U.S. Treasury Examining CDS Payments to Foreign Counterparties

WASHINGTON (HedgeWorld.com)–The U.S. Treasury Department announced that it is studying the issue of how it might give taxpayers guidance on credit default swaps, especially swaps in which the party selling protection is headquartered outside the country.

Such payments may be considered insurance, said a notice on CDS taxation, and insurance premiums paid to a foreign person with respect to a U.S. risk are subject to an excise tax. Furthermore, ensuring risks within the United States could constitute engaging in a trade or business within the United States. The tax treatment regarding these financial instruments remains uncertain, and many parties to them, including hedge funds, have asked for guidance.

The Treasury Department has responded to that question with questions of its own. It wants market participants to help it develop a more complete understanding of CDS contract terms, “both standard and negotiated, particularly with respect to credit events, subrogation rights, security interest in collateral, and collateralization requirements in general,” as well as on pricing, price quotation and dissemination, and market practice “regarding hedging, the management of bases risk, and the timing of CDS transactions relative to the assumption and disposition of analogous risks.”

It also wants to know how parties account for the value of their contracts in terms of regulatory capital, generally accepting accounting practices and their internal books.

In a statement issued simultaneously with this notice, July 19, Gregory Jenner, acting assistant secretary for tax policy, said that this “is an important market that has grown very rapidly and continues to evolve.” He added that he understands that taxpayers need guidance in the area.