As if it were not enough that the IRS issued a revenue ruling clarifying the tax treatment of foreign currency linked exchange traded notes (ETNs) – as well as other structured products – and a Notice questioning the tax treatment of other ETNs (both issued on Friday 12/7/2007), were not enough, Congress now officially enters the mix. Or should I say a singular Congressman enters.

On Wednesday night, Representative Richard Neal [D. MA], Chairman of the Subcommittee on Select Revenue Measures, introduced a bill to cause the current taxation of ETNs (and other structured notes). Not one other member of Congress co-authored the legislation or made any statement about it. Representative Neal introduced the bill literally moments before the House adjourned for the 2007 legislative year. Rep. Neal, from the proud state of Massachusetts, is a long-time supporter of the mutual fund industry. The investment company institute (the ICI – or mutual fund lobby) has been harassing members of Congress, and anyone else that will listen, for weeks about the "unfair" tax treatment of ETNs versus ETFs and mutual funds (bunch of hypocrites).It's not envisioned that the Neal bill will amount to anything more than what it appears – senseless pandering to one's constituents.

On Monday, Goldman Sachs, through their GS Connect ETN platform, launched their second ETN (GCE). The ETN is linked to a very strange (in my opinion) index – the Claymore CEF Index.

On the one hand the index is bizarre in that it is simply a compendium of the U.S. traded closed-end funds (CEFs) ranked by distribution yield and discount to NAV. The CEFs have no relationship to each other. The different CEFs concentrate on different sectors, styles, etc… It's strange in that an investor really isn't buying into any particular investment thesis. Each CEF is managed in a certain way for a certain economic goal, but their all different.

Late Friday the IRS released Revenue Ruling 2008-1 which effectively crushes the expected tax treatment of the Barclays exchange traded notes (ETNs) linked to individual foreign exchange rates. In the ruling the IRS argues that the fx-linked notes are nothing more than regular debt instruments (bonds) with a payout linked to the relevant fx rate. The result of this is that U.S. investors in ERO, GBB and JYN will be forced to accrue income for tax purposes each year they hold their investment even though the security pays no actual cash distribution (i.e., phantom income is generated for tax purposes).

This is indeed a set-back to the still immature ETN marketplace. However, the upshot is that the IRS did not make the same determination with respect to the rest of the ETN marketplace. This represents a tacit approval of what most tax practitioners had believed, that most ETNs are properly treated as forward contracts for U.S. tax purposes – which results in U.S. investors recognizing only long-term capital gains when they elect to exit the investment, assuming they have held the investment for more than 12 months at such time.