Treasury and IRS Issue Notice and Revenue Ruling Concerning "Prepaid Forward Contracts" (i.e., Non-Principal-Protected Structured Notes and Similar Instruments)

On December 7, 2007, the Treasury Department and the Internal Revenue Service issued Revenue Ruling 2008-1 and Notice 2008-2, both of which address certain tax issues related to “prepaid forward contracts.” The term “prepaid forward contract” is a term used by tax practitioners to characterize a variety of financial instruments, including: “exchange traded notes,” or “ETNs,” and other types of structured notes, such as equity-linked and commodity-linked notes, as well as reverse convertibles, variable stock purchase contracts, mandatory exchangeables, mandatory convertibles, and access notes. The Revenue Ruling and the Notice contemplate that such instruments may become subject to taxation on a current accrual basis at ordinary rates (as opposed to capital gains rates), and raise issues as to how such instruments should be treated for purposes of the U.S. withholding tax rules and international tax rules.