Assignment of the Times: New Tax Rules Respond to Concerns Regarding Assignment of Derivative Contracts Required by Dodd-Frank

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On July 21, 2011, the Internal Revenue Service (IRS) and Treasury issued temporary regulations (T.D. 9538) that modify Treas. Reg. § 1.1001-4 and generally provide that an assignment of a derivative contract by a dealer (or a clearinghouse) to a dealer or clearinghouse generally will not result in a taxable exchange to the non-assigning counterparty. The temporary regulations are significant because the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requires the transfer of certain derivative contracts. Although the stated purpose of the temporary regulations is to expand the existing exception for transfers of notional principal contracts to include most other derivative contracts that permit assignment, the temporary regulations make a possibly inadvertent, but obviously important, change by excluding commodity-based notional principal contracts from the exception. The temporary regulations also clarify that a contract will be treated as permitting assignment even if the non-assigning counterparty is required to consent to the assignment.

The IRS and Treasury acknowledged a need to amend the regulations under section 1001 because of Dodd-Frank, which, under the “Volcker Rule” and the “Bank Push Out Provision,” requires the movement of entire books of derivative contracts. A bank is required under the Volcker Rule to limit its proprietary trading activities, including investments in any securities or derivatives, to no more than 3% of its Tier One capital. In addition, a bank will lose federal deposit insurance, access to the Federal Reserve credit facility, and other potential federal assistance if it is registered as a swap dealer under the Bank Push Out Provision. As a result of these new rules, a bank may need to “push out” its derivatives trading activities to a subsidiary or another entity. Before the issuance of the temporary regulations, there was some concern that the transfer of existing derivative contracts could create a taxable event for the non-assigning counterparty.

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Published In: Administrative Agency Updates, General Business Updates, Finance & Banking Updates, Securities Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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