The IRS and the taxpayer agreed that the original contracts met Reverend Rul`s requirements. 2003-7 and that McKelvey had no profit or loss in 2007. The court ruled that the processing of the transaction opened under Reverend Rul. 2003-2007 is expected to continue to apply despite the extension of billing dates. This type of futures contract allows investors, for example, to protect securities/commodities positions from the risk of falling prices and at the same time benefit from rising prices. On the other hand, the General Court considered the enlarged treaties as a continuation of the original treaties and not as new agreements substantially different from the original treaties. As mentioned above, McKelvey had obligations under the original contracts in September 2008, but the commitments were extended until 2010 (specifically February 2010 for the contract with bofA). On the other hand, a deferral of a debt instrument obligation can be considered a new debt instrument for the United States. Federal tax purposes (see Regulations. Article 1.1001-3(e)(3)). In addition, the extension of the period for which an option applies may be considered as another option (see Reily, 53 T.C. 8 (1969); Advocate General`s Memorandum (GCM) 35918; and GCM 38206). A typical user of a variable prepaid futures contract could be a founder or senior executive of a company that has accumulated a large amount of shares in the company.
This person may want to diversify their investments or secure profits in the stock, or at least raise a large amount of cash. In both cases, a variable prepaid futures contract is suitable to reflect private information. This is attributed to the fact that the transaction covers a large number of shares of the company. The strategy is associated with a relatively average decline in excess returns, comparable to the Center for Research in Security Price (CSRP) value-weighted index, the CSRP equal-weighted index, an industry average, and a corresponding sample by size and sector. In Reverend Rul. In 2003-2007, an individual (the shareholder) held 100 shares of a publicly traded company, Y. The shareholder base in Y shares was less than $20 per share. On September 15, 2002, the shareholder entered into a prepaid variable futures contract when the Y shares had a FMV of $20 per share.
Upon conclusion of the contract, the shareholder received an advance cash payment from the counterparty in exchange for a conditional amount of the Y shares, which is to be determined on a formula basis at a future „exchange date”. A prepaid variable futures contract is an open transaction that is more like a stock option in that both relate to a future commitment. To better understand a PVFC, we can explain it by breaking it down into individual words; First of all, it is a contract, usually between an investor and a financial institution or brokerage firm. Secondly, it is a futures contract because the agreement provides that the shares will be delivered by the investor at a later date. There is also an option to settle in cash instead of shares. In addition, it is a prepaid futures contract because the investor usually receives all the money in advance without relinquishing ownership of the shares. The initial payment does not attract capital gains tax, as the transaction is not completed and the payment is treated as a loan/debt and the underlying collateral as a contingency. In addition, payment is made with a discount, which can be considered a form of interest charges on the debt. Finally, the prepaid futures contract is variable because the number of shares to be delivered by the investor depends on the value of the existing share at the relevant time of expiration/maturity. In general, a lower strike price and a higher threshold or strike price are usually set when entering into a contract. These strike prices guide the calculation on a sliding scale to determine the number of shares due.
Investors with a cumulative number of shares in a single company prefer the strategy as an alternative portfolio diversification option to the open market. The number of shares to be returned by the investor depends on the current value of the share at maturity date, hence the name „variable”. The performance of the contract generally sets the capped claim and the minimum price at the subsequent capital gain. It remains to be seen whether the McKelvey decision will have far-reaching repercussions, as it referred to the specific facts of the case. The court found that at the time of the extension, the taxpayer had no significant ownership rights, only liabilities. This situation rarely occurs with respect to other derivatives, so taxpayers may be limited in their ability to rely on McKelvey to argue that a contract renewal is not a taxable event. In many other derivative contracts (such as swaps, periodic futures trading, etc.), both parties have both rights and obligations throughout the life of the derivative. Moreover, the present case concerned only the consequences of the amendment of the contract for the selling party; The treatment of change in the buying banks was not taken into account. Furthermore, in a brief part of the statement, the Tax Court rejected the allegation that the contract amendment could be considered a constructive sale of the underlying shares of Monster Worldwide, Inc. McKelvey also entered into a second contract on similar terms with another counterparty, which it also signed on September 15. July 2008 to extend settlement dates to January 2010.
