Federal Tax

Taxation of Equity Derivatives (Portfolio 188)

  • This Portfolio analyzes the tax consequences of transactions involving equity derivatives ranging from “traditional” equity derivatives to more “modern” equity derivatives.

Description

Tax Portfolio, Taxation of Equity Derivatives, No. 188, analyzes the tax consequences of transactions involving equity derivatives. After discussing “traditional” equity derivatives, the Portfolio discusses more “modern” equity derivatives that have arisen in recent years. The Portfolio then turns to a discussion of special issues that arise when corporations take positions in their own stock.

The Portfolio examines “traditional” equity derivatives, including equity options, forward contracts, futures contracts, short sales, and convertible debt. For each type of transaction, the Portfolio analyzes the timing rules applicable to the resulting income (or loss), as well as the character and source of the resulting income (or loss). The Portfolio also addresses the impact these instruments may have on a tax ownership analysis of the underlying equity.

The Portfolio examines a number of “modern” equity derivative transactions, including notional principal contracts, equity-linked debt products, and forward-based products. The Portfolio analyzes the tax consequences of equity-linked debt products such as zero-coupon convertibles, contingent interest convertibles, reverse convertibles, and negative coupon debt. The Portfolio also analyzes the tax consequences of recent forward-based products, such as variable prepaid forward contracts, exchange-traded notes and debt/forward contract investment units. The impact these transactions may have on a tax ownership analysis of the underlying equity is also discussed. The possible application of several statutory anti-abuse provisions to transactions involving both a position in the underlying equity and a position in a related derivative is also discussed, as well as the recent rules under §871(m) intended to prevent certain transactions involving underlying U.S. source dividends from escaping U.S. withholding tax.

The Portfolio considers special issues that arise when corporations take positions in their own stock under §1032. The Portfolio explores the tax consequences of the use of options, forward contracts, futures contracts, convertible debt, and equity swaps by corporations taking positions in their own stock.

The Worksheets include a diagram of a variable forward pricing mechanism and a list of public offering memoranda relating to the “modern” equity derivatives discussed in the Portfolio. The Worksheets and Additional Resources also include relevant legislative history and IRS guidance relating to equity derivatives, including most recently, certain legislative history and IRS guidance related to Section 871(m).

This Portfolio may be used in conjunction with Schizer, 186 T.M., Financial Instruments: Special Rules.

This Portfolio may be cited as Chen and Kunkel, 188 T.M., Taxation of Equity Derivatives.

Table of Contents

I. Traditional and Modern Equity Derivatives
II. Special Issues

Sam_Chen
Sam Chen
Senior Manager
KPMG LLP
Paul Kunkel
Paul Kunkel
Director
KPMG LLP
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