Selected Provisions of the Rep. Camp Bill on Financial Products

Transcription

1 Selected Provisions of the Rep. Camp Bill on Financial Products Mark Leeds Tax Partner (212) June 2013 Mayer Brown is a global legal services provider comprising legal prac5ces that are separate en55es (the "Mayer Brown Prac5ces"). The Mayer Brown Prac5ces are: Mayer Brown LLP and Mayer Brown Europe- Brussels LLP both limited liability partnerships established in Illinois USA; Mayer Brown Interna5onal LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regula5on Authority and registered in England and Wales number OC ); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated en55es in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Prac5ces in their respec5ve jurisdic5ons.

2 Mark Leeds Mark Leeds ) is a tax partner with the law firm of Mayer Brown. Mark s professional prachce focuses on the tax consequences of a variety of capital markets products and strategies, including over- the- counter derivahve transachons, swaps, tax- exempt derivahves and strategies for efficient uhlizahon of tax apributes, such as net operahng losses. Mark is also the editor- in- chief of DerivaHves: Financial Products Report, a Thomson/RIA monthly publicahon. Prior to joining Mayer Brown, Mark was a shareholder at Greenberg Traurig, served as a Managing Director at Deutsche Bank, general counsel of a credit derivahve company and, prior to that, Mark was a partner at DeloiPe & Touche where he led the Capital Markets Tax PracHce.

3 The Treatment of Derivatives Under the Camp Discussion Draft 3

4 Background of the Rep. Camp Proposal In 2011, the American Bar AssociaHon issued a report suggeshng changes in the taxahon of financial products. The Camp Discussion Dra_ incorporates certain of those comments and expands on them. It also adopts its own proposals. The Discussion Dra_ was not put forward with a view towards the enactment of the specific provisions, as contained therein. Nonetheless, the Discussion Dra_ conhnues the march towards mark- to- market for financial products and a bias towards treahng gains & losses as ordinary in character. 4

5 Derivatives Is Broadly Defined under the Discussion Draft A derivahve would be defined as a (1) derivahve interest in stock, partnership interest, debt instrument, achvely traded commodity, currency, (2) swap and (3) derivahves on either (1) or (2). No requirement that any reference asset be publicly- traded. DerivaHve financial instruments would include swaps, ophons, forwards, futures, short posihons or similar financial instruments. The Discussion Dra_ incorporates the rule in Prop. Treas. Reg (c)(1)(ii) that treats accruals as payments to determine if a contract has 2 or more payments. 5

6 Are Weather Swaps Derivatives under the Discussion Draft? The Technical ExplanaHon accompanying the Discussion Dra_ provides that swaps are not based on objechve financial informahon are included in the definihon of derivahves. But the Technical ExplanaHon specifically excludes weather derivahves (degree day, precipitahon) from the definihon of a swap. The proposed legislahve language, however, is broad enough to include such instruments. 6

7 Real Estate Positions & Derivatives under the Discussion Draft DerivaHves with respect to real estate are not derivahves if: The derivahve is respect to a single tract of land; or The derivahve references real estate which would be inventory in the hands of the taxpayer. How the real estate rule dovetail with the rule for partnership interests? An ophon sold with respect to real property would not be a derivahve, but an ophon sold with respect to a partnership interest would be a derivahve. Should a look- thru rule apply? 7

8 Convertible Financial Instruments Would Be Subject to Bifurcation ConverHble bonds & debt instruments with embedded derivahves would be subject to bifurcahon. The FMV of the bond must be determined without the conversion or parhcipahng feature. The FMV of the bond without the conversion feature is then subtracted from the market price of the converhble bond. The excess is then subject to mark- to- market treatment. Is the proposal intended to reach holders or holders & issuers? Impact of Code 1032 on issuers? 8

9 Debt Instruments with Embedded Derivatives Would Be Subject to Subject to New Rules Debt instruments with embedded derivahves are par$ally subject to mark- to- market rules & ordinary treatment. A debt instrument has an embedded derivahve if some or all of the cash flows or the value of other payments could be affected by a derivahve- like payment. The Discussion Dra_ would require bifurcahon & the derivahve would be subject to mark- to- market, but the debt instrument would not be subject to MtM. ConHngent payment debt instruments (CPDIs) are not treated as having embedded derivahves. 9

