Document Type

Article

Publication Date

2013

Source Publication

Australian Tax Forum. Volume 28, Issue 2 (2013), p. 317-376.

Keywords

after-tax hedging; asymmetric swap; taxation and risk taking

Abstract

A strain of the academic literature on taxation and risk taking emphasizes the income effect and consequent transfer of risk to government through the income tax system in the presence of scaling of risky positions. The policy implications of this literature have been explored in considerable detail, although the practical significance for tax policymakers is ambiguous given the tax and non-tax constraints on scaling under the personal income tax. In contrast, fragmentary transactional evidence suggests that scaling of risky positions may have its most practical application in the context of corporate hedging transactions where many of the same tax and non-tax constraints do not apply. In fact, risk-transfer transactions in this very different context have been the subject of some recent attention by tax policymakers and tax administrators. This paper explores the case for, and design of, a targeted loss limitation intended to address the transfer of risk to government that otherwise is the result of hedged positions that are scaled to provide imperfectly offsetting pre-tax cash flows but perfectly (or near perfectly) offsetting after-tax cash flows. Although the case for such a limitation extends broadly to the entire range of such transactions, perceptions of costliness associated with the identification exercise, as well as perceptions of a negative impact on the decision to hedge, may lead to a more narrowly focused loss limitation patterned on legislation recently adopted by UK Inland Revenue. For the much more limited subset of risk-transfer transactions that are entered into for the purpose of providing a tax benefit, narrowly construed, general anti-tax-avoidance rules and/or doctrines can provide an effective response. An example of this type of transaction is the asymmetric swap that is the subject of a taxation determination recently released by the Australian Taxation Office ('ATO').

Comments

Reproduced with permission from The Tax Institute, publisher of Australian Tax Forum.

Creative Commons License

Creative Commons License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

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