KPMG TaxWatch Webcast: Comprehensive Tax Reform ......Liz DLiz Dyor,yor, TTaxax M Managinganaging...

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KPMG TaxWatch Webcast: ComprehensiveComprehensive Tax Reform – Financial Products Discussion Draft

February 20, 2013

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR O G S OS O O(ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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Speakers

Mark Price, Principal, Washington National Tax, Washington, DC

Jonathan Zelnik, Principal, Washington National Tax, Washington, DC

Liz Dyor, Tax Managing Director, Washington National Tax, Seattle, WALiz Dyor, Tax Managing Director, Washington National Tax, Seattle, WA

Paul Kunkel, Director, Washington National Tax, Chicago, IL


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Agenda

Introduction

Chairman Camp’s Discussion Draft on the Taxation of Financial Products

Q&AQ&


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Administrative

CPE regulations require online participants take part in online questions

– You must respond to a minimum of four questions per 50 minutes in order to be eligible for CPE credit

– Polling questions will appear on your media player on top of the slides

– Results will be reviewed in aggregate and may be published as a “pulse survey” of the marketplace in the aggregate. Please note that no responses will be tracked back to any individual or organization

To ask a question, use the “Ask A Question” icon on your media player or send an e-mail to [email protected]


Help Desk: 1-877-398-1471 or outside the U.S. at 1-954-969-3342

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Chairman Camp’s Discussion DraftDiscussion Draft

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Camp Discussion Draft Provisions

Part 1 – Derivatives and Hedging Sec. 401. Treatment of derivatives. Sec. 402. Treatment of hedges identified for financial accounting purposes.

Part 2 – Treatment of Discount and Income Sec. 411. Determination of issue price in the case of specified debt

modifications. Sec. 412. Deduction for amortizable bond premium allowed in determining

adjusted gross income. Sec. 413. Current inclusion in income of market discount. Sec. 414. Rules regarding certain government debt.


Part 3 – Certain Rules for Determining Gain and Loss Sec. 421. Cost basis of specified securities determined in accordance with

average basis method. Sec. 422. Wash sales by related parties.

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Sec. 401. Treatment of derivatives

New timing and character rules:

Require all derivatives to be marked to market for tax purposes

– Relies on fair value determined in report or statement to owners or report e es o a a ue dete ed epo t o state e t to o e s o epo tor statement for credit purposes

Treat all income, gain, loss, or deduction from derivatives as ordinary

Require other positions to be marked to market if part of a straddle with a derivative

– Built-in gain, but not loss, is included on entering into straddle

R l l i ti l ( ti f ti 475 ti


Replace several existing rules (e.g., portions of section 475, section 1234B, section 1236, and section 1256)

Apply to property acquired and positions established after December 31, 2013

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Knowledge Check #1

Under Chairman Camp’s mark to market proposal all gain and loss on derivatives would be capital?

True or false?


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Knowledge Check #1 Answer

True or false – Under Chairman Camp’s proposal all mark to market gain and loss on derivatives would be capital?

False


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Sec. 401. Treatment of derivatives (cont’d)

The term “derivative” is defined to include:

Derivative interests in

– Stock partnership interests trust interestsStock, partnership interests, trust interests

– Note, bond, debenture, or other evidence of indebtedness

– Real property (subject to exceptions)

– Actively traded commodity

– Currency

An expanded definition of notional principal contracts


An expanded definition of notional principal contracts

Embedded derivative components of debt instruments

– “Any terms that affect some or all of the cash flows or the value of other payments required by the instrument in a manner similar to a derivative”

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Examples

Taxpayer buys a call option on a U.S. publicly traded equity.

Taxpayer enters into a contract to acquire a privately held partnership interest in a year.

Taxpayer regularly enters into physical forward contracts to sell its property. These contracts are treated as normal sales and not subject to the mark-to-market rules in ASC 815.

Taxpayer holds a corporate bond portfolio as part of its liquidity management program. Taxpayer enters into interest rate swaps to manage its interest rate exposure.

T i tibl d bt


Taxpayer issues convertible debt.

