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April 10, 1989
TO: TAX COMMITTEE NO. 4-89
ACCOUNTING/TREASURERS COMMITTEE NO. 15-89
RE: INSTITUTE COMMENTS ON SECTION 851(g) DESIGNATED HEDGES
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As you know, section 851(g) was added to the Code by the
Conference Report to the 1986 Tax Reform Act to provide limited
relief from the short-short test for funds engaging in certain
hedging transactions. The Institute neither requested nor had
the opportunity to comment on the designated hedge rule provided
in the 1986 Act.
Last summer and fall, the Institute held several meetings
with representatives of the Treasury Department to discuss the
nature of the regulations to be drafted to implement section
851(g). The Treasury representatives informed us that they felt
constrained by the statute to require that an adjustment to the
basis of the hedged asset be made to reflect any netting of gain
and loss done in the hedge. A meeting of interested Institute
members was then held at which the conclusion was reached that
any regulations under section 851(g) would be so complex as to be
of essentially no value.
The attached letter to the Treasury Department reflects the
Institute's concern that section 851(g) will do almost nothing to
relieve funds of the burdens created by the short-short test and
calls, once again, for the repeal of section 851(b)(3). The
letter also expresses the Institute's appreciation for the time
Treasury spent discussing possible regulations under section
851(g) with us and, accordingly, passes along a few suggestions
for drafting the regulations (which will, nevertheless, be of
little use to most funds). The three general suggestions are
that (1) any regulations should permit a fund to identify as a
hedge any positions that are expected to move in opposite
directions with fluctuations in the market, (2) a hedge should
include both the underlying security and any number of secondary
products identified as hedging that security, and (3) in applying
the hedge netting rule to a portfolio of stocks hedged by an
index future or option, gross gains or losses from each side of
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the hedge should be netted against the gross corresponding basis
adjustment to the securities to which the netting was applied.
The Internal Revenue Service is working on a draft of the
section 851(g) regulations that, in general, has been deemed
acceptable to staff persons at both IRS and Treasury.
Regulations are not expected to be issued, however, for several
months at the earliest.
We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachment