n-15-73.pdf

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PART III – Administrative, Procedural, and Miscellaneous

Listing Notice – Basket Option Contracts

Notice 2015-73

The Treasury Department and the Internal Revenue Service (the “IRS”) are
aware of a type of structured financial transaction, described below, 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.
The Treasury Department and the IRS believe this transaction (the “basket option
contract”) is a tax avoidance transaction. Notice 2015-47, 2015-30 I.R.B. 76, identified
the basket option contract and substantially similar transactions as listed transactions
for purposes of § 1.6011-4(b)(2) of the Income Tax Regulations and §§ 6111 and 6112
of the Internal Revenue Code (“the Code”). Notice 2015-47 also alerted persons
involved in these transactions about certain responsibilities that may arise from their
involvement with these transactions.
Commenters expressed concern that difficulty in identifying transactions that are
the same as, or substantially similar to, the transaction described in Notice 2015-47 may
cause taxpayers to file disclosures for transactions that are not intended to be treated
as listed transactions at this time. This notice revokes Notice 2015-47. Section 2 of this
notice provides additional details on the types of transactions that are the same as, or

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substantially similar to, the transaction described in this notice, and thus listed
transactions for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112 of the Code.
Section 3.06 of this notice provides procedures for taxpayers to change their method of
accounting for transactions within the scope of this notice.
Section 2.04 of this notice more specifically describes the tax benefits that
identify the transaction described in this notice as a listed transaction. No inference is
intended regarding the appropriate treatment of transactions not described in this
notice. The IRS may challenge, including by asserting judicial doctrines, claimed tax
benefits under §§ 871, 881 and 882 or other provisions of the Code, and assert failures
to comply with reporting obligations associated with investments in passive foreign
investment companies and withholding and reporting obligations under Chapters 3 and
4 of the Code.
SECTION 1. BACKGROUND
In a basket option contract, a taxpayer (“T”), typically a hedge fund or a high net-
worth individual, enters into a contract that is denominated as an option with a
counterparty (“C”), typically a bank, to receive a return based on the performance of a
notional basket of referenced actively traded personal property (the “reference basket”).
T, or a designee named by T, will either determine the assets that comprise the
reference basket or design or select a trading algorithm that determines the assets.

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While the basket option contract remains open, T
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has the right to change the assets in
the reference basket, request that C change the assets in the reference basket, change
the trading algorithm, or request that C change the trading algorithm (collectively,
discretion).
2
The terms of the basket option contract may permit C to reject certain
changes requested by T to the assets in the reference basket or the trading algorithm.
C, however, generally accepts all or nearly all of the changes requested by T.
When the basket option contract is entered into, 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 its risk under the basket option contract, 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 either
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

1
When used in this sentence and subsequently with respect to changing or requesting changes
to the assets in the reference basket or the trading algorithm, references to “T” include T’s
designee as defined in section 2.02 of this notice.
2
See also section 2.03 of this notice.

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settlement of the basket option contract is based on the performance of the assets in
the reference basket. A common payout formula on the basket option contract entitles
T to a return equal to the upfront payment, plus net basket gain or minus net basket
loss. The net basket gain or net basket loss includes net changes in the values of the
assets in the reference basket, together with interest, dividend, and other periodic
income on the assets, reduced by C’s fee for its role in the transaction. The basket
option contract typically includes a provision automatically terminating the contract if the
amount of the net basket loss reaches the amount of the upfront payment, giving T a
cash settlement amount of zero. The basket option contract also may permit or require
T to provide additional collateral or otherwise reduce risk in the reference basket if a
specified level of risk is reached.
The basket option contract typically contains other safeguards to minimize the
economic risk to C. For example, C may terminate the basket option contract if T
violates investment guidelines that are part of the contract. C typically holds the rights
associated with legal title to the assets and positions in the reference basket, including
voting rights and the right to commingle, lend, 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 and, if the basket option contract is
held for more than one year, that the entire gain is treated as long-term capital gain.
The Treasury Department and the IRS are concerned that taxpayers are using a
basket option contract to inappropriately defer income recognition or convert ordinary

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income or short-term capital gain into long-term capital gain. In some cases, taxpayers
are also mischaracterizing a transaction as an option to avoid application of § 1260.
Therefore, the Treasury Department and the IRS are identifying transactions described
in section 2 of this notice as listed transactions.
The IRS may assert one or more arguments to challenge the parties’ tax
characterization of a basket option contract, 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 § 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 § 1001 with respect to the asset affected by the change. The IRS may
assert other arguments supporting the conclusion that T is the beneficial owner of the
assets in the reference basket for tax purposes.
SECTION 2. LISTED TRANSACTIONS
.01 Transactions Identified as Listed Transactions
A transaction is the same as, or substantially similar to, the transaction identified
in this notice 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 § 1.1092(d)-1(a); (4) the contract is

