Newspaper article International Herald Tribune

Closing in on Investors' Tax Games

Newspaper article International Herald Tribune

Closing in on Investors' Tax Games

Article excerpt

Representative Dave Camp has proposed to make substantial changes in the taxation of financial instruments. Changes that some on Wall Street are already talking about ways to abuse.

Tax reform, at least in American politics these days, is generally discussed at only the most abstract level. There is general agreement that it would be nice to lower tax rates while broadening the base by getting rid of loopholes. The latter, of course, are seldom specified in any detail and are very much in the eye of the beholder.

If real tax overhauls are ever to be adopted, the United States is going to have to get specific on small things as well as large. Representative Dave Camp, the Michigan Republican who heads the House Ways and Means Committee, has taken an impressive step in that direction with a proposal to make substantial changes in the taxation of financial instruments.

Mr. Camp's proposal got relatively little attention in the news media, although it has set off alarm bells in some Wall Street precincts, where it threatens to dismantle some cherished ways the financial industry has invented to allow banks to reap some sure profits by taking a cut of tax benefits they offer to customers.

"Congressman Camp's proposal reflects his efforts to respond to the changing realities of modern financial markets," said Mark Price, who led the Financial Institutions and Products group at KPMG's Washington National Tax practice.

Studying Mr. Camp's proposal is not always easy sledding. This is an area of law that has grown exceedingly complicated, in large part because each change in the law is greeted with new tax avoidance tactics and strategies, which eventually lead to new provisions to combat those but may open the way to still more gambits. And on and on. Many innovations in finance accomplish nothing for the overall economy, but instead are aimed solely at gaming either the tax or regulatory rules.

Lobbyists for one part or another of the financial services industry have gotten provisions passed to benefit their products over those of competitors, leading to demands by competitors for equal treatment.

It would be nice to report that Mr. Camp had found a magic way to end these games, but he has not. Some on Wall Street are already talking about ways that some of his proposals, if enacted, could be abused.

Mr. Camp understands that and has called his proposal a "discussion draft," one that is aimed at getting comments from those who would be affected.

He will get plenty of them.

One principle that the Camp proposal would establish is to provide what the congressman calls "uniform tax treatment of financial derivatives." That uniformity would come as a shock to a lot of taxpayers -- including many who have no idea that what they have been doing has involved derivatives.

The bill provides that investors should never be able to get capital gains tax treatment for profits from derivatives, or a contract whose value is derived from an underlying security, like futures or options on stocks, currencies or commodities. No matter how long it is held, a derivative could create only ordinary gains or losses. And changes in value would be subject to tax every year, as the market price changed, whether or not the investor sold it.

There are many tax-oriented strategies to create differing tax treatments for what are actually offsetting investments. The idea is to have a loss treated as ordinary income and recognized as soon as possible, while the offsetting gain is delayed and then treated as a long-term capital gain if that is possible.

The Camp proposal would establish a general rule that both arms of an offsetting strategy would be taxed as ordinary income or loss on a mark-to-market basis, a method of measuring asset values that can change over time, at the end of each year.

So if one position made money while the other lost, they would wash each other out. There would be little reason to enter into many such transactions. …

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