Tax-News
Congress
Studies US Financial
Products Tax Reform
by Mike Godfrey
25 March 2013
Led
by its Chairman Pat Tiberi (R –
Ohio), the Subcommittee on Select Revenue Measures has held a hearing
on the
draft proposals released by the United States House of Representatives
Ways and
Means Committee's Chairman Dave Camp (R – Michigan) on financial
products tax
reform.
As
part of its discussions on
comprehensive tax reform, the Ways and Means Committee released a
discussion
draft on January 24, 2013, of one specific component of broader tax
reform
legislation involving the uniform tax treatment of financial products.
It
was said that the Committee had
released that draft because it proposed fundamental changes in the way
the US
taxes financial products, and sought feedback from a broad range of
stakeholders, taxpayers, practitioners, economists, and members of the
general
public on how to improve this proposed set of rules. The Subcommittee's
hearing
formed part of that consultation.
In
announcing the hearing, Tiberi
said: "The Ways and Means Committee worked hard to produce a draft
proposal that reforms the arcane and often inconsistent tax rules
governing
derivatives and other financial products. This hearing will give the
Subcommittee
the opportunity to consider the potential impact on investors and other
participants in the financial markets."
The
draft proposals would provide
uniform tax treatment of financial derivatives. The draft would require
taxpayers engaged in speculative financial activity to mark certain
financial
derivative products to fair market value at the end of each tax year,
thus
triggering the recognition of gain or loss for tax purposes.
The
tax code already requires or
permits mark-to-market accounting for specific financial products, such
as
certain contracts and options that are traded on exchanges, and for
specific
taxpayers, such as securities and commodities dealers and traders, but
it is
suggested that broadly extending mark-to-market accounting treatment to
derivatives would provide a more accurate and consistent method of
taxing these
financial products and make them less susceptible to abuse.
It
has been stressed that
derivatives that are used by companies in the ordinary course of their
businesses to hedge against price, currency, interest rate and other
risks
would not be affected. In addition, for taxpayers that are engaged in
hedging
business risks, the draft would allow transactions that are properly
treated as
hedges for financial accounting purposes to also be treated as hedges
for tax
purposes.
Apart
from a reform to the tax
rules that apply to debt restructurings, the draft would also require
the
holder of bonds, which are acquired on a secondary market at a
discount, to
recognize taxable income on the discount over the remaining life of the
bond –
conforming the tax treatment of such transactions to bonds acquired at
a
discount directly from the borrower.
In
addition, to simplify tax
compliance and administration, and to determine more accurately the
amount of
gain or loss when a security is sold, the draft would require the cost
basis of
the security to be based on the average cost basis of all other shares
or units
of the identical security held by the taxpayer.
Finally,
the draft reform would
prevent the circumvention of the so-called "wash sale" anti-abuse
rule, intended to prevent taxpayers from harvesting tax losses by
selling
securities at a loss and then immediately reacquiring the same
securities, by
using related parties such as spouses, children or entities controlled
by the
taxpayer. The draft would reform the rule so that it applies to
transactions
involving closely related parties.
Richard
E. Neal (D –Massachusetts),
the Subcommittee's Ranking Member, confirmed that "just explaining the
different types of derivatives can fill volumes, plus the market is
constantly
evolving and growing," and he applauded Camp "for taking up the
challenge and releasing a discussion draft that has a lot of merit." He
confirmed that "this is an area where there is agreement between the
parties on how to address a problem with our tax rules."
"Camp's
legislation updates
the antiquated tax treatment of financial derivatives and replaces it
with a
single set of rules," Neal added. "Under current law, you can have
two types of derivatives that are economically similar but are taxed
differently. The Camp proposal would eliminate this distinction by
requiring
investors to use mark-to-market for all derivatives, except for
business
hedging. And I think harmonizing these rules makes a lot of sense."
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