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As members of the Australian tax community are probably all too aware, a joint project of the Australian Taxation Office (“ATO”) and the Treasury department to develop a comprehensive legislative regime for the taxation of financial arrangements was undertaken in the early 1990s and remains unfinished.[1] Apparently, this project, which is referred to commonly as ‘the taxation of financial arrangements’ (“TOFA”), has now been incorporated into the more general reform process that began in August 1998 with the release of the A New Tax System (“ANTS”) document[2] and continued with the Review of Business Taxation and its report (“Ralph Review”).[3] I am in no position to speculate on the reasons why the TOFA project remains unfinished. I remain convinced, however, that the proposals articulated by the ATO and the Treasury department are the most thoroughly developed of any government and provide a useful paradigm for the design of a comprehensive legislative regime in the context of a realisation-based income tax, in which interest and dividends and ordinary income and capital amounts are taxed differently. Moreover, I do not consider the proposals to be particularly radical, unlike many other initiatives described in the Ralph Review.
The income tax issues presented by financial instruments are relatively well known. Most income tax systems reflect a ‘cubbyhole approach’ to financial instruments. Under this approach, every financial instrument must be classified and its associated cash flows slotted within an accepted cubbyhole that attracts one of a defined set of different tax treatments. The tax cubbyholes are defined by certain features that result in differences in tax treatment associated with:
• ordinary income versus capital amounts;
• dividends versus interest; and
• realisation versus accrual recognition of gains and losses.
Capital gain and loss treatment is available for investors who hold instruments on capital account and not as traders; dividend treatment is available for instruments that are considered shares; interest treatment is limited to debt financing charges within the restrictive legal definition of interest; gain or loss (other than interest) is recognised when realised; and specific rules for the taxation of option premiums are limited to forward-based contracts that are properly characterised as call and put options.
These distinctions are artificial in the sense that they are irrelevant in capital markets, which recognise basic equivalences that underlie the arbitrage pricing of financial instruments. Although oversimplified, it is probably correct to say that all cash flows, whatever their form, must be valued for capital market purposes, and differences in attributes affect the valuation exercise only.[4] Arbitrage pricing identifies equivalent cash flows and ensures that they are priced equivalently. Under the recognised tax cubbyholes, slight changes in the form of financial instruments can produce significant differences in tax treatment that contrast with financial theory and its recognition of certain basic equivalences. The differences in tax treatment permit the replication of cash flows associated with conventional instruments in unconventional forms that attract different tax consequences.[5] In addition to avoidance opportunities, the need to classify new instruments for the purposes of specified tax treatments creates substantial uncertainty that can discourage the use of particular instruments for non-tax purposes.
In essence, a tension exists between the reality of financial equivalences recognized by capital markets and the specified differences in tax treatment for certain conventional instruments on which the income tax system is based. The tension manifests itself in tax avoidance opportunities centred on “inconsistencies” and “discontinuities” under the tax cubbyhole system.[6] “Inconsistencies” arise when equivalent cash flows associated with different financial instruments are taxed differently. “Discontinuities” arise when small changes in the pattern of cash flows result in disproportionately different tax treatment. In this respect, three aspects of the process of financial innovation are critical for tax policy purposes:
• All financial instruments are composites of a set of basic building block instruments (forwards, futures, swaps, options and credit-extension (debt) instruments) that provide a single payoff on the occurrence of a single contingency, resulting in expected time-value returns and/or unexpected gains and losses attributable to the resolution of a bet.[7]
• Forwards, futures and swaps are the fundamental derivative instruments in the sense that their value is derived from a specified bet on a specified asset, liability or financial position. “Hybrid instruments” consist of combinations of two or more separate instruments in one legally distinct instrument.[8] “Synthetic instruments” consist of the combination of two or more legally distinct instruments to replicate the cash flow pattern associated with another legally distinct instrument.[9]
• Basic parities or financial equivalences (interest-rate parity, futures parity, put-call parity and option pricing) underlie the arbitrage pricing of the building block instruments.
