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*/ Pursuant to Code Section 6110(j)(3), a private letter ruling
may not be used or cited as precedent except by the taxpayer to
whom the ruling was issued.
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July 17, 1989
TO: TAX MEMBERS NO. 24-89
OPTIONS AND FUTURES TASK FORCE NO. 5-89
RE: IRS PRIVATE LETTER RULING ON CODE SECTION 851(g)
DESIGNATED HEDGES
__________________________________________________________
Attached is the first IRS private letter ruling */1
considering what constitutes a designated hedge for purposes of
Code Section 851(g) and what identification requirements will be
deemed acceptable, in the absence of regulations, to establish a
designated hedge. Section 851(g) provides that, in determining
whether the Section 851(b)(3) short-short test has been
satisfied, increases and decreases in the value of positions
during the period that these positions are part of a designated
hedge shall be netted.
The two regulated investment companies (RICs) involved in
this ruling hedge their long-term positions in 30-year U.S.
Treasury bonds by investing in interest rate put options and/or
short positions in interest rate futures contracts. Each RIC
protects its positions in foreign securities against loss from
currency fluctuations by investing in put options on foreign
currencies, short positions in foreign currency futures contracts
or put options on foreign currency futures contracts. One RIC
protects its U.S. stock portfolio against loss by investing in
put options on broad-based stock indexes (such as the S&P 500),
short positions in stock index futures contracts and put options
on stock index futures contracts.
The ruling describes the RICs' identification procedure as
follows.
On the day a hedge is entered, the custodian for the [RIC]
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will note that the specified hedging instruments protect
specific securities identified by a transaction reference
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or tax lot number. The hedging positions will be placed in a
separate hedging account maintained by a futures commission
merchant. The futures commission merchant or custodian for the
[RIC] will confirm to the [RIC] in writing the purchase of the
hedging instruments, noting the number of options purchased or
futures contracts rendered, their price, the face value of the
hedge, the dollar value of the portfolio positions protected by
the hedging positions, and the date of the acquisition. The
futures commission merchant or custodian will also designate the
hedged and hedging positions identified as a designated hedge and
will provide the [RIC] with written confirmation of the
designation of the positions as a hedge. The written
confirmation will include the date the hedge is established, the
hedging positions, the hedged positions identified by transaction
reference or tax lot numbers, and the market value of the hedged
positions at the time the hedge is established.
The private letter ruling holds first that, prior to the
issuance of regulations prescribing the manner for identifying a
designated hedge, the identification procedure used by the RICs
in this ruling will be acceptable. The ruling then concludes
that the following transactions will constitute designated
hedges, provided that the values of the positions ordinarily vary
inversely with one another and appropriate identification of the
designated hedges is made:
(1) transactions consisting of securities denominated
in a foreign currency and offsetting short
positions in futures contracts, options, or options
on futures contracts on that currency;
(2) transactions consisting of long-term U.S. Treasury
bonds and short positions in interest rate futures
contracts, interest rate put options, and options
on interest rate futures contracts;
(3) transactions consisting of stocks held in the RIC's
U.S. stock portfolio and offsetting stock index put
options or short positions in offsetting stock
index futures contracts.
No opinion is expressed on either the application of Code
Section 988 to the facts in the ruling, the appropriateness of
the taxpayer's accounting principles or the procedures to be used
in netting increases and decreases in the value of positions
which are part of the designated hedge.
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We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachment