Barclays iPath notes linked to a single currency to be taxed like debt, IRS rules

New York, Dec. 10 - Barclays Bank plc said its iPath notes linked to the euro/dollar, pound/dollar and yen/dollar exchange rates will be taxed as if they are debt instruments.

As a result, any interest accrued during the contract is taxable to investors, even though with the iPath notes it is reinvested and not paid out until the holder sells the notes or the contract matures.

The ruling, number 2008-1, also means that gain or loss from the sale or redemption of the notes will be ordinary and investors will not be able to elect capital gain treatment, Barclays said.

The news came in a ruling Friday from the Internal Revenue Service that any financial instrument linked to a single currency should be treated like debt for federal tax purposes.

All financial products are covered, regardless of whether the instrument is privately offered, publicly offered or traded on an exchange.

The ruling does not apply to exchange-traded notes that are linked to equities or commodities.

The IRS also issued a notice asking for comments on the appropriate tax treatment of instruments described as prepaid forward contracts, which is how investors currently treat the equity and commodity exchange-traded notes for tax purposes.

"Ruling 2008-1 provides taxable investors clarity on the tax treatment of foreign currency exchange-traded notes," Philippe El-Asmar, managing director, head of investor solutions, Americas, at Barclays Capital, said in a news release.

"Institutional and individual investors increasingly recognize that currency exposure may constitute a separate asset class to provide portfolio diversification and add potential portfolio returns. The iPath Currency ETNs provide simple, transparent and cost-effective access to three significant exchange rates."

Three Barclays iPath products are covered by the guidance: the iPath EUR/USD Exchange Rate ETN (ticker ERO), the iPath GBP/USD Exchange Rate ETN (ticker GBB), and the iPath JPY/USD Exchange Rate ETN (ticker JYN).

Barclays noted that the products will be now be considered debt for federal tax purposes, even though the holder's initial investment and repayment are made in U.S. dollars, and the holder may get back fewer U.S. dollars than it invested.

Barclays said its view on equity and commodity exchange-traded notes is the same as that of the Securities Industry and Financial Markets Association (Sifma) - that the tax treatment of investment products should be driven by the product's tax attributes.

Mutual funds and exchange-traded notes are taxed differently because they are fundamentally different products, Barclays argued. Investors who buy shares in a mutual fund own the underlying securities and receive dividend income from those securities annually which is taxable. Exchange-traded note investors do not own underlying securities and receive no dividends while holding the exchange-traded notes.

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