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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