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Legislative Updates: May 2012

Capitol Call

The second session of the 112th Congress has been one of the least productive in recent memory due to partisan gridlock. The members currently seem to be more focused on politics and messaging than on legislating.

According to Democrats, their Republican counterparts are waging a “war on women” and want to cut spending at the expense of the most vulnerable.  And the Republicans accuse the Democrats of wanting to put the country deeper in debt while cynically declaring class warfare against corporations and job creators.

The accuracy of all the accusations flung at each other by the pundits, the executive branch, and those in Congress are clearly subjective.  Veteran Congress-watchers hoping for useful legislation to pass can only be patient and wait until after the election.

IRS Comment Letter

At the beginning of April, the OCC and the U.S. Securities Market Coalition submitted a comment letter on proposed IRS regulations that would impose a 30% U.S. withholding tax on certain options transactions entered into by non-U.S. persons, such as off-shore hedge funds.  If adopted as proposed, the regulations could potentially have a negative impact on the listed options markets by curtailing their use by foreign persons. {A copy of the letter (in PDF form) may be seen at http://www.cticompliance.com/assets/pdf/Covington & Burling LLP.pdf.}

As the letter says, “[The new regulations] would impose withholding tax on routine options trading strategies that have nothing to do with avoiding withholding tax on dividends and would effectively preclude foreign persons from using these trading strategies. The proposed regulations fail to recognize that options, unlike stock lending transactions and total return equity swaps, are not close substitutes for direct ownership of stock.”

In other words, they would effectively tax many “substitute dividends” and their equivalents at 30%. This would create a paperwork nightmare for broker-dealers that might lead to them deciding that it simply wouldn’t pay to permit their non-U.S. clients to engage in options transactions on American exchanges.  Foreign clients could probably avoid the U.S. options markets as well if faced with such a tax. The comment letter is one step the options industries are taking to avoid such an outcome.

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