On August 31^st, the U.S. Internal Revenue Service amended Temporary Treasury Regulations under Section 871(m) of the U.S. Internal Revenue Code of 1986, as amended, that were originally issued on January 23, 2012, postponing the effective date for the new regulatory scheme contemplated by Proposed Treasury Regulations also issued on January 23, 2012.  The Temporary Regulations now extend the definition of “specified notional principal contract” that is set forth in Section 871(m)(3)(A) to payments made before January 1, 2014.

Commentators on the Proposed Regulations have noted that they pose many challenges for the withholding tax system and expand the contexts in which a non-U.S. person may be required to act as a withholding agent.  It was further noted that Section 871(m) is principally aimed at arrangements that provide synthetic exposure to the full economic risk and reward of an underlying security (so-called total return or delta one transactions).  However, the Proposed Treasury Regulations could apply more broadly to other arrangements, including options and other instruments that are not economic substitutes for actual ownership.  In this regard, the amendment to the Temporary Treasury Regulations acknowledges that U.S. Department of the Treasury and the Internal Revenue Service received numerous comments that the proposed effective date of January 1, 2013, would not allow taxpayers enough time to build and test the systems required to implement the withholding rules for specified notional principal contracts.  In response to these comments, the amended Temporary Regulations effectively delay the applicability of the definition of “specified notional principal contract” that is set forth in the Proposed Treasury Regulations until January 1, 2014.  For additional information on this development, please click here.

The application of a financial transaction tax on bond, equity and derivatives transactions in Europe continues to be intensely debated. As noted in a previous alert,^[1] several months ago the European Commission proposed the introduction of a plan to tax derivatives and other financial transactions each time at least one of the parties to a transaction is located within the 27 member-state European Union (the “EU”). Equity and bond transactions would be assessed a 10 basis point tax and derivatives transactions would be assessed a 1 basis point tax. The tax under this plan would become effective in 2014 and was expected to raise approximately €57 billion per year. READ MORE →

On September 28th, the European Commission (“EC”) proposed the introduction of a plan to tax financial institutions on derivatives and other financial transactions each time at least one of the parties to a transaction is located within the 27 member-state European Union. In outlining the plan, EC President Jose Manuel Barroso noted that the public sector had provided €4.6 trillion in aid and guarantees to the financial sector and that it was now “time for the financial sector to make a contribution back to society.” The tax would become effective in 2014 and, if enacted, is expected to raise approximately €57 billion per year.

To avoid evasion by transacting in economically-equivalent (or similar) products, the plan would have a broad application, covering equities and bonds (which would be assessed a 10 basis point tax), as well as derivatives (which would be assessed a 1 basis point tax). Significantly, currency derivatives would be covered by the tax, although foreign exchange spot transactions—which constitute some $1.5 trillion of the $4 trillion average daily turnover foreign exchange market—would be exempt from the tax. Primary market transactions (which include sovereign and corporate bond auctions), private household transactions (such as home mortgages) and transactions with central banks also would be exempt. The purpose of the contemplated tax appears to be two-fold: to curb speculation and raise revenue, including possibly to support or recoup losses from member-state bailouts.

The idea of a financial transaction tax is not new and is perhaps most notably tied to Nobel prize-winning economist James Tobin, who argued for its application in the 1970s (consequently, financial transaction taxes are often referred to as a “Tobin taxes”). Opponents of the tax argue that it would merely constitute another cost passed on to customers and that, unless it were globally implemented, would lead to a decrease in trading activity where it applies.^[1] Supporters of the tax contend that these claims are exaggerated. If such a tax indeed is applied on a “per transaction” basis, it may especially impact high-frequency trading—which may now account for the majority of trading volume on exchanges—due to the sheer number of trades transacted.

Implementation of the plan would only occur throughout the European Union if, ultimately, the tax is ratified by each of the member states, which is not certain.^[2]

In the United States, a financial transaction tax was briefly considered in the House of Representatives in 2009. Secretary of the Treasury Timothy F. Geithner has stated his opposition to such a tax, arguing that it would negatively impact liquidity and exacerbate the financial crisis without reducing volatility or risk-taking.^[3] However, on October 4th, two lawmakers introduced a proposal for a financial tax on equities, bonds and derivatives in the United States. Estimated revenues from such a tax have not yet been released, although the 2009 proposal had estimated revenues of up to $150 billion per year.

^[1] Note that EC President Barroso on October 5th in fact announced that the EC would propose a global financial tax at the November 2011 meeting of the G20.

^[2] There appears to be a sharp difference of opinion about the tax among international regulators and, within the European Union, member-states. Germany and France, in particular, have been vocal supporters of the tax, while the United Kingdom and Sweden oppose it. Sweden has some experience in the assessment of financial transaction taxes, as it had imposed such a tax on equity and bond transactions between 1984 and 1991.

^[3] Seven industry groups (including the U.S. Chamber of Commerce) wrote to Secretary Geithner on September 22nd to reiterate their opposition to a financial transaction tax, noting that it would harm the entire U.S. economy, as it would “impede the efficiency of markets, impair depth and liquidity, raise costs to issuers, investor, and pensioners, and distort capital flows by discriminating against asset classes.” This letter may be found at http://www.nam.org/~/media/DB03A4A7EC744A4C9F880DCB033CB51E/FTT_Letter_to_Secretary_Geithner .pdf. Note that a small tax (i.e., 2-4¢ per $100 of stock) in fact existed on stock transfers in the U.S. from 1914 until 1966.

On July 15^th, the Department of the Treasury, Internal Revenue Service (“IRS”), issued temporary and proposed regulations (the “Temporary Regulations”)^[1] addressing when a transfer of certain derivative contracts does not result in an “exchange” to the remaining party for purposes of Section 1.1001-1(a) of the Income Tax Regulations (the “Tax Regulations”) of the Internal Revenue Code (the “Code”). The significance of the Temporary Regulations is that they clarify that, subject to certain specified conditions, a transfer of a derivative contract by a counterparty does not, in and of itself, result in an event for which gain or loss must be calculated by a remaining party, irrespective of whether the terms of the derivative contract itself require the consent of the remaining party for the transfer. READ MORE →

On May 11, 2009, the Obama Administration, responding to concerns about dividend withholding abuse, released legislative proposals that include a provision requiring withholding on certain equity swaps where the underlying position relates to a U.S. corporation. Our next issue will contain a detailed explanation of this provision and its implications.