In a recently released Chief Counsel Advice Memorandum (the CCA), the Internal Revenue Service broadened its scrutiny of so-called “barrier option” transactions, which taxpayers have used to defer recognition of income and to convert ordinary income and short-term capital gain to long-term capital gain.¹  The government had previously announced that it would scrutinize these transactions in guidance released in 2010 and in July of this year.²  The CCA is consistent with the previous guidance, and expands upon it in two ways:

• It specifically targets a transaction that is a barrier option on a hedge fund interest. While the previous guidance acknowledged that this type of transaction could come under scrutiny, the previous guidance did not examine the potential for perceived abuse inherent in this kind of transaction; and,

• It develops certain legal doctrines that the government may use to attack these transactions in more detail than the previous guidance.

Because of this, the CCA should be of interest to banks which provide exposure to this kind of option, to hedge funds whose interests are referenced thereby, and to potential investors.

_{¹ CCA 201547004, Aug. 11, 2015.
² AM 2010-005, Notice 2015-47 and Notice 2015-48.  See, also GT Alert New Guidance Regarding Basket Derivatives, Jul. 15, 2015.}