Financial Engineering Seminar
March 2, 2007 (Fri)
Time: 1:55 pm
Place: TBA
This paper focuses on three groups of issues raised by § 901(l) of the Internal Revenue Code, added as part of the American Jobs Creation Act of 2004.
Section 901(l) imposes a holding-period requirement for claiming foreign tax credits for withholding taxes on non-dividend income, including interest. Section 901(l) tolls the holding period when a taxpayer hedges the relevant instrument with a position in substantially similar or related property (SSRP). A taxpayer cannot count days during which it has hedged the instrument with a position in SSRP. Earlier legislation and administrative regulations addressed how the SSRP concept applies to equities.
First, the paper examines the risk profile of fixed-income instruments in light of the legislative history of § 901(l). The paper concludes that the definition of a position in SSRP should be the same for all Internal Revenue Code sections employing the term. Under this analysis, the directive in the legislative history of § 901(l) that hedging interest rate and FX risks does not toll the holding period under § 901(l) also should apply to all Internal Revenue Code sections using the SSRP concept. This includes the reduced rate of tax for qualified dividend income under § 1(h)(11), the corporate dividends-received deduction of § 243, the foreign tax credit rules for withholding tax on dividends under § 901(k), and the stock straddle rules of § 1092. The paper also discusses how some of the directives in the legislative history about excusing hedges of certain risks, such as credit risk, from the SSRP calculation in limited circumstances require implementing regulations before taxpayers can take advantage of them.
Second, the paper examines the risk profile of credit derivatives and structured credit products and evaluates when they might qualify as a position in SSRP to their reference obligations. It concludes that credit spreads are the key factor for credit derivatives and structured credit products referencing a single obligation, such as credit default swaps. It concludes that other factors, such as recovery rates, become more important as the credit derivative or structured credit product references more obligations. It also addresses how structural features of various products, such as the first-loss tranche of collateralized debt obligations, may affect this analysis.
Third, the paper discuss some basics of capital structure arbitrage and how § 901(l) may affect these trades. It also discusses certain tangential tax issues that § 901(l) raises.