Congress tax writer weighs changes for derivatives

WASHINGTON Thu Jan 24, 2013 6:30pm EST

WASHINGTON (Reuters) - The Republican head of the U.S. House of Representatives' tax-writing panel unveiled on Thursday options to revamp the tax treatment of derivatives and other financial instruments amid criticism the current law permits the system to be gamed.

The discussion draft comes from House Ways and Means Committee Chairman Dave Camp, who has been exploring for more than a year a tax code overhaul - a politically daunting project made more so by deep fiscal policy divisions in Congress.

Tax rules for financial instruments "are inconsistent with each other and have no basis in the reality of economics," said David Miller, a tax lawyer at the Cadwalader law firm, who also teaches derivatives taxation at Columbia University Law School.

"As a result, sophisticated taxpayers are free to choose a tax treatment that minimizes their taxes," he added.

Camp's draft lays out options for altering the tax treatment of financial products such as options and futures contracts and swaps.

One proposal would require marking most derivatives to fair market value at year-end, triggering recognition of gains or losses. Mark-to-market rules would not apply to end-users, such as airlines hedging the price of jet fuel.

Another Camp option would tighten "wash sale" rules intended to prevent an abusive strategy that involves gaining a tax deduction by selling a security at a tax-deductible loss and then immediately re-buying the same or a similar security.

More broadly, House Republicans wants to slash the top corporate tax rate to 25 percent from 35 percent and simplify the loophole-riddled tax code. The United States has one of the steepest corporate tax rates in the world.

Most companies do not pay the top rate after deductions and other tax breaks. But both parties and President Barack Obama back a corporate tax rate cut, although they disagree on how deep it should be.

Several industry officials did not have immediate comment, but commodities dealers in particular are likely to fight hard against any changes related to a favorable tax treatment known as 60-40 rules, which the industry has enjoyed since 1981.

HOUSE, SENATE SIZING UP CHANGES

Camp's House panel, along with the U.S. Senate Finance Committee, held a joint hearing on financial products in late 2011, exploring the taxation of stocks, bonds and derivatives.

The Camp proposals taken together could raise or lose government revenue, panel officials said, depending on how other parts of the tax code interact with the changes.

The financial crisis that led to worldwide recession in late 2007 was exacerbated by the tax treatment of complex financial products, aides said.

"We want to make sure Wall Street knows what the rules are and that the American people know they are playing those rules," said Sage Eastman, a policy adviser to Camp.

The proposal tries to tackle abuses in the tax code due to the disparate treatment of debt versus equity, often identified by tax experts as a problem. Debt interest is tax deductible while stock dividends are not.

Another Camp idea is to make losses and gains on derivatives subject to the ordinary individual income tax rate.

The proposal would change the "60-40" rule that applies to a limited number of derivatives contracts, requiring all of the income to be subject to ordinary tax rates, instead of capital gains tax rates.

That rule allows dealers to pay a blended tax rates on gains and losses from trading futures and options.

Obama has proposed a version of this in recent budget proposals.

Camp's goal is to slash the ordinary tax rate, now topping off at 39.6 percent, to as low as 25 percent.

The Camp draft is altogether different from a separate proposal made this week by two liberal Democrats to tax all financial transactions.

(Reporting by Kim Dixon; Editing by Kevin Drawbaugh, Kenneth Barry and Andre Grenon)

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