Daily Tax Update - July 21, 2011: Treasury, IRS Issue Temporary & Proposed Regulations Regarding Derivate Contracts

TREASURY, IRS ISSUE TEMPORARY AND PROPOSED REGULATIONS REGARDING DERIVATIVE CONTRACTS:  The Treasury Department and the IRS have issued temporary and proposed regulations that treat the assignment or transfer of certain derivative contracts as not resulting in a taxable disposition to the nonassigning party, if certain conditions are met.  The temporary regulations apply to transfers or assignments of derivative contracts made on or after July 22, 2011.

  • The temporary regulations modify Treas. Reg. 1.1001-4(a), which provides that the substitution of a new party on a notional principal contract (“NPC”) is not recognized as a deemed exchange by the nonassigning party if (1) the NPC is assigned or transferred between NPC dealers and (2) the terms of the contract permit the substitution. 
  • The preamble to the temporary regulations states that many NPCs permit assignment of the contract only with the consent of the nonassigning counterparty and that there had been some uncertainty as to whether a contract that requires the consent of the nonassigning counterparty as a condition to assignment will satisfy the second requirement of Treas. Reg. 1.1001-4(a).  The preamble also states that others have suggested that the scope of Treas. Reg. 1.1001-4 is too narrow because it only applies to NPCs.  The need to amend Treas. Reg. 1.1001-4(a) has been increased by the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, since such Act may necessitate the movement of entire books of derivative contracts, which raises the concern that such assignments may create a taxable event for the nonassigning counterparties to the assigned contracts. 
  • Under the new temporary regulations, the nonrecognition treatment is expanded to include assignments or transfers of certain other derivative contracts if three conditions are met.
    • First, the derivative contract must be assigned or transferred between dealers in securities or clearinghouses.
    • Second, the terms of the derivative contract must permit the assignment or transfer.  The new temporary regulations clarify that this condition may be satisfied by contracts that require the consent of the nonassigning counterparty as a condition to assignment.
    • Third, the terms of the derivative contract must not be otherwise modified in a manner that results in a taxable exchange under section 1001.
  • For the new temporary regulation to apply, the derivative contract must be one of the securities listed below.
    • An interest rate, currency, or equity notional principal contract;
    • A share of stock in a corporation;
    • A partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust;
    • A note, bond, debenture, or other evidence of indebtedness;
    • An interest rate, currency, or equity notional principal contract;
    • Any currency, including any option, forward contract, or short position;
    • Any similar financial instrument in such a security or currency (excluding section 1256(a) contracts); and
    • Any position that is not an NPC nor described above that (1) is a hedge with respect to such a security and (2) is clearly identified in the dealer's records as being described as a hedge with respect to such a security before the close of the day on which it was acquired or entered into.
    • Any consideration for the assignment or transfer paid between the assignor and assignee does not affect the treatment of the nonassigning counterparty.  However, any consideration received by the nonassigning counterparty will be analyzed under section 1001 to determine whether a taxable sale or disposition has occurred.
  • The regulations can be accessed via:
    http://www.steptoe.com/publications/2011-18529.pdf
    http://www.steptoe.com/publications/2011-18531.pdf
  • For additional information, contact Philip R. West - pwest@steptoe.com or  Mark J. Silverman - msilverman@steptoe.com

DEAL OR NO DEAL?  Despite some reports that the White House and Speaker John Boehner were close to a debt ceiling/deficit-reduction deal, White House Press Secretary Jay Carney countered that report.  Carney said today, "There is no deal.  We are not close to a deal.”  Carney added that there is "no progress to report."  Senate Majority Leader Harry Reid also said this afternoon there was no deal.  Reid said, "What I have to say is this.  The president always talked about balance.  There has to be some fairness in this.  This can't all be cuts.  There has to be some revenues.  The caucus agrees with that.  I hope the president sticks with that and I am confident he will." 

  • Earlier today, Senate Budget Committee Chairman Kent (a member of the Gang of Six) expressed support for a six-month increase to the debt ceiling.  Conrad said, "You know, I've always believed that there will be first a shorter-term extension.  I would prefer one that's perhaps six months in duration so that you start the process — you begin with a down payment, then you have time for the committees of Congress to come back with a floor package."  Conrad added, "That’s my own view of how this should work, and I think it's more in tune with the realities of the magnitude of the task."  Regarding tax reform, Conrad said, "The tax code is not going to be reformed in a matter of weeks — that's going to take months and months of work."
  • House Speaker John Boehner said earlier today that he would be willing to compromise.  Boehner stated, "I’m sure that we’ve got some members who [aren't willing to compromise], but I do not believe that’s anywhere close to a majority."  Boehner added, "The ball continues to be in the president’s court, and it’s been there for some time."
  • Meanwhile, House Ways and Means Committee Chairman Camp commented on the Gang Of Six’s proposal.  Camp said, "I think it’s a positive development that there’s some bipartisan approach to addressing the debt limit, and I like the fact that there’s lower rates, but I’m concerned about the revenue that’s raised that isn’t because the economy’s growing but because there’s a tax increase.  I’m concerned about that."
  • Another member of the Gang of Six said, "Given the fact the clock is ticking … there’s not going to be an opportunity to take any specific action on this proposal between now and August 2.  We’ll have to look at our options."
  • Tomorrow, the Senate is expected to hold a vote and defeat the "cut, cap and balance" plan.  Senate Majority Leader Harry Reid said, "I think this piece of legislation is about as weak and senseless as anything that has ever come on this Senate floor. I am not going to waste the Senate's time day after day on this piece of legislation."  Reid added, "I feel confident that this legislation will be disposed of one way or the other. The American people should understand that this is a bad piece of legislation, perhaps some of the worst legislation in the history of this country."
  • Reid also criticized the House for not working through the weekend.  Reid said, "Let me get this off my chest.  I just heard there is an announcement in the House of Representatives that they are taking the weekend off.  I think this is a very bad picture to have the House out this weekend when we have to likely wait for them to send us something, because as I understand the negotiations taking place deal with revenues which constitutionally have to start in the House."  Reid added, "I think it is just untoward.  That’s the kindest work I can say… What a bad picture."

