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IS A TACTICAL RETREAT ON §871(M) COMING?
According to reports in the media and from attendees, a Treasury representative indicated at a conference in Washington D.C. last week, that the department was reconsidering the scope of the §871(m) regulations, limiting it to delta one products even in 2019 and beyond. As a refresher, the §871(m) regulations treat equity-linked derivative instruments that are “simple contracts” as in-scope if the delta is 0.8 or above and those that are “complex contracts” as in-scope through application of the substantial equivalent test against a 0.8 delta simple contract benchmark. However, pursuant to IRS Notices 2016-76 and 2017-42, only instruments with deltas of one are in-scope for instruments issued in 2017 and 2018. Prior to last week’s announcement, the general expectation had been that in 2019 the regime would revert to the broader scope set forth in the §871(m) regulations.
While it is premature to celebrate, the announcement signals an acknowledgement of industry’s concerns around the disruptive complexity to the market from the broad scope of the §871(m) regulations. Much uncertainty, however, remains around the reduced scope, such as whether delta one is determined mathematically or by design (e.g. no optionality) and whether complex contracts will be excluded entirely. We cannot be certain until the IRS releases a formal declaration of this modification with further elaboration. Hopefully, such formal publication will be forthcoming soon so that affected financial institutions will have ample time to adjust their systems and process in accordance with the newly revised rules.
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