Bank Comments on Tax Treatment of Conversion Rate Adjustments
Bank Comments on Tax Treatment of Conversion Rate Adjustments
- AuthorsBreen, Daniel P.
- Institutional AuthorsCitigroup Global Markets Inc.
- Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2016-681
- Tax Analysts Electronic Citation2016 TNT 8-17
December 16, 2015
Honorable Mark Mazur
Assistant Secretary of the Treasury for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Room 3120
Washington, D.C. 20220
Dear Mr. Mazur:
I want to express my appreciation for the opportunity to meet with you, Jonah Crane from the Office of Domestic Finance and Jake Liebschutz from the Office of Capital Markets concerning the adverse impact to the convertible bond market if Treasury implements a change in the tax treatment for conversion rate adjustments.
We understand that a new interpretation of Section 305(c) is being considered in which the fair value ("make whole") adjustments provided in convertible securities would be treated as deemed dividends. This would result in a change in current practice, introduce uncertainty, unfairness and adversely impact the liquidity for this important sector of the capital markets.
As we discussed, we are specifically concerned that the IRS may he looking at a "parity value" methodology to determine the amount of the deemed dividend. Parity value is generally understood as the number of shares underlying the conversion rate adjustment multiplied by the closing price per share on the effective date. Parity value will always provide the wrong economic result because the potential to receive additional shares cannot be realized without foregoing valuable coupon and creditor rights. It certainly produces the wrong result when the securities are never converted. We submit that requiring a value determination prior to conversion will simply be Unworkable. These rate adjustments are not separable property rights and thus, the securities will have to be independently valued on a "with and without" basis accounting solely for the change in the conversion rate.
Valuing convertible securities is an inherently subjective and imperfect process. The uncertainty stems from the fact that many of these securities trade in the over the counter market with widespread and divergent market views relating to uncertainties about credit spreads and expected long dated stock volatilities among other factors. Many have contingent conversion features which prohibit the exercise of conversion rights unless and until the underlying stock exceeds certain benchmarks. Many securities will settle in cash for the par value plus a net number of shares equal in amount to the in-the-money value determined using closing stock prices over an averaging period. Taking all of these factors into account will simply be too complex and uncertain for the hundreds of billions of securities that trade in the market. Finally and most critically, the market acceptance for this product and its resulting liquidity will be adversely affected by introducing current taxes on what is essentially a loss recovery mechanism. This change in approach raises fundamental tax fairness issues.
For these reasons, we urge you to clarify that conversion rate adjustments should be taken into account under section 305(c) only on a "wait and see" basis after conversion has established that the bondholder will exchange the bond for stock. Thank for your consideration.
Daniel P. Breen
Managing Director
US Equities
Citigroup Global Markets Inc.
Jonah Crane, Office of the Under Secretary for Domestic Finance
Jake Liebschutz, Office of Capital Markets
Krishna Vallabhaneni, Deputy Tax Legislative Counsel
- AuthorsBreen, Daniel P.
- Institutional AuthorsCitigroup Global Markets Inc.
- Code Sections
- Subject Area/Tax Topics
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2016-681
- Tax Analysts Electronic Citation2016 TNT 8-17