10 Straddles Would Be Subject to Special Rules Mixed straddles (When a taxpayer enters into an offselng derivahve posihon with respect to a capital asset ): All built- in gain is immediately recognized on the capital asset & retains its character as capital. All built- in loss is locked as capital loss as of the acquisihon of the derivahve & is recognized under normal realizahon principles. All subsequent gain or loss on the straddle posihon would be taxed as ordinary (even on the non- derivahve piece). All posihons in the straddle are subject to mark- to- market treatment. 10

11 More on Mark-to-Market Rules for Derivatives Under the Discussion Draft All derivahves would be taxed on the mark- to- market method of accounhng. Dealer/trader/ investor dishnchon is eliminated. All gains & losses would be ordinary in character. TerminaHons of derivahves would not give rise to capital gains or losses. If no public mark on the derivahve is available, the Discussion Dra_ provides the value used for shareholder reports is to be for tax purposes. (Book- tax conformity) 11

12 More on Mark-to-Market Rules for Derivatives Under the Discussion Draft ValuaHon of posihons under MtM rules must be made without any blockage discounts or control premiums. Other than for commodihes, the Discussion Dra_ does not limit derivahves to posihons in achvely- traded posihons. Non- traded posihons can be derivahves. Since all gains & losses on derivahves would be ordinary, Code 1234B, 1236 & 1256 would be repealed. 12

13 Unintended Consequences Mark-to-Market Rules for Derivatives? What is the effect of the proposed rules on employee stock ophons? Is the answer different if the ophon is vested or subject to a substanhal risk of forfeiture? Would stock appreciahon rights (SARs) be affected by the proposed rules? Could interests in rabbi trusts be treated as forward contracts & subject to MtM? 13

14 The Treatment of Hedging Transactions Under the Camp Discussion Draft 14

15 Hedging Transactions Would Be Carved Out From Mark-to-Market Treatment DerivaHves held in hedging transachons would not be subject to mark- to- market rules. Straddle rules would be made inapplicable to hedging transachons. Code 263(g) disallowance rules for net interest & carrying charges would be made inapplicable to hedging transachons. 15

16 Disparate Treatment for Capital Asset Hedges A derivahve acquired to hedge risk in a capital asset would be subject to mark- to- market & ordinary treatment. If the hedged asset is a capital asset, gain or loss on the hedged item remains capital. 16

17 Bootstrapping Financial Accounting Hedge Designations The Treasury RegulaHon (b) definihon of a hedge would be codified (a promohon that would come without a raise). Hedges could be idenhfied by same day ID as a tax hedge; same as current rule OR If a taxpayer designates a transachon as a hedge on its audited financial statements, the transachon would be automahcally treated as a hedge for tax purposes. BUT a transachon designated as a book hedge would be treated as a tax hedge ONLY if treated as a hedge for some tax purpose. Trap for the unwary: many transachons qualify as tax hedges, but do not qualify as financial accounhng hedges. 17

18 The Treatment of Debt Modifications & Market Discount Under the Camp Discussion Draft 18

19 The Discussion Draft Would Create a Floor on the Issue Price of the Modified Debt When a debt is undergoes a significant modificahon, the debt is considered to be reissued. With a bias towards using FMV, the exishng rules can result in significant cancellahon of indebtedness ( COI ) income for issuers. Holders losses are usually deferred if the exchange is treated as a recapitalizahon. Discussion Dra_ would require valuahon of modified debt by using lesser of: Par value if required cash flows are at least equal to par by discounhng at this applicable Federal rate and Adjusted issue price of the pre- modified debt 19

20 The Discussion Draft Would Conform Market Discount Rules to the OID Rules Market discount on debt acquired a_er effechve date of Bill would be subject to current inclusion in income. Market discount would be determined as though bond were issued on date of acquisihon. Market discount on distressed debt would be limited to the greater of the original yield on the bond + 5% and the AFR (as of the acquisihon of the bond) + 10%. Market discount accruals would be reduced by OID accruals. Rules for short- term bonds would be conformed too. 20