[Congressional Record Volume 153, Number 195 (Wednesday, December 19, 2007)]
[Extensions of Remarks]
[Page E2663]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                INTRODUCTION OF PREPAID DERIVATIVES BILL

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                          HON. RICHARD E. NEAL

                            of massachusetts

                    in the house of representatives

                      Wednesday, December 19, 2007

  Mr. NEAL of Massachusetts. Madam Speaker, I rise today to introduce 
legislation addressing the taxation of prepaid derivative contracts. 
The appropriate tax treatment of financial products is ever evolving, 
just as the market for these products is. Occasionally, Congress or the 
Treasury must step in and clarify how these new offerings should be 
treated under the tax code. And my bill today will do that.
  Recently, a new product called Exchange Traded Notes, has caught the 
attention of regulators and investors. The main benefit of these notes 
is their tax treatment. Issuers have advised buyers that these 
interests receive almost unlimited tax deferral on any gain earned. 
And, they advise that even when the gain is recognized at the point 
that the note is sold or redeemed, it is taxed as long-term capital 
gain and not ordinary income. These notes can run as long as 30 years 
and track an exchange rate, index, or commodity.
  So, with almost unlimited tax deferral, it seems that many other 
investments would pale in comparison. Already, many investors have 
caught on. These exchange-traded notes have garnered $4 billion of 
investment in a very short period of time. Some argue that this tax 
treatment is justified, as holders of these notes have some credit 
risk. If the issuer goes under, the holder may not get paid.
  But this favorable tax treatment has not gone without notice. In a 
Tax Notes magazine article aptly titled, ``Too Good To Be True?'' one 
practitioner called this tax treatment, ``The Wild West of the tax 
law.'' And one columnist in the Washington Post likened this new tax 
sheltering opportunity as opening ``Pandora's Tax Box.'' It is 
important to note that this favorable tax treatment is premised on the 
opinion of one law firm.
  More recently, Treasury has stepped in to clarify that Exchange 
Traded Notes tied to foreign currencies are debt and do generate 
taxable income to investors. In a companion notice, Treasury asked for 
comments on whether holders of other prepaid forward contracts should 
be required to accrue income during the term of the contract. It is 
possible that Treasury will produce guidance providing appropriate 
clarity in this market, but in the interim, I believe legislative 
action is warranted.
  The legislation that I am filing today provides rules for the tax 
treatment of prepaid derivative contracts, which includes Exchange 
Traded Notes. Holders of such instruments will be required to include 
as interest income each year an amount determined by reference to a 
short-term interest rate. The basis in such contract would be adjusted 
by any income inclusion so that at disposition, any gain or loss would 
be properly accounted for just as it would be with any other investment 
receiving annual payments.
  In past Congresses, I have pursued legislation to curb vehicles 
providing unlimited tax deferral to investors, such as swap funds. I 
believe it is important that our tax laws reach instances where 
interest is earned or gain recognized, especially where the products 
are complex or lack transparency. The legislation that I am filing 
today takes another step in that direction. But I welcome constructive 
comments from practitioners on both sides of this issue. Above all, if 
we amend the tax code, we want to get it right the first time.
  I look forward to discussing this complex issue with my colleagues in 
the New Year and seeking their support for this bill.

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