The cubbyhole approach fails to recognise in any systematic sense these fundamental aspects of the process of financial innovation and, in fact, is based on specified tax treatments for a limited range of conventional instruments. These specified treatments are sometimes inconsistent in their treatment of expected gains and losses; they also require the articulation of boundary lines that are the source of discontinuities.
Some commentators have suggested that maintenance of the traditional tax cubbyholes is untenable in a world of financial innovation. Many of these same commentators, however, consider the problems presented by financial innovation to be intractable for any income tax system that falls short of the “accretion ideal” (that is, recognition of the full amount of gains and losses as they arise with changes in the value of financial instruments).[10] It is argued, here in this brief paper, that radical reform of existing income tax systems is unnecessary. The challenges presented by the latest wave of financial innovation are no different, in principle, than some of the more limited challenges of the past, and the fundamental features of past responses require only some limited modifications to provide a workable and theoretically defensible system.[11] This is reflected to various degrees in the TOFA proposals, certain of the US tax literature[12] and legislation, and the New Zealand accrual legislation.[13] As a second-best alternative to accretion taxation, this legislative approach (referred to here as “a comprehensive accrual regime”) minimises, to the greatest extent possible, the inconsistencies and discontinuities that plague the traditional tax cubbyhole system.
As an approach to the taxation of financial instruments, a comprehensive accrual regime runs counter to the position of certain commentators who have called for a moratorium on detailed legislative responses and have argued for a greater reliance on the courts to develop principled responses.[14] Under this alternative approach, which is sometimes referred to as “interpretive activism”, the taxation of financial instruments would be addressed through administrative practice and the courts, employing a proactive approach to the interpretation and application of existing provisions. In effect, the perceived economic substance of a particular financial instrument would be determined, and the instrument would be taxed accordingly within the existing cubbyholes applicable to interest and dividends, capital gains and losses, and business income generally. The institutional competence of the courts, however, means that the hope of interpretive activism is a false one. Inevitably, the courts become mired in the debate over the characterisation of transactions on the basis of legal form versus economic substance. That debate reflects a basic tension among various unarticulated reasons that are assumed to justify a boundary between acceptable and abusive tax avoidance. Whatever the verbal formula invoked by taxpayers, the courts and tax administrators, the fundamental question is the same from a tax avoidance perspective: when should the legal form be respected in preference to the substantive economics?
In the context of the existing tax cubbyhole system governing the income taxation of financial instruments, the answer to this question is not at all clear. The existing legislative frameworks in many countries, with their recognised cubbyholes, severely constrain the promise of interpretive activism. Instead of one overriding tax treatment applicable to all relationships that take a specified legal form or some economic equivalent, there are several different treatments applicable to various types of financial instruments that often combine characteristics of one another. The result is a lack of overriding or guiding principles which makes it very difficult to realise consistent taxation of all financial instruments that provide equivalent cash flows and differ only in their legal form.[15] It is expecting too much of tax administrators, practitioners, and the courts to make sense of what is, in essence, a nonsensical legislative scheme that flies in the face of the reality of financial equivalences. Indeed, within the constraints of the tax cubbyholes reflected in the general principles and rules in most legislation, it is unclear how equivalent cash flows should be taxed.[16] An adoption of interpretive activism that would result in the consistent taxation of financial instruments based on their associated cash flows would, more often than not, require a disregard of existing legislation that is not within the accepted role of tax administrators or the courts.[17]
I believe therefore that the responsibility for the development of some kind of sensible approach lies with tax policymakers, who should consider the adoption of a comprehensive accrual regime to address troublesome inconsistencies and discontinuities more completely. In this context, the debate over legal form or economic substance as the basis for the design of a tax system is irrelevant. Any sensible and coherent system of taxation designed to finance the provision of public goods and redistribute wealth should take appropriate account of the economic results of particular transactions.[18] The task of tax policymakers is to explore the extent to which tax legislation is constrained by a need to tax on the basis of legal form, and/or what alternative approaches are available as a means to implement taxation on the basis of economic substance.
