Synthetic prime brokerage and the risk of tax recharacterisation: Difference between revisions

===Why a [[synthetic equity]] position is not a secret [[custody]] position tax fiddle===

====The IRS position on the product generally====

As far as we know the IRS labours under no illusions about the synthetic equity swap product, understands it and is comfortable with how it trades. This is why it introduced [[871(m)]]. “High delta” equity derivatives are a widely traded, liquid, and standardised product; the IRS understands it, accepts it, and has already taken direct measures to ensure they are taxed appropriately (ie 871(m)). The [[IRS]]’s goal is to stop [[dealer]]s disguising nominee ownership arrangements, not to stop them paying the [[delta one]] value of securities to clients under genuine swap contracts. If that were their aim, the “[[hypothetical broker dealer]]” language wouldn’t work anyway; the [[dealer]] would have to adjust the [[delta]] ''away'' from 1 by a meaningful amount.  In turn, that would significantly transform the product:  the point of the synthetic equity swaps is to exactly replicate the performance of a stock through derivatives. It is hard to see the IRS’s interest in targeting legal “[[verbiage]]” to see if they catch [[dealer]]s out by extracting tax from those who have forgotten to use the word “hypothetical” here or there in a master confirm. If that were a genuine risk, the [[dealer]] should not be doing this business at all.