Taxation of Investment Derivatives

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Gavin Butler
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1 Taxation of Investment Derivatives TABLE OF CONTENTS Abstract Acknowledgements Table of contents References Abbreviations Chapter 1: Introduction 1.1. Appetizer 1.2. Scope of the study 1.3. Fundamental concepts 1.4. Methodology 1.5. Previous studies 1.6. Outline of the study and materials Chapter 2: Financial instruments 2.1. Introduction and outline of the chapter 2.2. Classification of financial instruments Classification tree Traditional instruments Common remarks Zero coupon bonds 2.3. Financial derivatives Common remarks Definitions of derivatives Notional principal contracts, forwards and futures Stock options Hybrid derivatives Character and purpose of hybrids Examples of hybrid derivatives 2.4. Investment derivatives Definition and common remarks Summary of selected investment derivatives Convertible bonds

2 Reverse convertible bonds Stock index bonds Chapter 3: Conceptual framework for the study 3.1. Introduction and outline of the chapter 3.2. Concepts and principles Principles of developed tax systems Common remarks Symmetry Neutrality Substance and form Fixed and contingent returns Source and residence principles Paying ability Debt and equity Concluding remarks on basic principles 3.3. Concept of income Generally on income in taxation Framework for economic income Schanz, Haig, Simons and the concept of income Generally on income in accounting Comprehensive income and accounting Concluding remarks on the concept of income 3.4. Accrual method Concept of accrual method Accrual method versus mark-to-market The potential of the accrual method Financial derivatives and mark-to-market Some theoretical remarks Some country-specific remarks Partial mark-to-market 3.5. Realisation method The concept behind the realisation method The status of the realisation method 3.6. Some comparisons Realisation versus mark-to-market Accrual and realisation methods in accounting 3.7. Bifurcation and integration Concepts

3 Evaluation of bifurcation and integration Chapter 4: Tax framework for the study 4.1. Introduction and outline of the chapter 4.2. Interest income and taxation The concept of interest income Taxation of interest income in OECD countries Deductibility of interest expenses Concluding remarks on interest income 4.3. Capital gains and taxation Definition of capital gains Capital and capital gains Capital gains and income types Different approaches Capital gains taxation in OECD countries Common remarks Capital gains in the OECD Model Convention Unrealised capital gains and losses Entitlement for tax on unrealised gains Tax deferral Lock-in effect Tax on unrealised gains and losses Concluding remarks on capital gains 4.4. Tax systems and principles in selected countries Principles of tax systems Summary of country practices Specific country notes Interest income in selected countries Summary of country practices Specific country notes United Kingdom Other selected countries Capital gains in selected countries Summary of country practices Specific country notes 4.5. Inflation and taxation Chapter 5: Accounting and financial derivatives

4 5.1. Introduction and outline of the chapter 5.2. The accounting framework for financial derivatives Common principles Generally accepted accounting principles Elemental valuation principles Fair value The concept of fair value Fair Value Directive International Financial Reporting Standards Basic principles of IFRS IFRS for financial instruments IAS 39 on recognition and measurement IAS 39 and investment derivatives Concluding remarks on concepts and methods 5.3. Investment derivatives and accounting in selected countries United Kingdom Germany Finland Sweden 5.4. Correlation between accounting and taxation Summary of country practices Generally on accounting versus taxation Financial derivatives and accounting versus taxation Chapter 6: Specific tax issues for financial derivatives 6.1. Introduction and outline of the chapter 6.2. Generally on taxation of financial derivatives Common remarks Tax policy issues Classification of debt and equity Classification of income OECD recommendations Tax practices in OECD countries Withholding taxes and financial derivatives Financial derivatives and tax avoidance Cross-border considerations 6.3. Additional tax method proposals Common remarks Expected return taxation

5 Retrospective taxation Evaluation of method proposals 6.4. Concluding remarks on different methods and issues 6.5. Specific financial derivative issues in selected countries United States United Kingdom Germany Finland Sweden Chapter 7: Tax treatment of investment derivatives 7.1. Introduction and outline of the chapter 7.2. Taxation of zero coupon bonds Common remarks Summary of country practices Specific country notes 7.3. Taxation of stock options Common remarks Summary of country practices Specific country notes United States United Kingdom Germany Finland Sweden 7.4. Taxation of convertible bonds Common remarks Summary of country practices Convertible bonds in selected countries United States United Kingdom Germany Finland Sweden 7.5. Taxation of reverse convertibles Common remarks Summary of country practices Reverse convertibles in selected countries United States

6 United Kingdom Germany Finland Sweden 7.6. Taxation of stock index bonds Income classification within stock index bonds Summary of country practices Stock index bonds in selected countries United States United Kingdom Germany Finland Current tax practice Commentary on domestic practice Sweden Current tax practice Commentary on domestic practice 7.5. Relevant cross-border issues in selected countries Chapter 8: Discussion on investment derivatives and principal tax issues 8.1. Introduction and outline of the chapter 8.2. Discussion on the taxation of investment derivatives Equivalencies and differences Classification of income Convertible bonds Reverse convertible bonds Stock index bonds 8.3. Discussion on unrealised gains and losses Common remarks Valuation and unrealised gains Timing and unrealised gains Paying ability and unrealised gains How do unrealised gains fit into concept of income? Why tolerate increased administrative work? Why bother with the taxation of unrealised gains? 8.4. Issues on classification, structure and accounting Is there right income classification for derivatives? One taxable derivative unit or several components? Should we prefer substance or form? Revision of current law texts or case law?

7 Should we increase book-tax conformity? 8.5. Some international aspects Common remarks Harmonisation of accounting and tax rules United States United Kingdom 8.6. Financial derivatives and development in Finland and Sweden Finland, accounting and taxation Common remarks Considerations before the new Companies Act Development after the new Companies Act Sweden, accounting and taxation Common remarks Ongoing development Chapter 9: Final remarks

Recognition of Deferred Tax Assets for Unrealised Losses (Amendments to MFRS 112) Deductible temporary differences

Recognition of Deferred Tax Assets for Unrealised Losses (Amendments to MFRS 112) This Addendum sets out the amendments to MFRS 112 Income Taxes. An entity shall apply the amendments in this Addendum for