A tax system that eliminates fundamental differences in the taxation of interest and dividends, as well as the distinction between capital and ordinary income amounts and accrual versus realisation-based recognition, would eliminate all incentives to replicate different instruments in an effort to capitalise on opportunities for tax avoidance. Such a system would also eliminate tax distortions of financing decisions and would allow suitable non-tax reasons to govern decision-making. Derivatives would be used primarily as risk management instruments that enhance the efficiency and liquidity of capital markets by permitting access to markets that might otherwise be unavailable to users and providers of financial capital.
As a theoretical starting point, most commentators have concluded that a benchmark income tax system applied to all financial instruments, including shares, should incorporate three fundamental principles:
• inclusion and deduction of the full amount of all gains and losses;
• annual recognition of changes in value by marking to market all financial instruments; and
• elimination of the corporate income tax and its replacement with a tax at the investor level on annual changes in the value of all financial instruments.
Under this benchmark, tax distortions would be eliminated, since there would be no characterisation or timing differences for the cash flows associated with particular financial instruments. In an important sense, financial instruments would be taxed according to their economic substance represented by annual changes in value. There would be no need to categorise financial instruments and their associated cash flows; nor would it be necessary to attempt to link certain financial instruments and tax them as a synthetic transaction, or break down a hybrid financial instrument into its component parts and tax those parts separately.
There are both historical and substantively defensible reasons explaining the failure to adopt this benchmark tax system. The three most commonly cited ones are: the valuation difficulties presented by financial instruments that do not trade publicly, liquidity problems for taxpayers forced to pay tax on unrealised gains, and unevenness in the recognition of unrealised gains and losses attributable to wide fluctuations in value. As a result, the corporate income tax is not about to be eliminated in favour of the accretion taxation of all financial instruments. Indeed, without such taxation or the conduit treatment of all legal entities, the corporate income tax must be maintained as a withholding tax on the unrealised capital gains of shareholders, particularly non-residents.
The need for a comprehensive approach to the tax treatment of financial instruments, and the accepted significance of practical obstacles to the adoption of accretion taxation, raise the issue of alternative reform options. In short, the obvious question is: are there any feasible, second-best options that approximate an accretion regime? As a principal policy goal, the consistent treatment of equivalent cash flows should be a minimum requirement of any sensible legislative regime, applied in the context of a necessarily second-best world of differentiated taxation. Otherwise, there are opportunities for “pure tax avoidance” in the sense that a tax-preferred legal form can be substituted for another form without compromising important non-tax considerations.[19] These instances of pure avoidance entail little, if any, efficiency losses, yet the revenue losses could be significant.
As an alternative to a system of accretion taxation, an effective legislative regime can realise an important measure of consistent taxation, provided that it is based on the premise that expected and unexpected gains and losses present different policy concerns that require different responses.[20] A comprehensive accrual regime, such as that described in the TOFA proposals, is an attempt to implement this premise and the dictates of “expected-return taxation”. The essence of this approach is the ruthless identification of expected gains and losses associated with disguised and embedded debt in any financial instrument. Accrual recognition of these gains and losses must be required. Realisation-based recognition can be applied to unexpected gains and losses arising on the resolution of a specified bet. This type of regime is already reflected in some of the provisions and principles of existing income tax systems, including:
• realisation-based recognition of unexpected gains and losses associated with forwards, futures and swap contracts; and
• accrual recognition of the expected gains and losses on fixed-payment debt and some forms of debt with contingent payments.
However, certain modifications and/or extensions of the existing tax cubbyholes are required, including:
• the elimination of the distinction between ordinary income and capital amounts;
• the extension of accrual recognition to the expected return attributable to the embedded debt in prepaid and off-market forwards and swaps, as well as options; and
• the application of accretion recognition to unexpected gains and losses on traded instruments that give rise to problems of “selective realisation”.
Although any approach to the taxation of financial instruments other than accretion taxation cannot address completely the more problematic hybrid and synthetic instruments, some of the challenges presented by these instruments disappear under a comprehensive system of expected-return taxation. In short, because these complex instruments are composites of the basic building block instruments, appropriate rules for the taxation of the more fundamental instruments can eliminate many tax avoidance opportunities that depend on the different taxation of the sum of the component parts of a synthetic and the combination of those parts assessed as a whole. This elimination can be achieved only by identifying and treating differently expected and unexpected gains and losses in all financial instruments. In effect, consistent tax treatment of equivalent cash flows, defined in terms of the distinction between expected and unexpected amounts, can be provided in a comprehensive manner that encompasses all of the basic building block instruments and, by necessary implication, all hybrid and synthetic instruments.
