[Congressional Record Volume 143, Number 22 (Wednesday, February 26, 1997)]
[Extensions of Remarks]
[Pages E333-E334]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




           INTRODUCTION OF SHORT AGAINST THE BOX LEGISLATION

                                 ______
                                 

                        HON. BARBARA B. KENNELLY

                             of connecticut

                    in the house of representatives

                      Wednesday, February 26, 1997

  Mrs. KENNELLY. Mr. Speaker, I rise today to introduce legislation to 
curb the use of innovative tax avoidance techniques that have enabled 
some investors to indefinitely defer, and in some circumstances 
completely avoid, capital gains taxes. Under current law, capital gains 
are subject to tax only when there is a sale or exchange of the 
property. In this respect, our tax laws have fallen far behind the 
financial markets. The financial markets have succeeded in creating 
transactions and instruments that are equivalent to sales in an 
economic sense but avoid the tax that would be required in the case of 
a sale. I must agree with Robert Willens, a managing director at Lehman 
Brothers, who was quoted recently in the New York Times as stating, 
``old fashioned notions of sale are totally inappropriate for the world 
we live in today.'' My bill redefines the concept of when there is a 
sale for tax purposes in order to take into account the economic 
substance of these new transactions.
  There is a growing perception that the capital gains tax has become 
voluntary for large investors. There is evidence that capital gain 
recognitions by large investors have stagnated

[[Page E334]]

in recent years even as the stock market has soared. Typically, average 
middle-income families have invested through mutual funds whereas 
relatively wealthier investors also hold direct investment in the stock 
market and in real estate. Taxable capital gains reported by investors 
who hold only mutual funds have soared in recent years whereas taxable 
capital gains reported by investors with direct stock and real estate 
investments have remained below the level reported in 1988. The 
availability of these avoidance techniques may have played a role in 
this decline.
  Many of the transactions affected by my bill are not available to the 
ordinary investor because of their cost. Bankers Trust, a company 
specializing in equity swap transactions, will do an equity swap only 
when the investor has a block of stock valued in excess of $2 million. 
Also, it should be emphasized that these transactions would not be done 
except for the tax avoidance potential. In an economic sense they are 
equivalent to an outright sale, but their costs are substantially 
greater than those involved in a simple sale.
  We rely on voluntary compliance to collect our income taxes. In fact, 
our current high level of voluntary compliance is the envy of the rest 
of the world. That high level of voluntary compliance is threatened by 
the existence of tax avoidance techniques that are only available to 
the wealthy in our society. The current law capital gains tax applies 
to all Americans. If the capital gains tax should be reduced it should 
be done legislatively for all taxpayers, not by Wall Street for the 
select few.
  The bill I am introducing today includes two provisions. The first 
provision would provide for recognition of gains in the case of 
transactions, like equity swaps and ``short against the box'' 
transactions, that are equivalent to sales. This provision is based on 
a proposal recommended by the President in his recent budget 
submission. I have modified the President's proposal to address 
concerns that it would adversely impact legitimate hedging 
transactions. My bill contains simplified accounting rules for 
securities traders and would trigger recognition of gain only when 
there is deferral of tax over year-end. However, I have retained the 
effective date recommended by the President since my bill is basically 
a modified version of his proposal.
  The other provision of my bill addresses another abuse, the so-called 
swap fund, that Congress thought it eliminated almost 30 years ago. In 
a swap fund transaction, an investor wishing to diversify his 
investment exchanges his holding of a specific stock for an interest in 
a diversified investment pool. The current version of this device 
involves having the fund hold at least 20 percent of its assets in 
investments that are not readily marketable. My bill eliminates that 
simple avoidance technique.
  I urge the support of my colleagues.

        Technical Description: Short Against the Box Legislation


                      constructive sales treatment

       The Kennelly bill would require a taxpayer to recognize 
     gain upon entering into a constructive sale of any 
     appreciated position in either stock, a debt instrument, or a 
     partnership interest. The taxpayer would recognize gain as if 
     the position were sold and immediately repurchased.
       The bill would define a constructive sale as any of the 
     following transactions (and any other transaction having 
     substantially the same effect as a transaction described 
     below):
       (1) a short sale of the same or substantially identical 
     property;
       (2) entering into an offsetting notional principal contract 
     with respect to the same or substantially identical property. 
     For this purpose, an offsetting notional principal contract 
     is a contract to pay the investment yield on the property for 
     a specified period in exchange for the right to be reimbursed 
     for decline in the value of the property and other 
     consideration;
       (3) entering into a futures or forward contract to deliver 
     the same or substantially identical property;
       (4) an acquisition of the underlying property where the 
     taxpayer holds an appreciated short position described in 
     subparagraphs (1), (2), or (3).
       The bill could not trigger gain in circumstances where the 
     underlying property is sold in a taxable transaction during 
     the year or where the constructive sale is closed during the 
     taxable year (and if closed in the last month of the year, is 
     not reestablished in 30 days).
       If the taxpayer makes a constructive sale of less than all 
     of his property, the determination of which property is 
     involved in the constructive sale would be made under the 
     principles applicable to outright sales. Under current law, 
     this would permit specific identification.
       The bill would not apply to any contract for the sale of 
     any stock, debt instrument or partnership interest that is 
     not a marketable security (as defined under the rules that 
     apply to installment sales) if the sale is reasonably 
     expected to occur within one year of the date the contract is 
     entered into. Nor would the proposal generally treat a sales 
     contract subject to normal terms and conditions as a 
     constructive sale. In addition, the proposal would not treat 
     a transaction as a constructive sale if the taxpayer is 
     required to mark the market the appreciated financial 
     position under Section 475 (mark to market for securities 
     dealers) or Section 1256 (mark to market for futures 
     contracts, options and currency contracts). The bill would 
     permit securities traders to elect mark to market treatment 
     under Section 475.
       Like the proposal included in the President's budget, the 
     bill would be effective for constructive sales entered into 
     after the date of enactment. In addition, the bill would 
     apply to constructive sales entered into after January 12, 
     1996, and before the date of enactment if the transaction 
     resulting in the constructive sale remains open after 30 days 
     after the date of enactment. The bill would apply to those 
     pre-enactment transactions as if the constructive sales 
     occurred on the date that is 30 days after the date of 
     enactment.
       A special rule would apply to constructive sale entered 
     into on or before the date of enactment by decedents dying 
     after the date of enactment. If the constructive sale remains 
     open on the date before the date of death and gain has not 
     been recognized under the bill, the appreciated financial 
     position would be treated as property constituting rights to 
     receive income in respect to a decedent under Section 691.


                          swap fund provisions

       Under current law, gain is recognized on the contribution 
     of property to a corporation or partnership that is an 
     investment company. The Code defines an investment company as 
     any corporation or partnership where more than 80% of its 
     assets by value consist of stocks or securities that are 
     readily marketable. The bill provides that all stocks and 
     securities, including those not readily marketable, are taken 
     into account under the 80% test.

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