Wednesday, February 08, 2012

Senate Legislation Would Close Swap Loophole and Align Tax Code and Securities Law Treatment of Stock Options

Senate legislation would align the tax code and securities law treatment of stock options, prevent corporate income tax deductions for stock options that exceed the expense shown in SEC-filed financial statements, close the offshore swap payments loophole, and require annual country-by-country reporting by SEC-registered corporations on employees, sales, financing, tax obligations, and tax payments. In addition, the measure would require anti-money laundering programs for hedge funds and private equity funds to ensure that they screen clients and offshore funds.

Introduced by Senator Carl Levin, (D-Mich), Chair of the Armed Services Committee and Senator Kent Conrad ( D-ND), Chair of the Budget Committee, the Cut Unjustified Tax Loopholes Act, S 2075, would also establish a penalty for corporate insiders who hide offshore holdings by authorizing a fine of up to $1 million per violation of securities laws.

As part of measures to combat offshore and tax shelter abuses, the Senate legislation would close an existing tax loophole that allows credit default swap payments to escape taxation if sent from the United States to persons offshore, such as an offshore hedge fund or foreign bank. The Act would close this swap loophole by treating credit default swap payments sent offshore from the United States as taxable U.S. source income. Another provision would increase publicly available information about multinational corporations by requiring them to include basic information on a country-by-country basis in their filings with the SEC to increase transparency and facilitate IRS inquiries into transfer pricing, foreign tax credits, and abusive offshore tax shelters.

The legislation would increase publicly available information about multinational corporations by requiring them to include basic information on a country-by-country basis in their filings with the SEC to increase transparency and facilitate IRS inquiries into transfer pricing, foreign tax credits, and abusive offshore tax shelters.

S 2075 would also eliminate favored tax treatment of corporate stock option deductions, in which corporations are currently allowed to deduct a higher stock option compensation expense on their tax returns than shown on their financial statements by prohibiting corporations from taking a tax deduction that exceeds the expense shown on their books. The legislation would allow corporations to deduct stock option compensation on their tax returns in the same year it is recorded on the company books, without waiting for the options to be exercised.

The Act would also establish rebuttable presumptions to combat offshore secrecy in US. tax and securities law enforcement proceedings by treating non-publicly traded offshore entities as controlled by the U.S. taxpayer who formed them, sent them assets, received assets from them, or benefited from them when those entities have accounts or assets in non-FATCA institutions, unless the taxpayer proves otherwise.

In addition, the legislation would strengthen FATCA by clarifying when, under the Foreign Account Tax Compliance Act, foreign financial institutions and U.S. persons must report foreign financial accounts to the IRS.

In a significant change, S 2075 would make corporate stock option deductions subject to the existing $1 million cap in Section 162(m) of the IRC on overall corporate deductions for compensation paid to the top executives of publicly held corporations. But there would be no change to stock option compensation rules for individuals or for incentive stock options used by start-up companies and small businesses.

Stock options are the only type of compensation where the federal tax code lets a company deduct more than the expense shown on in its financial statements. The legislation would align the GAAP treatment of stock options under FASB financial accounting standards with how options are treated under the Internal Revenue Code.

The legislation would bring stock option accounting and tax rules into alignment, so that the two sets of rules would apply in a consistent manner. It would accomplish that goal by requiring the corporate stock option tax deduction to reflect the stock option expenses as shown on the corporate books each year.

Specifically, the measure would end use of the current stock option deduction under Section 83 of the Code, which allows corporations to deduct stock option expenses when exercised in an amount equal to the income declared by the individual exercising the option, replacing it with a new Section 162(q), which would require companies to deduct the stock option expenses as shown on their books each year.