The significant problems under the TOFA proposals, or any other thoroughly developed accrual regime, are attributable to a continued acceptance of the different taxation of interest and dividends, and the application of the realisation requirement to shares and other non-traded financial instruments and non-financial assets. The principal pressure points arise in the following four areas: the boundary between debt and derivatives; boundary between debt and equity; synthetic replication; and hedge accounting.
A. Boundary Between Debt and Derivatives
The different taxation of debt and derivatives requires some limited application of bifurcation as a tax technique applied to hybrid instruments that are: (i) debt in form but have an embedded derivative or (ii) derivatives in form but have an embedded loan. As applied to the taxation of hybrid instruments, bifurcation is conventionally understood as the process by which an indivisible instrument is broken down into its component parts (the basic building block instruments), and a specified tax treatment consistent with the recognised cubbyholes is applied separately to each of those parts. Several US commentators[21] have correctly pointed out that this conventional concept of bifurcation is virtually impossible to apply as a general approach to the taxation of financial instruments under an income tax system that treats any of the basic building blocks of financial innovation inconsistently. The varieties of financial equivalences and the sophistication needed to bifurcate complex financial instruments means that bifurcation is administratively problematic. More fundamentally, the different taxation of the basic component parts of financial instruments renders bifurcation inconclusive in many instances, since different combinations of the basic parts can produce different tax treatments even after bifurcating a complex instrument. These difficulties can be addressed by identifying the embedded debt in all derivative instruments and imputing interest, whether the derivative is issued on a stand-alone basis or is embedded in a contingent-payment debt instrument. Possible revenue loss from increased interest deductions,[22] as well as perceived administrative and compliance problems associated with the logical extension of this approach, leave an uncertain and troublesome boundary line.[23] On one side of the line are derivative instruments with an embedded debt element that is perceived to be significant enough to require imputation of interest. On the other side of the line are derivatives and contingent-payment debt instruments with embedded derivatives subject to the traditional cubbyholes for contingent payments.
B. Boundary Between Debt and Equity
The different taxation of interest and dividends requires a distinction between debt and equity that is exceedingly difficult once a purportedly substantive approach is adopted in place of an approach based on an acceptance of legal form. Reliance on the legal form of an instrument as debt or equity is defensible only if some important features of a corporate income tax are adopted in an attempt to substitute for, and complement, a comprehensive accrual regime. In particular, the corporate income tax must be seen as a proxy for the shareholder-level tax on expected and unexpected gains. This role for the corporate income tax can be implemented successfully only if a comprehensive system of dividend imputation with a compensatory dividend tax is adopted. Such a system can be used to ensure that shares that are potential debt substitutes bear a tax burden that is roughly commensurate with that on interest income. The limitations of any imputation regime arise primarily with cross-border investment, where differences in national tax regimes provide tax avoidance opportunities based on the different classifications by source and residence countries of financial instruments. Until greater co-ordination of national tax regimes is achieved, a ‘facts and circumstances’ approach to the classification of financial instruments as debt or equity may be the only effective means to address avoidance opportunities.[24]
C. Synthetic Replication
Because accretion taxation must inevitably be limited to traded financial instruments that are easily valued, it remains possible to create financial equivalences that are advantageous from a tax perspective. For example, taxpayers can create offsetting positions with financial instruments that are subject to accretion taxation and others that are subject to expected-return taxation. Similarly, financial instruments subject to expected-return taxation can be used to replicate other instruments subject to accretion taxation. These kinds of transactions are advantageous because expected-return taxation requires the recognition of expected gains and losses on an accrual basis, while accretion taxation captures both expected and unexpected gains and losses. Avoidance opportunities may also be available because of rate differences among taxpayers and any exclusion from an accrual regime of instruments held by individuals. Other problematic areas are: (i) the exclusion of non-traded