The House Ways and Means Select Revenue Measures Subcommittee held a hearing this week to discuss possible tax reforms on financial products such as derivatives.

Wednesday’s hearing focused on a discussion draft released in January by the chairman of Congress’s tax-writing House Ways and Means Committee, Dave Camp, R-Mich., proposing a series of tax reforms for financial derivatives.

“The financial products discussion draft is a starting point for how the committee can modernize the taxation of financial products as part of comprehensive tax reform,” said Select Revenue Measures Subcommittee chairman Pat Tiberi, R-Ohio. “Simplifying the taxation of financial products is long overdue. However, it should only be done in the context of broader legislation that, amongst other things, lowers statutory tax rates. Indeed, these changes would have a different impact on financial products if the draft was enacted as a one-off revenue raiser or tax increase—something that neither Chairman Camp nor I would support.”

However, Tiberi acknowledged that the changes proposed in the discussion draft have received support from both sides of the aisle.

The ranking Democrat on the subcommittee, Rep. Richard Neal, D-Mass., noted that he has worked on the issue of the taxation of derivatives for some time, holding two hearings on the tax treatment of derivatives and exchange-traded notes, or ETNs, when he chaired the subcommittee several years ago. Neal has also introduced legislation to address the tax treatment of ETNs. In 1998, following the collapse of the hedge fund Long Term Capital Management, which needed a bailout in the billions of dollars, Neal had co-sponsored legislation to shut down the tax avoidance transactions set up through derivatives.

“With that experience, I can tell you that this topic is not for the faint of heart,” said Neal. “Just explaining the different types of derivatives can fill volumes, plus the market is constantly evolving and growing. But this is a very important area of our tax law and one in need of reform. So I applaud Chairman Camp for taking up the challenge and releasing a discussion draft that has a lot of merit. Chairman Camp's legislation updates the antiquated tax treatment of financial derivatives and replaces it with a single set of rules.”

Neal noted that under current law there are two types of derivatives that are economically similar but are taxed differently. Camp’s proposal would eliminate this distinction by requiring investors to use mark-to-market accounting for all derivatives, except for business hedging. “I think harmonizing these rules makes a lot of sense,” said Neal.

A senior official at the Internal Revenue Service cautioned that Congress should consult with the IRS before making any sweeping tax law changes.

“At the moment, both tax writing committees have charged their staffs with the preparation of detailed background information and sometimes even policy drafts on tax reform subjects,” said IRS chief counsel William J. Wilkins in a speech Monday at the Tax Executives Institute. “This is the kind of process that is most conducive to IRS being able to impart our concerns. On the other hand, we have seen other kinds of tax processes, where bills happen quickly and are driven by high level negotiations, that make it difficult to include IRS input. The thing that I would like to remind policymakers of is that stability in the tax law has its own value as a reform. Many of our most serious tax administration challenges come from the rapid pace of change and from uncertainty regarding the fate of temporary provisions. On this point, there is actually good news to report from the January 2013 ATRA legislation, because it changed several significant tax laws from temporary rules to permanent rules. From a tax administration viewpoint, enacting permanent alternative minimum tax rules is an extremely significant change.”

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