether positive or negative, attributable to the change in accounting method asordinary in character. The terms, conditions, and administrative procedures of Rev.Proc. 2015-13, as clarified and modified by Rev. Proc. 2015-33, do not apply to ataxpayer changing its method of accounting by amending its Federal income tax returnsunder section 3.06(3) of this notice.

(b) Manner of making change.A taxpayer filing amended returns under this notice must comply with therequirements of § 1.6011 -4 including, but not limited to, attaching to the amended returnany disclosure statements that may be required in accordance with § 1.6011 -4(a) and(e). In addition, a taxpayer filing an amended return under this section 3.06(3)(b) mustwrite “FILED UNDER NOTICE 2015-73” at the top of any amended paper return or, withrespect to any amended return submitted electronically, must indicate “FILED UNDERNOTICE 2015-73.”

 

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