shares from an accrual regime; (ii) the provision of exemptions from non-resident withholding tax for portfolio interest payments and payments on derivatives; and, (iii) the denial of dividend tax credits to non-resident shareholders and tax-exempt entities, such as pension funds. In these instances, long and short positions in financial instruments can be combined to: (i) constructively dispose of shares without attracting a disposition transaction for tax purposes; (ii) avoid non-resident withholding tax on interest and dividends;[25] and (iii) transfer the benefit of dividend imputation credits and foreign tax credits. These kinds of avoidance opportunities can be addressed, to some extent, with specific legislative responses and general anti-avoidance provisions applicable to transactions that involve synthetic replication.[26] Nonetheless, impossible questions surround the distinction between the tax-driven use of synthetics and legitimate hedging strategies.[27] Because the distinction between these respective categories is an unprincipled one involving differences in degree, any attempt to draw a boundary line and apply an integrated tax treatment of otherwise independent financial instruments is an arbitrary exercise.[28]
D. Hedge Accounting
A hedge accounting regime is a limited form of integrated treatment whereby a gain or loss on a financial instrument acquired as a hedge of the risk associated with an underlying asset or liability is taxed with reference to that underlying. Such a regime presents serious administrative and compliance problems. Indeed, the application of an integrated treatment of two or more financial instruments, or a financial instrument and a non-financial asset, has an intuitive appeal that tends to mask the difficult identification issues in an income tax system with different tax rules for particular types of instruments and assets. The problem centres on the appropriate identification of integrated positions and, in particular, the development of purpose-based identification criteria that can be administered effectively. In many respects, the comparable identification rules developed by the accounting profession (reflected to some extent in the US legislation) are excessively flexible and too subjective to be administrable for income tax purposes. To the extent that the distinction between ordinary income and capital amounts can be eliminated, hedging rules may be unnecessary and not worth the considerable administrative and compliance burdens.
Even with these kinds of problems, TOFA and all other comprehensive accrual regimes are preferable to the application of the conventional tax cubbyholes, primarily because of the reduction in much of the tax significance of distinctions among financial instruments and the broad elimination of opportunities to disguise expected gains as unexpected amounts. Because, however, even a well-thought out legislative regime cannot possibly deal with all circumstances, the courts must serve a critical supporting role, especially when the legislative framework must, of necessity, be second-best in nature. That role is performed most effectively where there is a clear legislative expression of general principles that the tax administration, practitioners, and the courts can focus on when working through the details of appropriate treatment for specific instruments. Some ambiguity in the difficult boundaries between debt and derivatives and debt and equity, along with some anti-avoidance provisions that attempt to address the worst instances of synthetic replication, may be justifiable in order to introduce sufficient legal risk to deter taxpayers from unduly exploiting the remaining cubbyholes.[29] The courts can serve a potentially useful role in policing the relevant boundary lines in these problematic areas. Consistency of result is not even a requirement, since the lines are necessarily vague and somewhat arbitrary. In fact, inconsistency may be tolerable, as a means to ensure that exploitation of the boundary lines does not “get out of hand”.[30]
* Associate Professor, Faculty of Law, The University of Western Ontario, London, and a senior research fellow, Taxation Law and Policy Research Institute, Deakin University, Melbourne. This paper draws on portions of other papers published previously by the author. See, for example, T Edgar, “Some Lessons from the Saga of Weak-Currency Borrowings̶[1] (2000) 48 Canadian Tax Journal 1; T Edgar, “The Tax Treatment of Interest and Financing Charges in a World of Financial Innovation: Where Should We Be Going?” in Current Issues in Corporate Finance, 1997 Corporate Management Tax Conference, Canadian Tax Foundation (1998) 10(1); and T Edgar, “The Debt-Equity Distinction and the Taxation of Financial Instruments: Past Practice and Future Directions in Australia and Canada” in JG Head and R Krever (eds), Taxation Towards 2000, Australian Tax Research Foundation (1997).
1 The project produced two separate discussion papers. See Australia, Taxation of Financial Arrangements: A Consultative Document, December 1993; and Australia, Taxation of Financial Arrangements: An Issues Paper, December 1996.
