n-15-48.pdf

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PART III – Administrative, Procedural, and Miscellaneous

Transaction of Interest - Basket Contracts

Notice 2015-48

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 may attempt to convert short-term capital gain
and ordinary income to long-term capital gain through a contract denominated as an
option, notional principal contract, forward contract, or other derivative contract. The
Treasury Department and the IRS believe this transaction (the “basket contract”) has a
potential for tax avoidance or evasion but lack enough information to determine whether
the transaction should be identified specifically as a tax avoidance transaction. This
notice identifies the basket contract and substantially similar transactions as
transactions of interest for purposes of § 1.6011-4(b)(6) of the Income Tax Regulations
and §§ 6111 and 6112 of the Internal Revenue Code (“the Code”). This notice also
alerts persons involved in these transactions about certain responsibilities that may
arise from their involvement with these transactions.
SECTION 1. TRANSACTION OF INTEREST
.01 Description
In a basket contract, a taxpayer (“T”) enters into a contract with a counterparty
(“C”) to receive a return based on the performance of a notional basket of referenced

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assets (the “reference basket”). The assets that comprise the reference basket may
include (1) interests in entities that trade securities, commodities, foreign currency, or
similar property (“hedge fund interests”), (2) securities, (3) commodities, (4) foreign
currency, or (5) similar property (or positions in such property). 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. While the basket contract
remains open, T
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has the right to request changes in the assets in the reference basket
or the specified trading algorithm.
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The terms of the basket contract also permit C to
reject certain changes requested by T to the assets in the reference basket. C,
however, generally accepts all or nearly all of the changes requested by T.
When the basket 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 contract, C typically acquires all or
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

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When used in this sentence and subsequently with respect to identifying the assets in the
reference basket or the trading algorithm, references to “T” include T’s designee.

2
For purposes of this Notice, a change in the assets in the reference basket as a result of
events outside of the control of T (such as a change in the notional securities in the reference
basket due to a stock split or a merger of existing companies) is not treated as a change
requested by T.

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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 contract has a stated term of more than one year or overlaps two of
T’s taxable years 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 contract is based on the performance of the
assets in the basket. A common payout formula on the basket contract entitles T to
receive back its 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 basket, together with interest, dividend, and other periodic income on the assets,
reduced by C’s fee for its participation in the transaction. The basket 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 contract also may permit or require T to provide additional
collateral or otherwise reduce risk in the basket if a specified level of risk is reached.
The basket contract typically contains other safeguards to minimize the economic
risk to C. For example, C may terminate the basket contract if T violates investment
guidelines that are part of the contract. C typically holds the rights associated with the
legal title to the assets and positions in the basket, including voting rights and the rights
to commingle, lend, 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 basket are deferred until the

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basket contract terminates and, if the basket 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 may be
using a basket contract to inappropriately defer income recognition and convert ordinary
income and short-term capital gain into long-term capital gain. In some cases,
taxpayers also may be mischaracterizing the form of the transaction to avoid application
of § 1260, to avoid U.S. tax liability under §§ 871, 881, and 882, to avoid tax or reporting
obligations associated with investments in passive foreign investment companies, and
to avoid withholding and reporting obligations under Chapters 3 and 4 of the Code.
Therefore, the Treasury Department and the IRS are identifying the basket contract and
substantially similar transactions as transactions of interest. The Treasury Department
and the IRS believe that the use of a basket contract to claim the tax treatment specified
herein may be improper.
.02 Effective Date
Transactions entered into on or after November 2, 2006, that are the same as, or
substantially similar to, the transactions described in this notice, and in effect on or after
January 1, 2011, are identified as transactions of interest for purposes of § 1.6011-
4(b)(6) and §§ 6111 and 6112 effective July 8, 2015. Persons engaged in transactions
entered into on or after November 2, 2006, and 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 July 8, 2015. Material advisors who
make a tax statement on or after January 1, 2011, with respect to transactions in effect

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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 transactions of interest, 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
Notice 2015-47, and as a transaction of interest under this notice, the transaction is
identified as a listed transaction. Persons satisfying the disclosure requirements for a
listed transaction under Notice 2015-47 are deemed to have satisfied the disclosure
requirements under this notice.
When the Treasury Department and the IRS have gathered enough information
to make an informed decision as to whether these transactions are a tax avoidance type
of transaction, the Treasury Department and the IRS may take one or more
administrative actions, including removing the transactions from the transactions of
interest category in published guidance, designating the transactions as a listed
transaction, or providing a new category of reportable transactions. In the interim, in
appropriate situations, the IRS may challenge the taxpayer's position taken as part of
these transactions under §§ 1260, 1001, or other provisions of the Code or under
judicial doctrines, such as substance over form.
.03 Participation
Under § 1.6011-4(c)(3)(i)(E), for each year in which a transaction described in
this notice (basket contract) is open, the following parties are treated as participating in
the transaction of interest identified in this notice: (i) the purchaser of the basket

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contract, (ii) if the purchaser of the basket contract is a partnership, any general partner
of the purchaser, (iii) if the purchaser of the basket contract is a limited liability
company, any managing member of the purchaser, and (iv) the counterparty to the
basket contract.
.04 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). For purposes of the transactions
described in this notice, the 90-day period provided in § 1.6011-4(e)(2) for certain
disclosures is extended to 120 days. However, if, under § 1.6011-4(e), a taxpayer is
required to file a disclosure statement with respect to the transaction of interest
described in this notice after July 8, 2015, and prior to November 5, 2015, 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 November 5, 2015.
.05 Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See
§ 301.6111-3(b)(3)(i)(B).
.06 Penalties
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

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involved in these transactions or substantially similar transactions, including the
accuracy-related penalty under §§ 6662 or 6662A.
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.
SECTION 2. DRAFTING INFORMATION
The principal authors of this notice are Anna H. Kim and Robert A. Martin of the
Office of Associate Chief Counsel (FIP). For further information regarding this notice,
contact Ms. Kim at (202) 317-4431 or Mr. Martin at (202) 317-4455 (not a toll-free call).