US Derivatives Sector Riled By Treasury Tax Plan

US Derivatives Sector Riled By Treasury Tax Plan. By Jacob Bunge
Dow Jones Newswires, May 12, 2009 14:41

CHICAGO -(Dow Jones)- A U.S. Treasury plan to end a preferential tax treatment for the derivatives industry could drive away market liquidity, according to opponents of the move.

The Treasury's 2010 revenue proposal release Monday would see banks, hedge funds, proprietary trading firms and other market makers would lose their so- called 60/40 tax treatment.

The move is the latest in long-running efforts to boost taxes on the derivatives sector, and would raise an estimated $2.5 billion over the next 10 years.

The futures and options industry, fresh from a scare that the administration would revive plans for a trading tax, immediately moved on the offensive.

Susan Milligan, senior vice president of government relations for the Options Clearing Corp., said the move would hit individuals and partnerships involved in market-making, who benefit from the blended capital gains and ordinary income tax rate.

Market makers are key to the efficiency of the markets by standing ready to buy or sell contracts.

"If individuals leave the market making profession because of [the tax increase], that has an impact on market quality," Milligan said.

The 60/40 tax treatment dates from 1981 when then-Rep. Dan Rostenkowski, (D- Ill.), pushed through a provision allowing derivatives market makers to pay 60% of their income tax at the capital-gains rate and the remaining 40% at the ordinary tax rate.

The treatment provides a blended tax rate of around 23%, according to industry estimates.

The 2010 budget proposal would tax 100% of these entities' income from futures and options trade at the ordinary tax rate, which currently tops out at 35%, but could rise to 39.6% in 2011.

"There is no reason to treat dealers in commodities, commodities derivatives dealers, dealers in securities and dealers in equity options differently than dealers in other types of property," Treasury officials wrote in a document explaining tax proposals for 2010, released Monday.

"Increasing taxes on players in the financial services industry is in vogue right now," said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, which represents the banking sector and plans to argue against the budget proposal.

Officials at Chicago-based CME Group Inc. (CME) were reviewing the proposal Tuesday, and the Chicago Board Options Exchange was preparing its own response, according to officials.

The International Securities Exchange, an electronic U.S. options platform owned by Deutsche Boerse (DB1.XE), said in a statement that events of the past year have highlighted the role of transparent, regulated markets.

"This is not the time to alter the tax treatment - and ultimately the health of - the very markets that our nation's regulators are attempting to drive business towards." Treasury representatives did not respond to requests for comment.

The financial services industry has successfully defeated challenges to the 60/40 rule in the past.

In 2003, the Senate was on the verge of repealing the provision before a lobbying campaign by exchanges and derivatives industry groups won a reprieve, arguing that elimination of the 60/40 tax treatment would hurt U.S. markets and investors.

-By Jacob Bunge, Dow Jones Newswires (Sarah N. Lynch contributed to this report.)

05-12-09 1441ET