ETN tax debate has greater implications for investment tools, resolution unlikely soon, tax experts say

By Kenneth Lim

New York, April 10 - The ongoing debate on the appropriate tax treatment for exchange-traded notes has implications across a wide range of investment instruments and is likely to be a long, drawn-out affair, a panel of tax experts said at the Structured Product Association's fourth annual conference in New York on Thursday.

"We are going to be in a protracted period of uncertainty," Morrison & Foerster partner Thomas Humphreys said.

Congress, the Treasury Department and the Internal Revenue Service are currently studying how certain pre-paid forward contracts, which include exchange-traded notes, are taxed. The current system treats ETN returns as capital gains, which allows holders to defer taxes until gains are realized.

But critics, most notably the mutual fund industry, say that the current treatment gives ETNs an unfair tax advantage over exchange-traded funds. A proposed bill by Rep. Richard Neal, D.-Mass., the chairman of the U.S. House Subcommittee on Select Revenue Measures, would impose taxes on the accrued income of these forward contracts.

If the proposed change succeeds, the structured products industry will be significantly affected.

A question exists as to whether and how, if the changes are approved, existing ETNs will be grandfathered into new legislation. Issuers will also have to think about transaction rules, key dates and disclosures, the panelists said.

But the panelists urged a broader view of the issue. The potential reach of the current debate goes beyond structured products because the tax principles underlying the issue involve fundamental questions about derivatives, Humphreys said.

"If you start to think about that, you are really talking about all derivative products," he said.

Co-panelist Chris Pinho of UBS added: "Once you start pulling on that thread, everything starts unraveling."

The mutual fund industry, which was one of the first to bring the issue before Congress, mainly to highlight the tax disparity with ETNs, may have gotten embroiled in a bigger issue than it wanted, Pinho said.

"People are trying to use a cannon to kill a fly," he said. "What they are proposing is going to have effects across the investment spectrum."

The complexity of the issue is one of the key reasons the panelists did not expect the issue to progress quickly.

"Guidance may take a while," Humphreys said.

The elections year may also keep the issue on the backburner for some time as politicians stay away from complicated issues that could potentially affect a large number of people and could be seen as taking a position on raising or lowering taxes overall, Pinho said.

"Nothing's going to come out from this thing soon," Pinho added.

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