The Treasury publicly backed legislation to eliminate commodity tax straddles for the first time yesterday.
In testimony before the House Ways and Means Committee, John Chapaton, assistant Treasury secretary for tax policy, told congressmen that the Treasury believes legislation is needed "to stem a growing use of commodities and commodities-related transactions for tax-avoidance purposes."
Merrill Lynch, Pierce, Fenner & Smith, the securities firm which Treasury Secretary Donald T. Regan headed until January, has been the best known promoter of schemes to avoid or reduce taxes by creating losses on trading in commodities futures. Although the Treasury had not come out publicly in favor of restricting these schemes before, it did include in the president's budget proposals some assumed revenue savings from closing the straddle loophole.
The Internal Revenue Service is challenging several of the favorable tax consequences of commodity trading. Chapaton said that although the Treasury believes the IRS ultimately would be successful in the courts, this could take so long that it would be better to legislate first.
But he emphasized that the administration puts passage of the president's main tax proposals ahead of other legislation. Bills to close the commodity loopholes have been introduced in both the House and Senate this session.
Taxpayers may use various different, complicated commodity transactions to postpone or lower their tax liabilities. Although commodity traders have used them for many years, their use by the wider public is a relatively new and rapidly growing phenomenon.
Chapaton commented that "taxpayers are currently engaged in an astonishing variety of transactions, whose principal purpose is tax avoidance, involving commodites [e.g., silver, soybeans, Treasury bills] and futures contracts for commodities."
The transactions commonly involve turning ordinary income into capital gains, creating artificial trading losses to offset other income, and deferring short-term capital gains so that they become long term and are subject to lower tax rates.
The Joint Committee on Taxation yesterday published a series of examples of how taxpayers have been using commodity tax straddles and other shelters.
Traders have argued that the move to restrict the tax-avoidance scheme cannot really be applied to them because it would upset the workings of markets and require very complicated administration. But the Treasury suggested using the daily recording of traders' positions, known as "marking to market," to calculate the underlying gains and losses on straddles made throughout the year, and then to treat these as ordinary income.
Chapaton said this would be a suitable way of circumventing the tax avoidance by traders.