Article 1259(d)(1) defines a forward contract as a contract to deliver an essentially fixed amount of goods (including cash) at an essentially fixed price. This definition of a futures contract has been developed in legislative history: at the moment the shares are delivered, the transaction is completed and therefore the deferred tax on the capital gains of the initial product becomes payable. The result achieved by a party to a prepaid futures contract is subject to the general rules governing the sale or assignment of the underlying security. In 2007, the taxpayer was appointed to the estate of Andrew J. McKelvey v. Commissioner, receiving more than $193 million in cash from two banks under variable prepaid futures contracts. In return, the taxpayer agreed to settle each contract by transferring a variable number of shares to each bank in 2008 without additional liquidity. The 2008 transaction would constitute a taxable sale of the shares. In 2008, the taxpayer paid each bank to extend each contract term until 2010. Finally, the court found that the renewals did not lead to a constructive sale of the underlying shares under Section 1259, since the renewed contracts were not separate financial instruments from the original contracts. On September 11, 2007, McKelvey entered into a variable prepaid futures agreement with Bank of America (BofA) for 1,765,188 of its Monster shares. On that day, Monster stock closed at $32.91.
Under the terms of the agreement, McKelvey received $50,943,578 (i.e., approximately 88% of the value, depending on the closing price or $28.86 per share) in advance in consideration of the agreement to deliver a conditional amount of the underlying shares to BofA during the 10 settlement dates in September 2008. PvF allows the investor to receive an initial payment (usually 75-85% of the market value) in exchange for the delivery of a variable number of shares or cash in the future. Since the contract sets minimum prices and threshold prices that determine the number of shares (or cash equivalents) returned at a given market price, the investor is protected against downside risks underground while enjoying potential for appreciation up to the threshold. A prepaid futures transaction differs from a standard futures contract in that the payment of the futures contract and the transfer of ownership of the underlying asset are made simultaneously at a future time, while its price is determined at the time of the contract. A prepaid futures contract may involve the sale of shares or other assets. A prepaid variable futures contract (PREPAID) is a strategy used by investors who have large shares and want to generate liquidity. Under a PVFC, an investor agrees to sell a number of shares at a discount, usually between 75 and 90% of the prevailing market value, but the buyer does not take possession of the shares immediately, but at a later date, usually after 2 to 5 years. However, the number of shares due at maturity is variable and not necessarily the previous fixed amount. Variable prepaid futures, as in Rev.
Rul. 2003-7 usually receives open transaction processing – the seller does not record a profit or loss until the shares are delivered to conclude the contract. This decision means that variable prepaid futures are often an attractive way to monetize valued assets while deferring the taxes associated with this increase in value. The IRS found a gap in McKelvey`s tax return for its 2008 tax year. The service argued that McKelvey (1) should have recognised a short-term capital gain on the renewal dates because the renewals resulted in a taxable exchange of the original contracts for the contracts renewed pursuant to § 1001 (where the profit was the number of shares pledged as collateral multiplied by the excess of the reserve prices in the original contracts above the closing price of the Monster share on the date ), and (2) the long-term capital gain from the renewal results from a constructive sale of the underlying shares in accordance with section 1259. Since the contract sets a minimum and maximum price for the final transaction, it also protects the investor from a high loss if the value of the share increases significantly before the transaction closes. The court also found that McKelvey did not realize a long-term capital gain on the underlying shares. He noted that the IRS in Reverend Rul.
2003-7 „approved the processing of `open` transactions for [prepaid variable futures] that meet certain criteria.” Using a variable prepaid futures contract allows that person to sell the shares to a brokerage company. .