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Knowledge Check #2

The conversion right contained in a convertible debt instrument would be a derivative under the discussion draft?

True or False?


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True or False - The conversion right contained in a convertible debt instrument would be a derivative under the discussion draft?

True.


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Sec. 402. Treatment of hedges

Existing law requires hedging transactions to be identified for tax purposes as hedging transactions on or before the day the transaction is entered.

– Financial accounting identification does not meet this requirement

New provision treats designation of derivative as hedging transaction for US GAAP audited financial statements as a valid hedge identification for tax purposes.

Transaction must still meet the substantive tax requirements to qualify as a tax hedging transaction.

New provision would apply to transactions entered into after December 31, 2013


2013.

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Knowledge Check #3

Only a transaction that is identified as a hedging transaction for US GAAP audited financial statements would be treated as a valid hedge for tax purposes.

True or false?


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True or false – Only a transaction that is identified as a hedging transaction for US GAAP audited financial statements would be treated as a valid hedge for tax purposes.

False.


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Sec. 411. Determination of issue price

Under current law, issuers can incur cancellation of indebtedness income (COD income) on debt restructurings even if principal is not forgiven.

– Test for COD income and gain/loss to holder is based on issue price of new instrumentnew instrument

Under new provision, in the case of specified debt modification, the issue price of the new instrument is the lesser of

– The adjusted issue price of the existing debt instrument, or

– The issue price of the modified debt instrument determined using the rules of section 1274 (regardless of whether section 1274 applies)

The result will generally be that an issuer will not have COD income unless


e esu t ge e a y be t at a ssue ot a e CO co e u essthe principal amount is reduced.

– Holder’s amount realized will also be affected.

New provision would apply to transactions after December 31, 2013.

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Example

Facts. Fund pays $10 to acquire a debt with a face amount of $100 and a 5% coupon. Fund and the debt issuer then modify the debt as part of a workout (the workout does not reduce the face amount). At the time of the modification, the FMV of the unmodified debt is $50, and the FMV of the modification, the FMV of the unmodified debt is $50, and the FMV of the modified debt is $40. The modification constitutes a significant modification for tax purposes. The AIP of the unmodified debt is $100.


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Example

Under current law:

If the modified debt is publicly traded, the issue price of the modified debt equals its FMV at the time of modification ($40). The issuer has $60 of COD income; Fund has $30 of gainCOD income; Fund has $30 of gain.

If the modified debt is not publicly traded but the unmodified debt is, the issue price of the modified debt is the FMV of the unmodified debt ($50). The issuer has $50 of COD income; Fund has $40 of gain.

If neither debt is publicly traded, the issue price of the modified debt is its SRPM ($100). The issuer has no COD income; Fund has $90 of gain.

Under proposed law:


The issue price of the modified debt is the lesser of the AIP of the unmodified debt ($100) or the issue price of the modified debt as if section 1274 applied ($100). The issuer will recognize no COD income; Fund will recognize $90 of gain and its basis in the modified debt is $100.

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Knowledge Check #4

A debt instrument is significantly modified. At the time of the modification, the fair market values of the old and new debt instruments are $75, the adjusted issue price of the old debt instrument is $90, and the stated redemption price at maturity of the new debt instrument is $85. Under the redemption price at maturity of the new debt instrument is $85. Under the proposal, would the issue price of the new debt instrument be:

a) $75

b) $85

c) $90


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A debt instrument is significantly modified. At the time of the modification, the fair market values of the old and new debt instruments are $75, the adjusted issue price of the old debt instrument is $90, and the stated redemption price at maturity of the new debt instrument is $85. Under the ede pt o p ce at atu ty o t e e debt st u e t s $85 U de t eproposal, would the issue price of the new debt instrument be:

b) $85 – The issue price is the lesser of the adjusted issue price of the old debt instrument and its issue price determined under section 1274.


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Sec. 412. Deduction for amortizable bond premium

New provision treats amortizable bond premium as an above-the-line deduction.

New provision would apply to taxable years beginning after December 31, 20132013.


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Sec. 413. Current inclusion of market discount

Under current law, taxpayers can elect whether to recognize market discount into income currently.

