SWAPS can trigger income when a counterparty assigns his position to someone else.

That’s because the assignment is considered an exchange of the old swap for a new one with a different counterparty for the person still holding the swap. Any exchange of one instrument for another has the potential to trigger income if the new instrument is considered more valuable than the old one.

However, the IRS said in regulations that it finalized in November that an assignment of a swap or other derivatives contract by a dealer or clearinghouse to another dealer or clearinghouse will not be treated as a taxable exchange. This is true only if the transfer is permitted by the terms of the contract and the terms are not otherwise modified. The regulations can be found under section 1001 of the US tax code.

The implication is that there could be a taxable exchange in other circumstances.

It is potentially a taxable exchange if the holder of a swap or other derivatives contract ends up with a “materially different” credit on the other side of the contract.

By Keith Martin