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The article says that this scheme occurred during specific years.

During the 1990’s they also beat the market.

“Medallion, which is open only to current and former Renaissance employees, has generated returns of about 40 percent after fees for decades by using computers to spot market patterns. It’s distinct from the funds Renaissance makes available to outsiders, such as the Institutional Equities Fund.

Medallion earns most of its money through short-term trading of securities and other assets. Such earnings typically get taxed at the same marginal rate as salary. The tax code rewards longer-term investments with a preferential, lower rate.

The dispute centers on transactions the firm carried out with Barclays Plc and Deutsche Bank AG between 2000 and 2015 that had the effect of transforming short-term trading gains into long-term returns. Rather than own securities directly, Renaissance instructed the banks to buy and sell them within a portfolio of assets. It then bought an option from the banks tied to the portfolio’s performance”

I’m confused. Doesn’t the recipient pay these taxes, so it wouldn’t show up when comparing fund returns?

I'm not a finance guy, but I think the idea is this:

Ren says "we bought an option and held it for a year". The option's counterparty was a bank, I guess, so they just form a company to hold the bag, and the company that is created reports to the IRS that they don't have any assets, just a basket of assets to offset the option they're responsible for.

At the end of the contract (and there can be more than one of these going on at the same time) the assets can be sold, and would be sold, in order to pay for the option contract which was now held for a year. Some money would go to the broker for executing the trades over time, etc. but much less than the taxes that would otherwise be paid.

So, the part that has the tax man scratching his head is that if Ren was directing the buying and selling of the assets in the basket constantly, is that really holding on to an asset, or is it just a lie? They say they got a tax lawyer to sign off on it, so it goes to court to see if it's a defensible position. If not, they'll probably pay a slap on the wrist and won't get to do it again.

It's not done in isolation IIRC. This sounds a lot like how I understand swaps are done, so it may be that this is only slightly unusual.

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