Variable Forward Ruling Now "Public"
Advice Memorandum that we discussed in our last newsletter (“On
The Grapevine") has become “public”. The TAM holds
that when an investor lent its shares in connection with a prepaid
variable forward, that arrangement (as well as other indicia of
the contract) created a sale under common law.
portion of the TAM is circulating among tax advisors.
The analysis notes that the counterparty acquired
possession and use of the shares, including the ability to trigger
the shares’ delivery. It also notes that the shares could not be
withdrawn during the contract and replaced by other collateral and
that the contract demanded physical settlement.
The analysis also focuses on voting and dividend rights; it
states (rather ambiguously) that the taxpayer was to forfeit
dividends on the shares during the contract.
The TAM has not yet been published by the IRS, so some facts are as yet
unknown. Twenty-First Securities does not agree with the TAM’s
conclusions but has, since 1998, alerted investors to the possible
risk in loaning hedged shares to the counterparty. (See “Potential
Tax Traps For Equity Collars”).
We continue to recommend caution and believe it prudent,
until there is further clarity, to operate as if the ruling were
law. For this reason,
we advise investors who hedge with prepaid variable forwards not
to lend the hedged stock to the counterparty.
published December 20, 2005.
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information purposes only. They are not intended to be
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investors. Before engaging in an options
transaction, investors must review the booklet "Characteristics
and Risks of Standardized Options".