New provision would require taxpayers to recognize market discount into i tl i t t i ld th d bj t t li itincome currently using a constant yield method, subject to limit.

Cap is calculated by treating debt as issued on the acquisition date for issue price determined by using a discount rate equal to the greater of

– The bond’s yield to maturity plus 5 percentage points, or

– The applicable federal rate plus 10 percentage points.

New provision would also eliminate special rules for short-term


e p o s o ou d a so e ate spec a u es o s o t tenongovernmental obligations.

New provision would apply to obligations acquired after December 31, 2013.

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Example

Facts. On January 1, 2014, a corporation issues for $960 a $1,000, publicly-traded, 10-year note with a 5% coupon. On January 1, 2016, Fund buys the note on the secondary market for $950, when the AIP of the note is $966.38.is $966.38.

Under current law. Fund continues to accrue the OID currently, but it may defer recognizing MD until it disposes of the note. Any gain on disposal will be ordinary to the extent of accrued MD.


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Example

Under proposed law. Fund accrues both the OID and the MD currently. Fund accrues the OID per the note’s yield on date of issuance (5.53%). Fund accrues the MD per the yield calculated based on Fund’s adjusted basis of $950 (5.80%). In this case, if Fund held the note until maturity, bas s o $950 (5 80%) t s case, u d e d t e ote u t atu ty,Fund would accrue the following amounts of OID and MD:

Year OID Market Discount

2016 3.45 1.63

2017 3.65 1.74

2018 3.85 1.85

2029 4.06 1.97


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2020 4.29 2.09

2021 4.52 2.22

2022 4.77 2.36

2023 5.04 2.51

Totals: 33.62 16.38

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Knowledge Check #5

Under the market discount proposal, a cash method holder that acquires a bond with market discount after December 31, 2013, would not have to include market discount in income as it accrues.

True or false?


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True or false – Under the market discount proposal, a cash method holder that acquires a bond with market discount after December 31, 2013, would not have to include market discount in income as it accrues.

False.


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Sec. 414. Rules regarding certain government debt

New provision repeals provision allowing tax-free exchange of certain U.S. government savings bonds.

– New provision would apply to exchanges after December 31, 2013.

New provision also requires investors to accrue discount on short-term government obligations.

– New provision would take effect on the date of enactment.


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Sec. 421. Average basis method for determining cost basis

Under current law, taxpayers can specifically identify which shares of stock, debt instruments, and other financial instruments are sold in a transaction.

N i i ld i t t th b i th d t New provision would require taxpayers to use the average basis method to determine basis for these positions.

Average basis is determined on an account-by-account basis with respect to positions acquired after December 31, 2013.

This provision would be effective for sales, exchanges, and other dispositions after December 31, 2013.


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Sec. 422. Wash sales by related parties

New provision would extend the wash sale rules to apply where a related party acquires the substantially identical stock or security (or enters into an option or contract such stock or security).

R l t d t i l d d d t titi t ll d b ( Related party includes spouse, dependents, entities controlled by (or controlling) the taxpayer, IRAs, and other certain other parties.

Basis adjustment rules for acquired position does not apply to acquisitions by related parties (other than the taxpayer’s spouse).

New provision would apply to sales and other dispositions after December 31, 2013.


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Polling Question

Would you like a KPMG professional to contact you regarding the topics discussed today?

– Yes

– No


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Q&A

Q&A (continued)

Today’s Presenters

Mark Price (202) 533 4364 mhprice@kpmg comMark Price (202) 533-4364 [email protected]

Jonathan Zelnik (202) 533-4193 [email protected]

Liz Dyor (425) 449-8973 [email protected]

Paul Kunkel (312) 665-2051 [email protected]


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Thank you for joining us. Please send any questions to [email protected]

Visit www.kpmgtaxwatch.com for a calendar of upcoming eventscalendar of upcoming events.

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG name, logo and ‘cutting through complexity’ are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).

KPMG TaxWatch Webcast: Comprehensive Tax Reform ......Liz DLiz Dyor,yor, TTaxax M Managinganaging...

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