The Biden Administration has proposed to modernize certain tax rules relating to securities, including nonrecognition rules applicable to certain securities lending transactions and the mark-to-market rules under Internal Revenue Code (IRC) section 475, to extend them to cryptocurrencies and other digital assets. The tax proposals, which were set out in the Treasury “Green Book” released 28 March 2022 would also expand certain reporting requirements to digital assets (for an analysis of the Green Book proposals, see the article in this issue).
Gain or loss on certain securities lending transactions, which are common in securities markets, are eligible for tax nonrecognition treatment, provided certain requirements are met. The requirements aim to ensure that the securities lender remains in a substantially similar economic position as it would have been in absent the loan. For purposes of the nonrecognition rules, “securities” include stocks, bonds, notes and related interests, but not digital assets.
The Administration’s proposal would extend these nonrecognition rules to “loans of actively traded digital assets recorded on cryptographically secured distributed ledgers.” Treasury would have authority to determine when a digital asset is publicly traded, and the authority to extend the rules to non-actively traded digital assets. The change is intended to modernise the rules to account for the expansion of the market for financial asset lending to include digital assets. The proposal would also “clarify” that, except as provided by Treasury, certain fixed-term loans are subject to the nonrecognition rules (assuming all other requirements are satisfied) and would provide Treasury with the authority to extend nonrecognition treatment to loans of other assets, such as interests in publicly traded partnerships.
The change is proposed to be effective for tax years beginning after 31 December 2022.
Under IRC section 475, dealers in securities must value their inventory and non-inventory securities at year end using mark-to-market accounting. Mark-to-market accounting is also available by election for dealers in commodities and traders in securities and commodities. For this purpose, securities include stock and certain other financial instruments. However, mark-to-market accounting under section 475 is not available for dealers or traders of digital assets, including those that are actively traded.
The Administration proposes to extend elective mark-to-market accounting to dealers and traders of “actively traded digital assets and derivatives on, or hedges of, those digital assets.” Importantly, digital assets would not be treated as securities or commodities for purposes of Section 475, and therefore would only be eligible for mark-to-market accounting when held by an electing dealer or trader of digital assets.
The change is proposed to be effective for tax years beginning after 31 December 2022.
The Green Book also sets out two new proposed reporting regimes in connection with digital assets.
One proposal would create new reporting requirements for certain financial institutions and brokers for purposes of international information exchange. The proposal would, together with existing law, require brokers (such as U.S. digital asset exchanges) to report gross proceeds (and any other information that Treasury may require) with respect to the sale of digital assets by their customers and, in the case of certain passive entities, their substantial foreign owners. The proposed requirements would be effective for returns filed after 31 December 2023.
The other reporting proposal would amend IRC section 6038D, which requires reporting by certain taxpayers holding interests in a “specified foreign financial assets,” to extend the reporting requirement to “any account that holds digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider.” For this purpose, a foreign digital asset account is expected to be defined based on where the exchange or service provider is organized or established. The reporting requirement would continue to apply only to taxpayers with an aggregate value of specified foreign financial assets in excess of USD 50,000. This requirement is proposed to be effective for returns required to be filed after 31 December 2022.
Attempting to apply existing tax law to address transactions with respect to digital assets has presented significant challenge to both taxpayers and the IRS. The Administration’s proposals to extend nonrecognition treatment to certain loans of digital assets – transactions that are increasingly common but for which no guidance has been provided to date – and to permit dealers and traders in digital assets to elect mark-to-market accounting would be welcome modernizations of existing law. On the other hand, new reporting requirements aimed at tackling tax avoidance could also impose new obligations on taxpayers.
As the Green Book proposals do not introduce legislation but only represent the Biden Administration’s “wish list” for legislative action during the year, it remains to be seen whether the digital asset proposals or other proposed provisions will ultimately be enacted. Nevertheless, the inclusion of these provisions in the Administration’s 2023 Budget indicates that additional guidance with respect to transactions in digital assets continues to be a priority in Washington
Michael Bauer
michael.bauer@bdo.com
Kevin Ainsworth
kainsworth@bdo.com