The Uncertain Tax Treatment of Swaps

Financial institutions have greatly increased the use of interest rate swaps since the swaps' inception in 1981. These transactions, in which 2 parties exchange their interest payments with respect to an agreed-upon principal sum for a given period of time, can be used by institutions as hedgin...

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Bibliographic Details
Published inBankers monthly Vol. 105; no. 2; p. 21
Main Authors Knoll, Mina J, Brown, Steven C
Format Journal Article
LanguageEnglish
Published New York Faulkner & Gray, Inc 01.02.1988
Subjects
Banks
Buy or lease decisions
Communications equipment
Documentation
Financial institutions
Financing
Hedging
Interest rate swaps
Interest rates
Leasing
Payments
Swap arrangements
Tax controversies
Tax regulations
Taxes
Vendors
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Summary:Financial institutions have greatly increased the use of interest rate swaps since the swaps' inception in 1981. These transactions, in which 2 parties exchange their interest payments with respect to an agreed-upon principal sum for a given period of time, can be used by institutions as hedging devices. However, taxation of these swaps has not been addressed explicitly by the Internal Revenue Code or Treasury regulations, and it is, therefore, uncertain. Nevertheless, Revenue Ruling 87-5 indicates that periodic payments between swap partners should not be treated as interest since there is no advance of funds. If related to borrowing, the payment should be characterized by banks as an ordinary and necessary business expense. Also, the recognition of swap payments may depend on the motive for entering into the swap. Although much tax treatment uncertainty persists, the interest rate swap remains a very valuable financing tool. However, complex swap transactions may require the help of a tax adviser.
ISSN:0005-5476