SENATE FINANCE TAX REFORM HEARING ON HOW TAX CODE AFFECTS HIRING, GROWTH:  On July 27, the Senate Finance Committee will hear perspectives from top business decision-makers about how tax laws affect hiring and economic growth.  The hearing is titled "CEO Perspectives on How the Tax Code Affects Hiring, Businesses and Economic Growth."

  • Witnesses at next Wednesday’s hearing will include:
    • Mr. Michael T. Duke, President and Chief Executive Officer, Wal-Mart Stores, Inc.
    • Mr. Thomas J. Falk, Chairman and Chief Executive Officer, Kimberly-Clark Corporation
    • Mr. Gregory S. Lang, President and Chief Executive Officer, PMC-Sierra, Inc.
    • Mr. Larry J. Merlo, President and Chief Executive Officer, CVS Caremark Corporation

WITNESS LIST FOR WAYS & MEANS HEARING ON TAX REFORM AND CONSUMPTION-BASED TAXES ANNOUNCED: The witnesses for the July 26th hearing on tax reform and consumption-based taxes have been announced.

  • The witnesses are:
    • PANEL (FairTax):                   
      • Mr. Mike Huckabee, former Governor of Arkansas, Hope, AR.
      • Dr. Laurence J. Kotlikoff, Professor of Economics, Boston University, Boston, MA.
      • Mr. Bruce Bartlett, Columnist, Tax Notes, The Fiscal Times, Contributor, The New York Times, Great Falls, VA.
    • PANEL (Value Added Tax):                                                         
      • Mr. Michael J. Graetz, Columbia Alumni Professor of Tax Law, Columbia University, New York, NY.
      • Dr. Rosanne Altshuler, Professor and Chair, Economics Department, Rutgers University, New Brunswick, NJ.
      • Dr. Robert J. Carroll, Ernst & Young LLP, Washington, DC.
      • Mr. Jim White, Director, Tax Issues, Government Accountability Office, Washington, DC.
      • Dr. Daniel J. Mitchell, Senior Fellow, Cato Institute, Washington, DC.
      • Dr. Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, Sloan School of Management, Massachusetts Institute of Technology, former Economic Counselor and Director of the Research Department at the International Monetary Fund, Cambridge, MA.

WAYS & MEANS OVERSIGHT SUBCOMMITTEE ANNOUNCES HEARING ON NEW IRS PAID TAX RETURN PREPARER PROGRAM:  On July 28, the House Ways and Means Subcommittee on Oversight will hold a hearing on the new IRS paid tax return preparer program. In announcing the hearing, Subcommittee Chairman Charles Boustany said, "This hearing is a continuation of the Subcommittee’s oversight of the IRS and the alarming rates of tax noncompliance. With so many Americans relying on paid professionals to prepare their returns, it is critical that we better understand what the IRS is doing and what impact the new regulations will have on taxpayers, paid tax return preparers, and tax compliance."

TAX BILLS INTRODUCED JULY 20TH:

1. [112nd] H.R.2604 : To amend the Internal Revenue Code of 1986 to provide for the treatment of securities of a controlled corporation exchanged for assets in certain reorganizations.
Sponsor: Rep Slaughter, Louise McIntosh [NY-28] (introduced 7/20/2011)      Cosponsors (16)
Committees: House Ways and Means
Latest Major Action: 7/20/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

2. [112nd] S.1390 : A bill to amend the Internal Revenue Code of 1986 to simplify, modernize, and improve public notice of and access to tax lien information by providing for a national, Internet accessible, filing system for Federal tax liens, and for other purposes.
Sponsor: Sen Levin, Carl [MI] (introduced 7/20/2011)      Cosponsors (1)
Committees: Senate Finance
Latest Major Action: 7/20/2011 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

STEPTOE & JOHNSON LLP - TAX PRACTICE
Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving. Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them. Read more information on Steptoe's tax practice.