Recent Ruling on iPath Currency ETNs
An exchange-traded note is a debt-based instrument that, like its ETF cousins, trades throughout the day on the secondary market like a stock. In December of 2007, the IRS issued a ruling on the taxation of a certain class of currency-based exchange-traded notes sponsored by iPath, a division of Barclays. In their simplest form, ETNs represent a promise by the issuer to pay the ETN holder the value of the underlying index plus interest at the maturity date. ETFs, by contrast, represent a fractional ownership in all the stocks of the underlying index.
It’s important to note two things: 1) The December 2007 IRS ruling applies only to the iPath currency-linked ETNs; and 2) The IRS doesn’t tax currencies the same way it taxes investments in debt or equity. The IRS treats currencies much like collectibles; in fact, it doesn’t really consider foreign currencies to be an investment at all.
Prior to the IRS ruling, the interest on the iPath currency ETNs was incorporated automatically into the price of the ETN, and ETN holders didn’t owe any taxes on this income until they sold their shares. Thus, as long as investors held the ETN for more than a year, the income would be taxed at the long-term capital gains rate of 15 percent. In the original prospectus materials for its currency ETNs, iShares was also telling investors that any additional long-term gains in the price of the ETN would be taxed at the capital gains rate. All that changed when the IRS weighed in last December.
In the wake of the December 2007 ruling, investors in the iPath currency-linked ETNs will owe ordinary income tax on income from these securities, even where this income is incorporated back into the value of the note. The bottom line for investors is that they will have to come up with this tax payment, even though they won’t actually receive that taxable income until they liquidate their position in the ETN.
LOOK CLOSE AT THE 2ND PARAGRAPH
An exchange-traded note is a debt-based instrument that, like its ETF cousins, trades throughout the day on the secondary market like a stock. In December of 2007, the IRS issued a ruling on the taxation of a certain class of currency-based exchange-traded notes sponsored by iPath, a division of Barclays. In their simplest form, ETNs represent a promise by the issuer to pay the ETN holder the value of the underlying index plus interest at the maturity date. ETFs, by contrast, represent a fractional ownership in all the stocks of the underlying index.
It’s important to note two things: 1) The December 2007 IRS ruling applies only to the iPath currency-linked ETNs; and 2) The IRS doesn’t tax currencies the same way it taxes investments in debt or equity. The IRS treats currencies much like collectibles; in fact, it doesn’t really consider foreign currencies to be an investment at all.
Prior to the IRS ruling, the interest on the iPath currency ETNs was incorporated automatically into the price of the ETN, and ETN holders didn’t owe any taxes on this income until they sold their shares. Thus, as long as investors held the ETN for more than a year, the income would be taxed at the long-term capital gains rate of 15 percent. In the original prospectus materials for its currency ETNs, iShares was also telling investors that any additional long-term gains in the price of the ETN would be taxed at the capital gains rate. All that changed when the IRS weighed in last December.
In the wake of the December 2007 ruling, investors in the iPath currency-linked ETNs will owe ordinary income tax on income from these securities, even where this income is incorporated back into the value of the note. The bottom line for investors is that they will have to come up with this tax payment, even though they won’t actually receive that taxable income until they liquidate their position in the ETN.
LOOK CLOSE AT THE 2ND PARAGRAPH