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not fully settled at intervals of one year or less; (5) T or T’s designee (as defined in
section 2.02 of this notice) has exercised discretion (as defined in section 2.03 of this
notice) 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,
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reflects a tax benefit described in section 2.04 of this notice.
Notwithstanding any other provision in this notice, a transaction is not the same as, or
substantially similar to, the listed transaction identified in this notice if the transaction is
described in section 2.05 of this notice.
.02 Designee
For purposes of this notice, any reference to T having the right to change or
request changes to the assets in the reference basket or the trading algorithm includes
T’s designee as defined in this section 2.02. T’s designee is 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, request, or determine changes in the assets in the
reference basket or the trading algorithm. A person will not, however, be treated as
compensated or selected by T as a result of: (1) the person’s position as an investment
advisor, officer, 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, the person’s payment of a licensing fee for the right to use, or the person’s authority
to suggest, request, or determine changes in the assets included in (y) a widely used

3
See section 3.01 for disclosure requirements.

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and publicly quoted index that is based on objective financial information or (z) an index
that tracks a broad market or a market segment.
.03 Discretion
For purposes of this notice, T will not be treated as having discretion to change
(either directly or through a request to C) the assets in the reference basket or the
trading algorithm if changes in the assets in the reference basket or the trading
algorithm are made according to objective instructions, operations, or calculations that
are disclosed at the inception of the transaction (the rules) and T does not have the right
to alter or amend the rules during the term of the transaction or to deviate from the
assets in the reference basket or the trading algorithm selected in accordance with the
rules. For these purposes, T will not be treated as having authority to alter or amend
the rules solely because T has the authority to: (1) exercise routine judgment in the
administration of the rules provided, however, that such routine judgment does not
include deviations or alteration to the rules that are designed to improve the financial
performance of the reference basket; (2) correct errors in the implementation of the
rules or calculations made pursuant to the rules; or (3) make an adjustment to respond
to an unanticipated event outside of T’s control, such as a stock split, merger, listing or
delisting, nationalization, or insolvency of a component of a basket, a disruption in the
financial markets for specific assets or in a particular jurisdiction, regulatory compliance
requirement, force majeure, or any other unanticipated event of similar magnitude and
significance.

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.04 Tax Benefit
For purposes of this notice, a tax benefit is 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.
.05 Excluded Contracts
A transaction is not the same as, or substantially similar to, the transaction
described in this notice if: (1) the contract is traded on (a) a national securities exchange
that is regulated by the Securities and Exchange Commission or a domestic board of
trade regulated by the Commodity Futures Trading Commission, or (b) a foreign
exchange or board of trade that is subject to regulation by a comparable regulator; or
(2) the contract is treated as a contingent payment debt instrument under § 1.1275-4
(including a short-term contingent payment debt instrument) or a variable rate debt
instrument under § 1.1275-5. With respect to T, a transaction is not the same as, or
substantially similar to, the transaction described in this notice unless T’s tax return for a
taxable year ending on or after January 1, 2011,
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reflects a tax benefit of the transaction
that is described in section 2.04 of this notice. With respect to C, a transaction is not
the same as, or substantially similar to, the transaction described in this notice if: (1) T
represents to C in writing under penalties of perjury that T’s tax return has not and will
not reflect a tax benefit described in section 2.04 of this notice in any taxable year
ending on or after January 1, 2011,
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or (2) C has established that T is a nonresident

4
See section 3.01 for disclosure requirements.
5
See section 3.01 for disclosure requirements.

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alien that is not engaged in a U.S. trade or business or a foreign corporation that is not
engaged in a U.S. trade or business by obtaining a valid withholding certificate from the
beneficial owner of the payments made or to be made under the basket option contract
(W-8BEN, W-8BEN-E, or W-8EXP), or in the case of payments made outside of the
U.S. on offshore obligations, by obtaining documentary evidence as described in Treas.
Reg. §1.1441-1(c)(17).
SECTION 3. RULES OF APPLICATION
.01 Effective Date
Transactions in effect on or after January 1, 2011, that are the same as, or
substantially similar to, the transaction described in this notice are identified as "listed
transactions" for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112 as of October 21,
2015. 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 the
taxpayer participated in the transactions, provided that the period of limitations for
assessment of tax had not ended on or before October 21, 2015. Material advisors who
make a tax statement on or after January 1, 2011, with respect to transactions in effect
on 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 the
same as, or substantially similar to, the transaction described in this notice may already
be 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 and
as a transaction of interest in Notice 2015-74, the transaction is identified as a listed

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transaction. Persons satisfying the disclosure requirements for a listed transaction
under this notice are deemed to have satisfied the disclosure requirements under Notice
2015-74.
.02 Participation
Under § 1.6011-4(c)(3)(i)(A), for each year in which a transaction described in
this notice (basket option contract) is open, only the following parties are treated as
participating in the listed transaction identified in this notice: (1) the purchaser of the
basket option contract, (2) if the purchaser of the basket option contract is a partnership,
any general partner of the purchaser, (3) if the purchaser of the basket option contract is
a limited liability company, any managing member of the purchaser, and (4) the
counterparty to the basket option contract.
.03 Time for Disclosure
For rules regarding the time for providing disclosure of a transaction described in
this notice, see § 1.6011-4(e) and § 301.6111-3(e). However, if, under § 1.6011-4(e), a
taxpayer is required to file a disclosure statement with respect to the listed transaction
described in this notice after October 21, 2015, and prior to January 19, 2016, that
disclosure statement will be considered to be timely filed if the taxpayer alternatively
files the disclosure with the Office of Tax Shelter Analysis by January 19, 2016.
.04 Material Advisor Threshold Amount
For the threshold amounts necessary to become a material advisor to a listed
transaction, see § 301.6111-3(b)(3)(i)(B).

