On August 6, 2009, Senator Ron Wyden (D-Oregon) introduced the “Stop Tax-breaks for Oil Profiteering Act” in the Senate, which is intended to temporarily curb excessive speculative trading in the oil and gas futures markets by eliminating the preferential tax treatment of direct and certain derivative interests in oil and natural gas. Under current law, direct or derivative interests in oil and natural gas generally are treated as capital assets and, as such, give rise to capital gains or losses. Long-term capital gains recognized by an individual are generally subject to tax at a preferential rate, whereas short-term capital gains are generally subject to tax at ordinary income rates.

The Wyden bill would generally treat all gain or loss from the sale or exchange of any “applicable commodity” which would otherwise be treated as long-term capital gain or loss, as short-term capital gain or loss. An applicable commodity generally includes direct or derivative interests in (i) actively traded oil or natural gas or any primary product of oil or natural gas (such as diesel fuel and gasoline), or (ii) an index, a “substantial portion” of which is based on actively traded oil or natural gas or any primary product of oil or natural gas.

The bill would also affect partnerships and tax-exempt organizations. The bill would treat any gain or loss recognized upon the sale or exchange of a partnership interest (such as an interest in a hedge fund or investment partnership) as short-term capital gain or loss to the extent a portion of such gain or loss is attributable to unrecognized gain or loss with respect to any applicable commodity. It would also treat any income, gain or loss derived by a tax-exempt organization with respect to any applicable commodity as unrelated business taxable income, subjecting the income to tax at corporate rates. In addition, if a tax-exempt organization holds an interest in a foreign corporation, it would be required to take into account, on a current basis without regard to whether there was an actual distribution from the corporation to the organization, its pro rata share of any income, gain or loss of such foreign corporation with respect to any applicable commodity as if the tax-exempt organization held such commodities directly.

In its current form, the bill raises a number of issues and questions. First, it is unclear what portion of an index must be based on actively traded oil or natural gas for it to be “substantial” within the meaning of the proposed legislation. Second, the bill can be expected to have far-reaching consequences for any tax-exempt organization holding stock in a foreign corporation that has income, gain or loss from any applicable commodity. Such corporations could include widely held international oil and gas companies. It is interesting to note that an exempt organization investing in a domestic oil company would not be subject to the same rules. Third, whether intended or not, it would appear that an applicable commodity would include exchange-traded notes or other structured notes that are linked to oil, natural gas, or an oil or gas index. Finally, the bill would affect the taxation of an investment in exchange-traded funds holding an applicable commodity whether or not they are treated as partnerships for federal income tax purposes. All or a portion of the gain from an investment in applicable commodities through exchange traded funds likely would lose its preferential treatment if the bill is enacted into law.

The bill, if enacted, would apply to any applicable commodity acquired after August 31, 2009 and before January 1, 2014. For a more detailed discussion of the bill, see our prior alert “Stop Tax-breaks for Oil Profiteering Act: Proposed Tax Legislation Intended to Reduce Excessive Speculative Trading in Oil and Natural Gas.”