Using the Income Tax System as Your Hedge Counterparty

Australian Tax Forum, Vol. 28, No. 2, Forthcoming 2013

Sydney Law School Research Paper No. 12/77

60 Pages Posted: 18 Jul 2012 Last revised: 29 May 2013

See all articles by Timothy Edgar

Timothy Edgar

Osgoode Hall Law School

Amir Aghdaei

The University of Sydney - Faculty of Law

Date Written: July 17, 2012


A strain of the academic literature on taxation and risk taking emphasizes the income effect and consequent transfer of risk to government through the income tax system in the presence of scaling of risky positions. The policy implications of this literature have been explored in considerable detail, although the practical significance for tax policymakers is ambiguous given the tax and non-tax constraints on scaling under the personal income tax. In contrast, fragmentary transactional evidence suggests that scaling of risky positions may have its most practical application in the context of corporate hedging transactions where many of the same tax and non-tax constraints do not apply. In fact, risk-transfer transactions in this very different context have been the subject of some recent attention by tax policymakers and tax administrators.

This paper explores the case for, and design of, a targeted loss limitation intended to address the transfer of risk to government that otherwise is the result of hedged positions that are scaled to provide imperfectly offsetting pre-tax cash flows but perfectly (or near perfectly) offsetting after-tax cash flows. Although the case for such a limitation extends broadly to the entire range of such transactions, perceptions of costliness associated with the identification exercise, as well as perceptions of a negative impact on the decision to hedge, may lead to a more narrowly focused loss limitation patterned on legislation recently adopted by UK Inland Revenue. For the much more limited subset of risk-transfer transactions that are entered into for the purpose of providing a tax benefit, narrowly construed, general anti-tax-avoidance rules and/or doctrines can provide an effective response. An example of this type of transaction is the asymmetric swap that is the subject of a taxation determination recently released by the Australian Taxation Office ('ATO').

Keywords: taxation and risk taking, after-tax hedging, asymmetric swap

JEL Classification: H25

Suggested Citation

Edgar, Timothy and Aghdaei, Amir, Using the Income Tax System as Your Hedge Counterparty (July 17, 2012). Australian Tax Forum, Vol. 28, No. 2, Forthcoming 2013, Sydney Law School Research Paper No. 12/77, Available at SSRN: or

Timothy Edgar (Contact Author)

Osgoode Hall Law School ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3

Amir Aghdaei

The University of Sydney - Faculty of Law ( email )

New Law Building, F10
The University of Sydney
Sydney, NSW 2006

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