[2] Australia, Treasury, Tax Reform: Not a New Tax, a New Tax System, 13 August 1998 (“ANTS”).
[3] The incorporation and refinement of the TOFA proposals in the Ralph review process is evident in Australia, Review of Business Taxation, A Platform for Consultation – Building on a Strong Foundation Discussion Paper 2, Vol I, February 1999, chs 5-7 (“A Platform for Consultation”); and Australia, Review of Business Taxation, A Tax System Redesigned - More Certain, Equitable and Durable, July 1999, ch 9 (“Ralph Review”); and Australia, Draft Legislation - A New Tax System (Income Tax Assessment) Bill 1999, July 1999.
[4] Steinberg, “Commentary” (1995) 50 Tax Law Review 725 at 725.
[5] C Warren, “Financial Contract Innovation and Income Tax Policy” (1993) 107 Harvard Law Review 460.
[6] Strnad, “Taxing New Financial Products: A Conceptual Framework” (1994) 46 Stanford Law Review 569.
[7] Shuldiner, “A General Approach to the Taxation of Financial Instruments” (1992) 71 Texas Law Review 243.
[8] A Weisbach, “Tax Responses to Financial Contract Innovation” (1995) 50 Tax Law Review 491.
[9] Ibid.
[10] The term “accretion taxation” is used here to avoid confusion with the term “accrual taxation” in its more limited sense of a requirement to spread expected gains and losses over the term of a financial instrument for the purpose of recognizing such amounts as they are expected to arise (that is, “accrue”).
[11] The types of limited modifications that comprise the modest legislative agenda described here are suggested by Halperin, “Saving the Income Tax: An Agenda for Research” (1998) 24 Ohio Northern University Law Review 493.
[12] P Hariton, “The Taxation of Complex Financial Instruments” (1998) 43 Tax Law Review 731; B Land, “Contingent Payments and the Time-Value of Money” (1987) 40 The Tax Lawyer 237; B Cunningham and H Schenk, “Taxation Without Realization: A ‘Revolutionary’ Approach to Ownership” (1992) 47 Tax Law Review 725; H Scarborough, “Different Rules for Different Players and Products: The Patchwork Taxation of Derivatives” (1994) 72 Taxes 1031; and Shuldiner, note 7 supra.
[13] Income Tax Act, 1994 (New Zealand), as amended, Subpart H of Part E, ss EH A1-EH 18 (Division 1 applicable generally to financial arrangements entered into on or after October 23, 1986 and before May 20, 1999); and ss EH 19-EH 59 (Division 2 applicable generally to financial arrangements entered into on or after May 20, 1999).
[14] See, for example, JS Wilkie, “Looking Forward into the Past: Financial Innovation and the Basic Limits of Income Taxation” (1995) 43 Canadian Tax Journal 1144. See also P Hariton, “The Tax Treatment of Hedged Positions: What Hath Technical Analysis Wrought?” 50 Tax Law Review 803, who suggests the abandonment of detailed legislative rules (“technical analysis”) in favour of the resolution of specific cases by applying general principles under a method of “logic, parallelism and judgment”. See also LE May, “Further Reflections on Derivative Taxation” (1999) 47 Canadian Tax Journal 534 (doubting the need for further legislation in the absence of reform that eliminates fundamental asymmetries).
[15] J Frost, “Taxation of Financial Instruments” in Papers Presented at the Eleventh National Conference of the Taxation Institute of Australia, May 1993, 103 at 107.
[16] P Gergen, “Apocalypse Not?” (1995) 50 Tax Law Review 833 at 858.
[17] See G Duff, “Interpreting the Income Tax Act - Part 2: Toward a Pragmatic Approach” (1999) 47 Canadian Tax Journal 741 at 787-97 (criticising a consequentialist approach to statutory interpretation for its disregard of the wording of the legislative text).
[18] See, for example, Ralph Review, note 3 supra at 15 (“A major motivation of the reforms to the taxation of financial arrangements was to ensure that different forms of financial instruments are taxed according to their economic substance rather than their legal form”).
