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Income Taxation of Derivatives and Other Financial AXEL HILLING AXEL HILLING AXEL HILLING Income Taxation of Derivatives and other Financial Instruments Income Taxation of Derivatives and other Financial Instruments Income Taxation of Derivatives – Economic Substance versus Legal Form – Economic Substance versus Legal Form and other Financial Instruments A study focusing on Swedish non-financial companies – Economic Substance versus From an economic viewpoint, derivatives and credit-extension instruments are the basic building blocks of all financial instruments. By structuring these building Legal Form blocks in various combinations, it is possible to attain the economic substance of any conventional financial instrument – regular shares or bonds, as well as more complex financial instruments such as contingent debt instruments. The legal form of financial instrument in the Swedish income tax legislation A study focusing on Swedish non-financial companies is not systematically based on the instrument’s economic substance. This creates situations in which the payoff from a certain economic substance is taxed arbitrarily. The payoff from a financial instrument is not always taxed similar to the net payoff from its building blocks, a situation that provides tax arbitrage opportunities within the Swedish income tax system. The study presented in this book addresses the Swedish income tax treatment of derivatives and other financial instruments held by non-financial companies. Special emphasis is given to the income tax treatment of and tax arbitrage opportunities related to hybrid financial instruments and synthetic instruments. Possible ways of dealing with financial instruments used for hedging the business risks of non-financial companies are also discussed. In addition, the book presents methods for improving the tax treatment of financial instruments and preventing existing tax arbitrage opportunities related to them. 042 JIBS Dissertation Series No. JIBS Dissertation Series ISSN 1403-0470 ISBN 91-89164-79-2 No. 042 AXEL HILLING AXEL HILLING AXEL HILLING Income Taxation of Derivatives and other Financial Instruments Income Taxation of Derivatives and other Financial Instruments Income Taxation of Derivatives – Economic Substance versus Legal Form – Economic Substance versus Legal Form and other Financial Instruments A study focusing on Swedish non-financial companies – Economic Substance versus From an economic viewpoint, derivatives and credit-extension instruments are the basic building blocks of all financial instruments. By structuring these building Legal Form blocks in various combinations, it is possible to attain the economic substance of any conventional financial instrument – regular shares or bonds, as well as more complex financial instruments such as contingent debt instruments. The legal form of financial instrument in the Swedish income tax legislation A study focusing on Swedish non-financial companies is not systematically based on the instrument’s economic substance. This creates situations in which the payoff from a certain economic substance is taxed arbitrarily. The payoff from a financial instrument is not always taxed similar to the net payoff from its building blocks, a situation that provides tax arbitrage opportunities within the Swedish income tax system. The study presented in this book addresses the Swedish income tax treatment of derivatives and other financial instruments held by non-financial companies. Special emphasis is given to the income tax treatment of and tax arbitrage opportunities related to hybrid financial instruments and synthetic instruments. Possible ways of dealing with financial instruments used for hedging the business risks of non-financial companies are also discussed. In addition, the book presents methods for improving the tax treatment of financial instruments and preventing existing tax arbitrage opportunities related to them. 042 JIBS Dissertation Series No. JIBS Dissertation Series ISSN 1403-0470 ISBN 91-89164-79-2 No. 042 AXEL HILLING Income Taxation of Derivatives and other Financial Instruments – Economic Substance versus Legal Form A study focusing on Swedish non-financial companies Jönköping International Business School P.O. Box 1026 SE-551 11 Jönköping Tel.: +46 36 10 10 00 E-mail: [email protected] www.jibs.se Income Taxation of Derivatives and other Financial Instruments – Economic Substance versus Legal Form: A study focusing on Swedish non-financial companies JIBS Dissertation Series No. 042 © 2007 Axel Hilling and Jönköping International Business School ISSN 1403-0470 ISBN 91-89164-79-2 Printed by ARK Tryckaren AB, 2007 Acknowledgement My doctoral studies have come to the end. In retrospect, this journey has been an interesting and challenging one, and I am grateful