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IRS issues safe harbour regulations governing the assignment of derivatives

By Daniel Mayo, Principal Consultant (KPMG in the US) and Rowan Liu, Associate (KPMG in the US) in the Financial Services Tax practice in New York City – On 5 November, 2013, the US Treasury Department (Treasury) and the Internal Revenue Service (IRS) issued final regulations1 that address when a transfer or assignment of a derivative contract does not result in a taxable event to the non-assigning counterparty  for purposes of section 1001 and Treasury regulations section 1.1001-1(a). 

The final regulations adopt the safe harbor approach provided in the temporary regulations that were released in 2011,2 and clarify that payments made to or from an assigning party will not create a deemed loan under the rules in Treasury regulations section 1.446-3(g)(4) (relating to certain significant nonperiodic payments).


Section 1001 provides rules governing the computation, realization, and recognition of gain or loss from a sale, exchange or other disposition of property. The Treasury regulations promulgated thereunder provide that gain or loss is realized upon an exchange of property for other property differing materially either in kind or in extent.3  The modification of a contract can be a taxable disposition of the old contract if the modified contract differs materially from the old contract either in kind or in extent.4 Thus, the assignment of a contact, including many modern derivatives, may be treated as a taxable disposition to the non-assigning party.5 

Following the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act,6 derivatives are increasingly cleared by clearing organizations or assigned by dealers to their affiliates; in some instances, dealers may even be required to transfer or assign entire books of derivative contracts in order to satisfy regulatory requirements. As a result, taxpayers such as hedge funds and other broker-dealer counterparties were concerned that such contract assignments by the dealer community could create a taxable event for the non-assigning party.  

The Regulations

Treasury and the IRS first addressed these concerns in July 2011 with the issuance of temporary regulations. The temporary regulations addressed these concerns by providing that the transfer or assignment of a derivative contract is not treated as a deemed exchange of the contract by the non-assigning party for purposes of Treasury regulations section 1.1001-1(a) if three conditions are satisfied:7

  • The transfer or assignment is between dealers or clearinghouses; 
  • The terms of the contract permit the transfer or assignment, whether or not the consent of the nonassigning counterparty is required; and
  • The terms of the contract are not otherwise modified as to trigger recognition under section 1001.

One of the more important impacts of the temporary regulations was to broaden the safe harbor that existed in the prior regulations (which were issued in 1998). Previously, only dealer-to-dealer transfers of Notional Principal Contracts (“NPCs”) qualified for the safe harbor; the temporary regulations applied to derivative financial instruments on securities, currencies, or commodities, including options and forward contracts, in addition to NPCs.8 Further, the temporary regulations expanded the safe harbor to also apply to transfers to and from clearinghouses, not just dealers.

Another important impact of the temporary regulations was to clarify that taxpayers can qualify for the safe harbor in the regulations even if their contracts require the assigning or transferring party to obtain consent from the non-assigning party.
The final regulations issued on November 5, 2013 adopt the language of the temporary regulations without modification and added one additional practical point of interest to the assigning or transferring party. The final regulations provide that, with respect to derivative contracts that qualify as notional principal contracts under Treasury regulations section 1.446-3, any payment between the assignor and the assignee would not constitute an embedded loan under Treasury regulations section 1.446-3(g)(4) as long as the transfer or assignment satisfies the conditions in the final regulations.9 Treasury and the IRS believe that it would be inconsistent to find an embedded loan from a transfer that does not create a taxable event for the non-assigning counterparty.10


The tax community, including those representing the buy side and the sell side, generally was pleased with the expansion in the temporary regulations of the safe harbor for the non-assigning party.  The regulations also cleared up the market uncertainty surrounding the issue of whether a contract permitted assignment if consent was required of the non-assigning party. Perhaps this explains why the IRS received no written or electronic comments to the temporary regulations and no public hearing was requested or held.  Similarly, the final regulations are welcome news because they adopt wholesale the text of the temporary regulations and provide greater certainty for assigning parties.  These final regulations should greatly facilitate the movement of derivatives without creating unnecessary tax hurdles.


  1. T.D. 9639 (November 5, 2013).
  2. T.D. 9538 (July 21, 2011).
  3. Treas. Reg. § 1.1001-1(a).
  4. See Rev. Rul. 90-109, 1990-2 C.B. 191 (ruling that a fundamental change to the contract is a disposition under section 1001).
  5. See Cottage Savings Ass’n v. Commissioner, 499 U.S. 554, 566 (1991) (finding properties to be materially different “so long as they embody legally distinct entitlements”).
  6. P.L. 111-203 (2010).
  7. See Treas. Reg. § 1.1001-4(a)(1)-(3).
  8. See Treas. Reg. § 1.1001-4(c).
  9. Treas. Reg. § 1.1001-4(c).
  10. T.D. 9639, supra, Preamble.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
KPMG LLP, the audit, tax and advisory firm (, is the U.S. member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 152,000 professionals, including more than 8,600 partners, in 156 countries.

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