Release Date: March 5, 2008
Contact:
Travis Larson, (202) 962-7357, tlarson@sifma.org

Changing Tax Rules for Exchange Traded Notes (ETNs) Causes SIFMA Concern

Washington, D.C., March 5, 2008 – The Securities Industry and Financial Markets Association (SIFMA), represented by Leslie B. Samuels of the firm of Cleary Gottlieb Steen & Hamilton, today testified that the tax treatment of prepaid derivative contracts and exchange traded notes (ETNs) should be clear, consistent, administrable and recognize that such products are complex instruments.  Samuels also noted the industry’s concern that H.R. 4912 as introduced may create new uncertainties and disparities as it attempts to alleviate others.

“We welcome the opportunity to provide our views on the development of a comprehensive set of rules for taxation of prepaid derivative contracts that are consistent, administrable, fair and certain,” said Samuels in prepared testimony. “We are concerned that H.R. 4912 would impose an overly complex tax regime that would single out prepaid derivative contracts for unfavorable treatment by requiring that investors include amounts in income that they have no right to receive and may never receive.”

The mutual fund industry has expressed concern that the availability of exchange-traded notes to retail investors reduces the relative attractiveness of mutual funds and puts them at a competitive disadvantage. But, SIFMA believes that these arguments (that ETNs are substantially similar to mutual funds and that they benefit from far superior tax treatment) are oversimplified.

In his testimony, Samuels noted the differences between the two products, which currently qualify them for different tax treatment:

1) ETN Investors Have No Right to Receive Cash Distributions

A fundamental rule of tax law is that an investor who has the full right to take cash income, but elects not to, is subject to taxation on that cash as if it were received. Investors in mutual funds have a current right to receive cash (through dividends); holders of ETNs do not.

2) ETNs Do Not Represent Ownership of Any Assets

Investors in mutual funds effectively own the underlying securities held by the mutual funds. Upon a liquidation of a mutual fund, investors will receive their pro rata share of securities held by the fund. In contrast, a prepaid derivative is an unsecured contract between the investor and the issuing company that provides for a payment at maturity determined by an objective formula, subjecting ETN owners to credit risk not associated with mutual funds.

“In light of the complexity of the issues that will need to be resolved in order to arrive at fair and administrable tax rules, we respectfully suggest that the legislative review be coordinated with the Treasury’s consideration of these same issues,” added Samuels. “We look forward to participating in this important dialogue.”

The full written testimony can be found here:

http://www.sifma.org/legislative/testimony/pdf/derivative-ETNStatement03-05-08.pdf

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The Securities Industry and Financial Markets Association brings together the shared interests of more than 650 securities firms, banks and asset managers. SIFMA's mission is to promote policies and practices that work to expand and perfect markets, foster the development of new products and services and create efficiencies for member firms, while preserving and enhancing the public's trust and confidence in the markets and the industry. SIFMA works to represent its members’ interests locally and globally. It has offices in New York, Washington D.C., and London and its associated firm, the Asia Securities Industry and Financial Markets Association, is based in Hong Kong.

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Position:
SIFMA opposes any substantive changes to the provisions of the Commodity Exchange Act applicable to over-the-counter (OTC) derivatives.

Status:
The House Agriculture Committee approved the Commodity Futures Trading Commission Reauthorization Act of 2007.  SIFMA joined the International Swaps and Derivative Association (ISDA), the Futures Industry Association (FIA), and the Managed Funds Association (MFA) in a letter of support for the bill.  CFTC reauthorization language was included in the Senate-approved farm bill (H.R.2419).  It is expected the House and Senate will work to reconcile differences between the two bills in January. 

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Overview:
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Position:
SIFMA supports open investment policies and the free flow of capital.

Status:
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