[Congressional Record (Bound Edition), Volume 145 (1999), Part 14]
[House]
[Page 19744]
[From the U.S. Government Publishing Office, www.gpo.gov]


[[Page E1739]]

                         SWAP FUND TRANSACTIONS

                                 ______
                                 

                          HON. RICHARD E. NEAL

                            of massachusetts

                    in the house of representatives

                       Wednesday, August 4, 1999

  Mr. NEAL of Massachusetts. Mr. Speaker, today I am introducing 
legislation to eliminate a tax avoidance technique available only to 
the very wealthy. This technique involves the use of swap funds.
  Like the legendary phoenix, a bird that lived for 500 years, burned 
itself to ashes on a pyre, and rose alive from the ashes to live again; 
this swap fund transaction has been closed down by Congress three times 
to date, only to see life again in the form of new and more exotic 
designs to get around whatever restrictions had been placed into law.
  Legislation to shut down this particular practice was enacted in 
1967, 1976, and again in 1997. In 1967, Congress enacted a law to 
prevent swap funds from being transacted in the form of a corporation, 
as was popular at the time. This led to the swap fund transaction being 
resurrected in the form of a partnership, which was closed down in 
1976. Subsequently, the industry developed methods to get around both 
laws by manipulating the 80 percent test for investment companies. The 
Taxpayer Relief Act of 1997 closed these transactions down by 
broadening the definition of financial assets that are taken into 
account for purposes of the 80 percent test. Obviously, the point here 
is that three times Congress has acknowledged the tax avoidance 
potential of this transaction, and three times Congress has made a 
public policy decision to close this shelter down. And three times 
Congress has failed. We will not fail again.
  Swap funds are designed to permit individuals with large blocks of 
appreciated stock to diversify their portfolio without recognizing gain 
and paying tax. In this transaction, a fund is established into which 
wealthy individuals with large blocks of undiversified stock transfer 
their stock. In exchange for the transferred stock, these individuals 
receive an equivalent interests in the fund's diversified portfolio. In 
effect, these individuals have now diversified their holdings by mixing 
their shares of stock with different shares of stock from other 
individuals, without having to sell that stock and pay tax on the gain 
like ordinary Americans.
  The swap fund transaction is complicated, and is limited to 
individuals with large blocks of stock. For example, a recent offering 
was limited to subscriptions for $1 million, although the general 
partner retained the right to accept subscriptions of lesser amounts. 
This, however, does not mean an individual with only a million dollars 
in stock could invest in the swap fund. In order to avoid Securities 
and Exchange Commission registration requirements, these transactions 
are often limited to sophisticated investors who under SEC regulations, 
according to a 1998 prospectus, must have total investment holdings in 
excess of $5 million.
  As outlined above, current law tries to stop swap funds involving a 
corporation or a partnership that is in investment company. An 
investment company is a corporation or partnership where the 
contribution of assets results in a diversification of the investor's 
portfolio, and more than 80 percent of the assets of which are defined 
by law as includable for purposes of this test.

  In the most current form of the swap fund transaction, that 
limitation is avoided by holding at least 21 percent of assets in 
preferred and limited interests in limited partnerships holding real 
estate. In fact, the purpose of the fund is clearly identified by the 
prospectus, which states that ``the value of the Private Investments 
will constitute at least 21% of the total value of the Fund's 
portfolio, so that the Fund will satisfy the applicable requirements of 
the Code and the Treasury Regulations governing the nonrecognition of 
gain for federal income tax purposes in connection with the 
contribution of appreciated property to a partnership.'' As in past 
years, the bill I am introducing addresses the specific transaction 
being used; that is, the bill would eliminate the latest avoidance 
technique by providing that such investments would be treated as 
financial assets for purposes of the 80 percent test.
  The second part of this bill at long last recognizes the inadequacy 
of the above approach, given its 32 year record of failure. This 
section states that any transfer of marketable stock or securities to 
any entity would be a taxable event, if that entity is required to be 
registered as an investment company under the securities laws, or would 
be required to register but for the fact that interests in the entity 
are only offered to sophisticated investors, or if that entity is 
formed or availed of for purposes of allowing investors to engage in 
tax-free exchanges of stock for diversified portfolios.
  The effective date of this legislation is for transfers after date of 
Committee action, with an exception for binding contracts signed prior 
to date of introduction. While it is clear that the Committee will 
decide on the appropriate effective date, I do not believe it would be 
fair to apply this legislation to contracts signed prior to the date 
that taxpayers were first on notice of a potential change in the law. 
This effective date is, by the way, similar to the effective date the 
Committee chose for the 1997 change.
  For those taxpayers who react by rushing their deals, they should be 
on notice that I intend to attach this legislation to the first tax 
bill that emerges from the Committee on Ways and Means after September 
1, 1999. For those who have technical suggestions to make to the 
legislation, it would behoove them for the same reason to analyze this 
bill carefully and make whatever technical suggestions they have as 
soon as they practically can.
  Mr. Speaker, the life and death of this transaction is not simply 
another instance of American ingenuity and creativity which we can all 
admire. It is, in reality, a practical example of the need to seriously 
consider what generic powers should be granted to the Department of the 
Treasury to close down certain tax shelters without waiting for 
Congress, which inevitably can only attempt to keep up with the most 
obvious techniques being utilized to minimize tax payments.
  One of the great dangers I see on the horizon, Mr. Speaker, is that 
the proliferation of tax shelters will eventually lead to a severe 
backlash by Congress that may not be as well crafted as many, including 
myself, would like.

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