Tax Treatment of OTC Covered Calls May Change

WASHINGTON (HedgeWorld.com)--The United States Senate has passed a proposed amendment to the tax laws that, if enacted, will deny qualified covered call treatment for over-the-counter options, while maintaining that treatment for exchange-listed options.

The provision, ?464(d), is an almost inconspicuous part of S. 1637, which carries the grand name, "Jumpstart Our Business Strength (JOBS) Act."

It would have three adverse tax consequences for investors who deal in these instruments: capitalization, rather than deduction, of any interest expense connected with margin loans; deferral of any loss upon cash settlement of the call options; and elimination of the holding period for the underlying shares, if such holding period did not exceed one year when the covered call option was sold.

The bill passed the Senate on May 11, on a vote of 92 to 5. The House of Representatives is in recess until after Memorial Day.

A staffer at the House Ways and Means Committee said Thursday that its members would like to complete work on their version of the bill soon after they return to work. He also said that the House version might resemble a bill the same committee reported out last year, the American Jobs Creation Act. That bill, H.R. 2896 did not contain any provision regarding QCCs.

On May 19, the International Swaps and Derivatives wrote to the chairman and ranking minority member of the Ways and Means Committee making clear ISDA's opposition to this change. It urged that no such provision as ?464(d) be included in the House version.

"We believe it is not sound tax policy to provide favorable QCC tax treatment to listed options, including 'flex options' that are economically similar to OTC options, while denying that same treatment to OTC options," said the letter, signed by John Anderson, ISDA's policy director and head of government affairs.

The differential treatment will reduce competition and investor choice in the options markets.

Mr. Anderson said Thursday that the size of the majority in the Senate vote didn't surprise him because it's a big bill, with a lot of provisions, and the QCC clause likely didn't loom large in the eyes of the bill's supporters.

He also said that he doesn't expect a response to his letter. "This type of letter is usually taken as a comment. It flags an issue for further consideration."

CFaille@HedgeWorld.com

Contact Robert F. Keane with questions or comments at:

bkeane@ia-mag.com.

Reprints Discuss this story
This is where the comments go.