[19] N Brooks and Head, “Tax Avoidance: In Economics, Law and Public Choice” in S Cooper (ed) Tax Avoidance and the Rule of Law, (1997) 53 at 54-78; and S Scholes and Wolfson, Taxes and Business Strategy, Prentice Hall (1992), chs 6 and 7.
[20] These policy concerns and their significance for the design of a comprehensive accrual regime are described in Tim Edgar, Income Tax Treatment of Financial Instruments: Theory and Practice, Canadian Tax Foundation, forthcoming.
[21] See, for example, V Battle Jr, “Bifurcation of Financial Instruments” (1991) 69 Taxes 821; P Hariton “New Rules on Bifurcating Contingent Debt – A Mistake?” (1991) 51 Tax Notes 235; KC Kau, “Carving Up Assets and Liabilities – Integration or Bifurcation of Financial Products” (1990) 68 Taxes 1003; and in D Kleinbard, “Beyond Good and Evil Debt (And Debt Hedges): A Cost of Capital Allowance System” (1989) 67 Taxes 943.
[22] LE May, “Overview of Financial, Tax, and Accounting Principles for Derivative Financial Instruments” in Report of Proceedings of the Forty-Seventh Tax Conference, 1995 Conference Report Canadian Tax Foundation (1996), 29:1 at 10-1; and May, note 14 supra at 540.
[23] P Hariton, “The Accrual of Interest on Derivatives: Where Do We Go From Here?” (1996) 74 Taxes 1011.
[24] See May, note 14 supra at 543 (the “real” tax avoidance activity is focused on cross-border arbitrage of the debt-equity distinction).
[25] For an excellent description of various synthetic instruments that can be used to avoid US-withholding tax, see May, “Flying on Instruments: Synthetic Investment and the Avoidance of Withholding Tax” (1996) 13 Tax Notes International 1625. See also in the Canadian context, G Broadhurst, “Derivatives in International Tax Planning” in 1997 International Tax Seminar, International Fiscal Association – Canadian Branch, Carswell (1998) 85.
[26] See, for example, Australia, Treasury, “Tax Avoidance: Foreign Tax Credit Schemes” , Treasurer’s Press Release No 078, 1998; and Australia, Treasury, “Measures to Prevent Trading in Franking Credits”, Treasurer’s Press Release No 47, 1997. See also Income Tax Act, RSC 1985, cl 1 (5th Supp), as amended, subsections 82(1) and 112(2.3) (denying the dividend gross up and tax credit and the intercorporate dividend deduction for dividends received as part of a “dividend rental arrangement” defined in s 248(1)); ss 126(4.1)-(4.4) (denial of foreign tax credits in respect of certain credit-trading transactions); and Internal Revenue Code 1986, s 1259 (entering into offsetting positions that eliminate all or substantially all of the risk associated with a long position in certain assets treated as constructive sale).
[27] L Paul, “Another Uneasy Compromise: The Tax Treatment of Hedging in a Realization Income Tax” (1996) 3 Florida Tax Review 1.
[28] But see A Weisbach, “Line Drawing, Doctrine, and Efficiency in the Tax Law” (1999) 84 Cornell Law Review 1627 (noting the lack of any normative basis for various boundary lines in tax law, but arguing that these lines should be drawn at particular points based on efficiency considerations associated with the substitutability of transactions).
[29] P Gergen and Schmitz, “The Influence of Tax Law on Securities Innovation in the United States: 1981-1997” (1997) 52 Tax Law Review 119 (suggesting that an uncertain factors approach to the classification of instruments as debt or equity for US tax purposes is desirable as a constraint on tax-driven innovation along the boundary line between debt and equity). See also A Weisbach, “Formalism in Tax Law” (1999) 66 The University of Chicago Law Review 860 (suggesting that purpose-based anti-avoidance rules can be effective in suppressing discontinuities that are the focus of tax-driven or “uncommon transactions”).
[30] V Battle Jr, “Corporate Tax Shelters, Financial Engineering and the Colgate Case” (1997) 75 Taxes at 703 (“Perhaps the concern is attributable to a belief that the doctrine [taxation on the basis of economic substance rather than legal form] is not a clear principle of law applicable to rich and poor alike but, instead, is a fuzzy notion that has been useful to keep things from getting out of hand”).
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