Sometimes it’s useful to be reminded that not all financial structuring is designed to get around capital requirements or defraud customers. Some is designed to get around taxes and defraud the treasury! One group of people who like to think about that kind of thing is the Congressional Joint Committee on Taxation, who took some time out from shouting about payroll taxes yesterday to have a geeky hearing about the state of financial instrument taxation. Short version is, they’re not all that happy about it.
The JCT staff generally say pretty smart stuff about tax policy, and they get that shit is fucked up and bullshit. Or as they put it more diplomatically:
The timing, character, and source rules apply differently to (and are sometimes uncertain for) equity, debt, options, forward contracts, and notional principal contracts. These five basic instruments can be combined in various ways to replicate the economic returns of any underlying asset. … The flexibility of financial instruments also creates great difficulties in the taxation of financial instruments. This report provides examples of taxpayers’ uses of financial instruments to achieve desired timing, character, and source outcomes and describes how the tax laws have or have not addressed this tax planning.
There are two useful takeaways here. One is kind of weird: there are a bunch of fairly basic things (exchange-traded notes, CDS) where nobody – not the IRS, not the JCT, nobody – knows how they’re supposed to be taxed. That … seems like a bad thing. And, I’m going to guess, not so much the fault of evil financial innovators.