The House Ways & Means Committee’s Subcommittee on Select Revenue Measures holds a hearing today on The Tax Treatment of Derivatives.  From the hearing announcement:

The hearing will focus on various forms of derivatives. Interest in certain types of derivatives has increased over the last few years as many innovative structures have reached the financial markets. The hearing will examine the tax treatment of some of these products. …

In announcing the hearing, Chairman Neal stated, "The expanding derivatives market is already a $516 trillion global enterprise, only some of which is subject to regulation and transparency. I think it is appropriate for Congress to review the tax rules as they apply to these complex financial products and determine whether changes may be necessary.”

Here are the witnesses scheduled to testify:

• Panel #1:
  • Michael J. Desmond (Tax Legislative Counsel, U.S. Treasury Department)
  • Alex Raskolnikov (Columbia Law School)
  • Reuven S. Avi-Yonah (University of Michigan Law School)
  • Keith A Styrcula (Chair, Structured Products Association)
• Panel #2:
  • George U. "Gus" Sauter (Chief Investment Officer, The Vanguard Group; Managing Director, Quantitative Equity Group)
  • William M. Paul (Covington & Burling, on behalf of Investment Company Institute)
  • Leslie B. Samuels (Cleary Gottlieb Steen & Hamilton, on behalf of Securities Industry and Financial Markets Association)
  • Michael B. Shulman (Shearman & Sterling)

In connection with the hearing, the Joint Committee on Taxation has released Present Law and Analysis Relating to the Tax Treatment of Derivatives (JCX-21-08):

This document provides a brief introduction to financial derivative instruments (“derivatives”) and the complex tax policy issues that they raise. In Section II, we provide a definition of derivatives and discuss their uses in business and financial markets. We then define and explain options, forwards and swaps, the fundamental building blocks of all other derivatives. Expanding on the discussion of options and forwards, we outline in Section III how derivatives and debt instruments can be combined to synthesize the economic returns of an equity security. In Section IV we explore in general terms the challenges that derivatives and their uses pose for the income tax system. Section V contains a brief discussion of current tax law as it applies to options, forwards and swaps, along with two summary tables. The first table provides a broad overview of tax rules that currently apply to derivatives. The second table shows how the particular factual circumstances that apply to holders of the same type of instrument (a call option) can radically change the tax rules applicable to that asset. In Section VI, we present a more detailed case study of a single prepaid derivative contract (a “mandatory convertible”) that provides its holder with an economic return that matches an active stock trading strategy. In that context, we discuss various approaches to the tax treatment of prepaid derivative contracts, including the interest accrual approach adopted by H.R. 4912. As described in greater detail below, H.R. 4912 changes the tax treatment of certain prepaid derivative contracts by requiring holders of the contracts to include on an annual basis as interest income an amount generally calculated by reference to a short-term applicable federal rate.

The hearing will take place at 10:00 a.m. in the main Committee hearing room (1100 Longworth House Office Building).