US Securities Market Coalition Commentary on Section 871(m) and Complex Contracts

In a letter dated, February 24, 2016 (the “Coalition Letter”), the US Securities Markets Coalition addressed comments to Treasury regarding a number of topics associated with the new Section 871(m) regulations.  In particular, the Coalition Letter specifically addressed the potential application of the substantial equivalence test to a combination of listed options, which would individually be simple contracts.  The Coalition Letter states:

“…applying the Combination Rule to multiple listed options should not result in the creation of complex contracts that must be tested under the substantial equivalence test.  Each listed option is a simple contract and potential combinations of individual listed options contracts should be tested under the rule for simple contracts. Applying the Combination Rule to listed options is sufficiently challenging without layering on the need to apply the substantial equivalence test to multiple potential complex contracts that might be created.”

I described the complexities relating to combinations of simple contracts in this post and also indicated that this was a potential solution as well.  This would obviously narrow the potential instruments subject to withholding.

But this also leaves a potential hole in the regulations and a mismatch between the treatment of single instruments that constitute complex contracts and combinations.   As I also pointed out in my earlier post, it appears that Treasury, at least up to this point, has been taking a view to plugging as many holes as possible and creating a unified treatment for all instruments, whether they be a single instrument, multiple instruments, simple or complex.  While the substantial equivalence test does treat complex instruments differently than simple instruments, it certainly must be seen as attempting to draw the same line around single and complex instruments, but giving into the fact that the delta 0.80 threshold simply doesn’t make sense as applied to complex instruments.

Moreover, assuming complex contracts are a concern for avoiding withholding, it would be interesting to know if taxpayers would attempt to avoid withholding by entering into combinations which would technically be treated as complex contracts (even by the barest of margins) in order to avoid withholding.   And presumably, withholding agent systems would not be designed to capture any information related to such combinations because they would be exempted.

In any case where Treasury accepts this exclusion from the treatment of complex contracts, I would also expect them to backstop the rule with some sort of anti-avoidance or anti-abuse provision.  Even that may be a long shot, however, as Treasury has seemed to favor more objective tests thus far.

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