Friday, March 26, 2010

The HIRE H.R. 2847

EuroSpooz. EYurDOW. EYooSpooz.

Whatever kinds of clever phonetic variations on sythetically creating U.S. stock market returns without triggering Witholding tax arrangments under this BRAND NEW section of the Internal Revenue Code will become quite lucrative, just as the Eurodollar markets were "quite lucrative" when they began.

So I, The Recapitulator, have looked at this new law, which immediately becomes Chapter 4 of Title 26; The U.S. Tax Code.

What are the effects of foreign holders of U.S. financial assets when confronted with a 30% witholding tax, which will be null IF said foreign holder discloses the beneficial owner of the security and its related cash flows.

The point here is Power. The U.S. will know the ownership of U.S. financial assets. This is a way to "keep score" in the world economy to determine where U.S. interests should be magnified or minimized. Foreign Central Banks are exempt from this provision, but the Fed and Treasury ostensibly know all about CB to CB transactions. Recall that taxation is an aggregate demand management system, and is not needed to "get" dollars for governmental use.

So, what happens if a Russian bank purchases an interest rate swap arrangement from and American Bank (or a subsidiary of same)? Is disclosure of ownership required or a 30% tax is levied? This, it would appear, is why Treasuries have fallen. Investors are fleeing the cash markets for Swaps.

This level of disclosure will REQUIRE new equity-linked securities to be invented in order to circumnavigate this provision, less Jersey, The Isle of Man, Bermuda, the Caymans, and other tropical off-shore financial destinations wish to cease operations. At this point I am assuming that international banks simply cannot inform the Treasury that "Account #xxxxxiiii is not owned by a U.S. entity or citizen nor does a U.S. entity or citizen have beneficial ownership of Account #xxxxxiiii", but rather must IDENTIFY the purchaser of the fiancial asset, regardless of jurisdiction in order to definitively "prove" non-U.S. involvement.

But we are getting ahead of ourselves...or is it behind?

For purposes of this blog, most of the minutiae is irrelevant. What is interesting to me are the possible unintended consequences from this provision. Chief among this list are the effects on international capital flows and global liquidity. This week has seen flows avoid Cash Treasuries. This is why I warned in a previous post that globalization is entering a new manifestation due to measures such as H.R. 2847

So what can be taxed?

For purposes of this chapter—
(1) WITHHOLDABLE PAYMENT.—Except as otherwise provided
by the Secretary—
(A) IN GENERAL.—The term ‘withholdable payment’
means(i) any payment of interest (including any original
issue discount), dividends, rents, salaries, wages, premiums,
annuities, compensations, remunerations,
emoluments, and other fixed or determinable annual
or periodical gains, profits, and income, if such payment
is from sources within the United States, and
‘‘(ii) any gross proceeds from the sale or other
disposition of any property of a type which can produce
interest or dividends from sources within the United

"From sources within the United States". Presumably, since this is a witholding tax, this would mean that only U.S. cash market securities would be effected.

However, "can produce" language is troubling. Taken literally, this would subject any security that derives its cash flows or capital gains from U.S. activity to fall under the possible witholding tax, provided the security is to be considered "property".

Thus, this is a far-reaching new addition to the U.S. Tax code. Some of the ramifications and potential pit-falls will be discussed in a subsequent post coming soon. The Devil is in the details, and, this being the U.S. tax code, we will have to review the details carefully.

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