[Congressional Record (Bound Edition), Volume 147 (2001), Part 6]
[Extensions of Remarks]
[Pages 7909-7910]
[From the U.S. Government Publishing Office, www.gpo.gov]



            ONE SWAP FUND TRANSACTION CONTINUES TO AVOID LAW

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                          HON. RICHARD E. NEAL

                            of massachusetts

                    in the house of representatives

                         Wednesday, May 9, 2001

  Mr. NEAL of Massachusetts. Mr. Speaker, I introduced legislation in 
the previous Congress to eliminate a tax avoidance technique available 
only to the very wealthy. This technique involves the use of swap 
funds. Today I am introducing this legislation again.
  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.
  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 interest in the funds' 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, one offering was 
limited to subscriptions of $1 million, although the general partner 
retained the right to accept subscriptions of lesser amounts. This, 
however, does not mean an individual with ony 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

[[Page 7910]]

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 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.
  Mr. Speaker, the Committee on Ways and Means regardless of the party 
in charge has traditionally been concerned with tax transactions 
constructed for the very few the sole purpose of which is to avoid 
paying tax. I believe the Committee continues to hold this concern and 
look forward to working with the Members to enact this law later this 
year.

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