On August 6, 2026, the U.S. Tax Court held in SIH Partners LLLP v. Commissioner, 167 T.C. No. 8, that a partnership was not entitled to qualified dividend income (QDI) treatment or associated foreign tax credits (FTCs) on dividends received from four Swiss stocks because the partnership held a position in "substantially similar or related property" (SSRP). Even though the transaction did not implicate a mechanical test for SSRP, the Tax Court found that it triggered an anti-abuse rule found in Treas. Reg. § 1.246-5(c)(1)(vi).

The Applicable Rules

Under section 1(h)(1) and (11), QDI is taxed at preferential capital-gains rates. To qualify, taxpayers must hold stock for a specific period, in this case 60 days. 

The holding period is subject to section 246(c)(1), which disregards any time in which "the taxpayer is under an obligation… to make related payments with respect to its positions in" SSRP. Congress enacted section 246(c) to prevent risk-free "dividend arbitrage," where a taxpayer holds offsetting long and short positions in the same stock around the dividend record date, collecting the dividend (and its preferential tax treatment) while hedging away exposure to the stock's price movement. Congress left the test for when a taxpayer has impermissibly diminished risk to the Department of the Treasury.

Treas. Reg. § 1.246-5 supplies the applicable rules. A taxpayer has "diminished its risk of loss" when changes in the fair market value of the stock and the position with respect to SSRP are reasonably expected to vary inversely. The regulation further sorts positions by size – positions reflecting a "portfolio" of stocks (defined as a group of stocks of 20 or more unrelated issuers) are tested under the "Portfolio Rules" of paragraph (c)(1)(ii)-(iv) and positions reflecting more than one stock but fewer than 20 issuers are subject to the "Nonportfolio Rules" and are tested separately against each underlying stock under paragraph (c)(1)(v). Finally, paragraph (c)(1)(vi) provides an overriding anti-abuse rule.  

Under the Portfolio Rules, Treas. Reg. §1.246-5(c)(1)(iii) provides a "Substantial Overlap Test," which the court applies and describes as a mechanical, bright-line test for testing whether a portfolio position is SSRP. The Substantial Overlap Test includes three steps: 

1. Construct a "Subportfolio" consisting of stock in an amount equal to the lesser of (i) the fair market value of each stock represented in the short position and (ii) the fair market value of that stock in the taxpayer's stock holdings (i.e., not in the short position). 
2. If the fair market value of the Subportfolio is equal to or greater than 70 percent of the fair market value of the stocks represented in the position, the position and the Subportfolio substantially overlap, and the position is SSRP.
3. If the position does not substantially overlap with the Subportfolio, the taxpayer repeats steps 1 and 2 while reducing the size of the position (maintaining the relative proportions of each stock). The largest percentage of the position that produces a substantial overlap is treated as SSRP with respect to that percentage. 

Testing for substantial overlap occurs on each "testing date," which is any day the taxpayer buys, sells, or changes the composition of the position. See Treas. Reg. §1.246-5(c)(1)(iv). The test functions as a safe harbor permitting up to 70 percent overlap (i.e., requiring at least 30 percent unhedged risk). 

To illustrate the first two steps in the Substantial Overlap Test, assume that the value of the position in a short portfolio is $6,750 and the value of stocks in the Subportfolio (i.e., the overlap computed under step 1) is $4,100. Because the fair market value of the Subportfolio represents 60.74 percent ($4,100/$6,750) of the position, there is no substantial overlap, and the position is not SSRP. 

The regulatory analysis doesn't end there, however. An anti-abuse rule applies "notwithstanding" the Portfolio and Nonportfolio Rules and can treat a position as SSRP even where the Substantial Overlap Test is satisfied. For the rule to apply, each of the following elements must be met: 

1. Changes in the value of the position (or the stocks reflected in it) are reasonably expected to "virtually track" (directly or inversely) changes in the value of the taxpayer's stock holdings 
2. The position is held as part of a plan a principal purpose of which is to obtain tax savings
3. Whose value is "significantly in excess" of the plan's expected pre-tax economic profits

See Treas. Reg. § 1.246-5(c)(1)(vi).

Transaction Summary

The transaction in SIH Partners involved a portfolio swap arrangement with Morgan Stanley that included: (1) an unhedged short position maintained in one or more indexes or securities to mitigate firm-wide risk in the event of an overall market downturn (the Firm Hedge), (2) long positions in Novartis, Roche, Nestle, and Swisscom (collectively, the Swiss Equities), and (3) offsetting identical short positions in the Swiss Equities. 

SIH Partners LLLP (SIHP) held the Swiss Equities across their respective ex-dividend dates, generating $170.8 million in dividends. Because the equities were issued by Swiss-domiciled "qualified foreign corporations," the dividends were potentially eligible for QDI treatment, subject to the SSRP rules. Finally, because a holder of a short position does not receive dividends but must instead pay a "substitute dividend" to the counterparty, SIHP remitted roughly 78 percent of the Swiss Equities' dividends back to Morgan Stanley, leaving it with roughly $40.6 million in net dividends from its long positions. 

The Tax Court's Holdings 

The court, relying on the plain text of Treas. Reg. § 1.246-5, rejected the Internal Revenue Service's (IRS) primary argument, which urged the court to disregard the form of the portfolio swap arrangement and disaggregate the "Firm Hedge" from the swap causing the Swiss Equities to be tested as separate positions under the "Nonportfolio Rules." The court held that the swap transaction's form matched its substance. In doing so, the court emphasized that the IRS must "apply the SSRP regulations as written" and cannot invoke the substance-over-form doctrine to further what the court called the IRS's "subjective views regarding the propriety of the Transaction at issue." 

The court then determined that because the short on the Swiss Equities and the Firm Hedge should be considered together, the "Portfolio Rules" under Treas. Reg. § 1.246-5(c)(1)(ii)-(iv) applied. Under that test, the short position was not SSRP to the Swiss Equities.

SIHP's substance-over-form victory was short-lived, however. As it frequently does, the IRS had a back-up argument: the anti-abuse rule of Treas. Reg. § 1.246-5(c)(1)(vi). The court agreed with the IRS and held that the anti-abuse rule applied because the offsetting long and short positions in the Swiss Equities satisfied the "virtual tracking" test and the expected tax savings exceeding $25 million were "significantly in excess" of an expected pre-tax profit of, at most, $2.4 million. As a result, the applicable holding periods of the Swiss Equities were reduced and the dividend income was not eligible for QDI treatment. Because the Swiss Equities were SSRP, the court further held that SIHP's FTC was barred under section 901. 

Takeaways

SIH Partners is a precedential opinion and reaffirms that courts must engage with statutory and regulatory text as a first step in a substance-over-form analysis. Moreover, even though the substance-over-form doctrine did not apply as the IRS wanted, the court arguably considered the substance of the transaction as it applied the more general anti-abuse rule (which requires examining tax benefits versus non-tax benefits). The court also provides a helpful roadmap for applying the "virtual tracking," "principal purpose," and "significantly in excess" prongs of the anti-abuse rule, which have not previously featured in a Tax Court opinion. Furthermore, important to the court's determinations relating to the expected pre-tax economic profit were the reports and testimony of experts. SIH Partners is a reminder that the persuasiveness of economic analyses can be determinative in these types of cases. 

For more information, please contact:

Andy L. Howlett, ahowlett@milchev.com, 202-626-5821

Eric J. Albers-Fiedler, ealbers-fiedler@milchev.com, 202-626-5568

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