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.05 Penalties and Period of Limitations
Persons required to disclose these transactions under § 1.6011-4 who fail to do
so may be subject to the penalty under § 6707A. Persons required to disclose these
transactions 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 IRS) may be subject to the
penalty under § 6708(a). In addition, the IRS may impose other penalties on parties
involved in these transactions or substantially similar transactions, including the
accuracy-related penalty under §§ 6662 or 6662A. Persons required to disclose these
transactions under § 1.6011-4 who fail to do so may be subject to an extended period of
limitations on assessment under § 6501(c)(10).
The Treasury Department and the IRS recognize that some taxpayers may have
filed tax returns taking the position that they were entitled to the purported tax benefits
of the type of transaction described in this notice. These taxpayers should take
appropriate 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 as
otherwise provided, a taxpayer must secure the consent of the Commissioner before
changing 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 method
change, a taxpayer must file a Form 3115, Application for Change in Accounting
Method, during the taxable year in which the taxpayer desires to make the proposed
change. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe

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administrative procedures setting forth the limitations, terms, and conditions deemed
necessary to permit a taxpayer to obtain consent to change a method of accounting in
accordance 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 the
Commissioner to change a method of accounting for federal income tax purposes.
Under the non-automatic change procedures of Rev. Proc. 2015-13, a taxpayer
generally must file a Form 3115 during the year of change. When a taxpayer computes
its taxable income using a method of accounting that differs from the method of
accounting used during the preceding taxable year, a § 481(a) adjustment is required to
prevent 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 any
Form 3115 requesting consent to make a change in method of accounting in any
situation in which the national office determines that permitting the requested change in
method of accounting would not clearly reflect income or would otherwise not be in the
interest of sound tax administration. As part of this determination, the national office will
consider whether the change in method of accounting would clearly and directly
frustrate compliance efforts of the IRS in administering the income tax laws. The
national office will consider all the facts and circumstances and exercise discretion
under §§ 446(e) and 481(c) in a manner that generally minimizes distortions of income
across 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 erroneous
method of accounting for two or more consecutive taxable years, the taxpayer has

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adopted a method of accounting. The ruling further provides that a taxpayer may not,
without the Commissioner's consent, retroactively change from an erroneous to a
permissible method of accounting by filing an amended return. See also Rev. Proc.
2015-13, section 2.03(1).
(2) In general. The IRS has determined that it is not in the interest of sound tax
administration to permit a prospective change in method of accounting
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for a transaction
within the scope of this notice. Accordingly, the IRS will not process applications for any
changes in method of accounting filed under the non-automatic change procedures of
Rev. 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 this
notice 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 the
scope this notice to file amended returns to retroactively change from an impermissible
method of accounting to a permissible method of accounting for the transaction. This
consent is granted only if the taxpayer files such amended returns using a permissible
method of accounting for such transactions for the first taxable year in which the
taxpayer used the impermissible method of accounting for any such transaction (or if
the period of limitations has expired for such taxable year, for the first taxable year for

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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.

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which the period of limitations has not expired) and for each subsequent taxable year in
which the taxpayer’s use of the impermissible method of accounting for these
transactions affected the taxpayer’s taxable income. If the period of limitations has
expired for the first taxable year in which a taxpayer used the impermissible method of
accounting for these transactions and the taxpayer files amended returns pursuant to
this notice, the amended return for the first taxable year for which the period of
limitations has not expired must include the entire amount of the § 481(a) adjustment,
whether positive or negative, attributable to the change in accounting method as
ordinary 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 a
taxpayer changing its method of accounting by amending its Federal income tax returns
under section 3.06(3) of this notice.
(b) Manner of making change.
A taxpayer filing amended returns under this notice must comply with the
requirements of § 1.6011-4 including, but not limited to, attaching to the amended return
any 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) must
write “FILED UNDER NOTICE 2015-73” at the top of any amended paper return or, with
respect to any amended return submitted electronically, must indicate “FILED UNDER
NOTICE 2015-73.”
SECTION 4. EFFECT ON OTHER DOCUMENTS
Notice 2015-47 is revoked.

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SECTION 5. DRAFTING INFORMATION
The principal authors of this notice are Orla J. O’Connor and Robert A. Martin of
the Office of the Associate Chief Counsel (Financial Institutions and Products). For
further information regarding this notice, contact Ms. O’Connor at (202) 317-6367 or Mr.
Martin at (202) 317-4455 (not a toll-free call).