One very difficult issue in the notices notices trying to determine what transactions are “substantially similar” to those being discussed. I don’t really have the resources (or the will) to do a thorough search of that term but I suspect that even if I did (or if I did), I’d probably come up with pretty close to nothing. For now, we’ll just pretend it means a very close approximation and also pretend that we have a common understanding of that term.
Of course, the real difficulty is that lawyers spend their careers distinguishing one set of facts from another set of facts. I won’t go through all of the relevant facts of the two notices since anybody can just click on the rulings and start reading. Thankfully, Notice 2015-47 actually defines what is “substantially similar”:
(1) the transaction is denominated as an option contract;
(2) substantially all of the assets in the reference basket primarily consist of actively traded personal property as defined under § 1.1092(d)1(a);
(3) the purchaser of the option or the purchaser’s designee either have the right to (a) determine the assets in the reference basket both at the inception of the transaction and periodically over the term of the transaction or (b) select or use a specified trading algorithm under its control to determine the assets in the reference basket; and
(4) the purchaser of the option, the purchaser’s designee, or the specified trading algorithm actually changes one or more of the assets in the reference basket during the term of the basket option contract.
The most important feature is (3); the ability of the taxpayer, or its designee, to periodically change the composition of the basket. This is important as a way to distinguish this from, say, a derivative on the S&P500 or other index funds. Index funds would naturally change their composition from time-to-time and therefore, taxpayers who entered into a derivative on those funds would be very surprised to find that those derivatives were the subject of this notice. They are not. The main difference being that the composition of the baskets are generally determined by third parties unrelated to the taxpayer. Where the taxpayer, or a designee of the taxpayer, determines the composition of the basket, the issues of tax ownership and modification of the contract (see Rev. Rul. 1990-2 C.B. 191, 1990-52 I.R.B. 17) start to come into play.
On the prior point, though, it should be noted that the Notice specifically refers to a “designee” of the taxpayer and not an agent of the taxpayer. This would seem to have some import since an agent is often one who is employed by the taxpayer, either as an actual employee or independent contractor. A designee could simply be someone you pointed at. Per dictionary.com, a designee is, in part, “
Lastly, it’s interesting that Notice 2015-47 does not define “substantially similar” by result. That is, the primary concern of the notices was the deferral of income and the potential conversion of ordinary income or short-term gain into long-term capital gain. The Notice, however, does not appear to require that result in order for the transaction to be treated as substantially similar. In a way, this makes sense. The IRS proposed four different theories where each theory could lead to a different result. It would be difficult, and likely perplexing, for the IRS to identify which taxpayer position is the appropriate one since that will depend on the facts in each case, even where the taxpayer didn’t adopt the most aggressive position.
That said, could a taxpayer get comfortable in not disclosing if they, in fact, applied one of the more “conservative” theories set forth by the IRS? They probably could but, assuming the taxpayer was not taking an aggressive position in the first place, it may ultimately make sense to disclose.
This is not tax advice. Talk to your tax advisor.