to the many people who have made this project possible. Above all, I would like to express my gratitude to my wife, Maria Hilling, Assistant Professor of Tax Law at Linköping University, for her love, support, and encouragement; and for the countless hours she spent scrutinizing and commenting on my manuscript. Without her I would not have made it! I would like to warmly thank my supervisors – Björn Westberg, Professor of Financial Law at Jönköping International Business School; and Kristina Artsberg, Associate Professor of Accounting at Lund University. They not only convinced me to write my dissertation on derivatives and other financial instruments, but also provided essential help and support during the journey that was this thesis. Claes Norberg, Professor of Financial Law at Lund University, acted as opponent for my final seminar on this thesis and commented on earlier copies of the manuscript. I thank him for his insightful comments, always presented in a positive and encouraging way. I am deeply indebted to Agostino Manduchi, Assistant Professor of Financial Economics at Jönköping International Business School, who introduced me to the world of derivatives (as well as Italian football!) and encouraged me in my aspiration to learn more about it. Special thanks go to Anne Rutberg, tax lawyer and partner in Mannheimer Swartling; and to Lars Möller, Commission Secretary of the Swedish Ministry of Finance, who made valuable comments on a late version on the manuscript. I am grateful to them for sharing their profound knowledge in areas relevant to my thesis project. I am sincerely grateful to Drs. Nina Colwill and Dennis Anderson for their accurate and professional language editing of my final dissertation manuscript, and for all their encouragement throughout that process. I would also like to thank Carol-Ann Soames, Lecturer in the English language at Jönköping International Business School, for her efforts in language checking earlier versions of the document. Drafts of this manuscript were presented in seminars at the Faculty of Law at Jönköping International Business School, and I am grateful to those who read and commented on these manuscripts during and following my presentations. In particular, I would like to thank Niclas Virin, former Head of Tax Department at Svenska Handelsbanken; Ann-Sophie Sallander and Pernilla Rendahl, Doctoral iii Candidates of Tax Law at Jönköping International Business School; Kjell Johansson, Doctoral Candidate of Tax Law/Financial Accounting at University College of Borås; Fredrik Ljungdahl, Assistant Professor of Accounting at Jönköping International Business School; Börje Johansson and Börje Norling, Legal Experts at the Swedish Tax Agency; and Samuel Cavallin, Associate Professor of Law at Lund University. Furthermore, I would like to thank Peter Nordqvist, tax lawyer and partner in Mannheimer Swartling, for the opportunity to present parts of the manuscript to the tax law group at Mannheimer Swartling and to the Stockholm Chamber of Commerce Tax Committee. I received many valuable comments from these practitioner audiences. I split my time as a doctoral student between the Department of Commercial Law and the Department of Accounting and Finance at Jönköping International Business School. I want to acknowledge all my colleagues who contributed in various ways to making these years memorable. The librarians at the University Library of Jönköping University assisted me in a highly professional and pleasant manner, and I am grateful to them for their invaluable service. I spent one semester at the VU University Amsterdam studying finance, and one at the International Tax Center in Leiden studying international tax law. These experiences proved valuable when writing this thesis. For making these stays possible, I would like to acknowledge Torsten och Ragnar Söderbergs Stiftelser, Sparbanksstiftelsen Alfas internationella stipendiefond för Högskolan i Jönköping and Stiftelsen Näringslivets Donationsfond i Jönköping. Furthermore, I would like to express my thanks to Emil Heijnes Stiftelse för rättsvetenskaplig forskning for their generous financial support for the language editing of this thesis. Finally, without the continuous care and encouragement of family and friends the writing of this dissertation would not have been possible. Thanks to all! Axel Hilling Linköping, July 2007 iv Abstract The aim of this book is to examine the Swedish income tax treatment of derivatives, to ascertain the extent to which this treatment provides tax arbitrage opportunities, and to present possible solution that may prevent existing arbitrage opportunities. This study establishes that there are two types of financial instruments that constitute the greatest challenges regarding tax arbitrage opportunities in the
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