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Taxation of Exchange-Traded Notes  

Author:  Dashiell Shapiro.; Daniel Mulcahy.

Source: Volume 25, Number 04, Summer 2008 , pp.3-17(15)

Journal of Taxation of Investments

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Holders of prepaid forward contracts have traditionally not been required to accrue income during the term of the contract. As commentators have noted, this treatment has been considered appropriate because prepaid forward contracts do not provide holders with principal protection and provide for a contingent payment only at maturity. A requirement that a holder accrue income during the term of a contract would tax the holder prior to the receipt of any distributions with respect to the contract, even though there is no guarantee of any payment at maturity. Recently, however, there has been increased interest regarding the taxation of a subset of prepaid forward contracts, exchange-traded notes (“ETNs”), that have gained in popularity among retail investors. As a result of this increased interest in ETNs, there may be future guidance or legislation regarding ETNs, and possibly a new comprehensive approach to the tax treatment of prepaid forward contracts. This article provides a brief background on the taxation of prepaid forward contracts and ETNs and discusses the various approaches that could inform the taxation of these products: the Neal Bill, mark-to-market treatment, Section 7872 loan treatment, Section 1260 constructive ownership, Section 446 income reflection, contingent payment debt instrument (“CPDI”) rules, and other approaches, including potential hybrid approaches that seek to retain aspects of current law treatment. The article provides a brief overview of the advantages and disadvantages inherent in the various approaches, and discusses which regimes would require legislative implementation and whether any changes should be made to current law.


Affiliations:  1: Cadwalader, Wickersham & Taft LLP; 2: Cadwalader, Wickersham & Taft LLP.

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