International Tax Aspects of Foreign Currency Transactions

(iii) Rollover of an Existing Contract. Where the taxpayerextends the maturity date of a contract, and the built-in gainor loss on the old contract is reflected in the price of thenew contract, this transaction is treated as a taxable eventwith respect to the old contract. However, to the extentthere is a significant time value of money component to theprice adjustment in the contract, the time value of moneycomponent is amortized over the life of the contract as if itwere interest income or expense.(b)Notional Principal Contracts under Reg. § 1.988-4(e).The § 988 regulations compute currency gain or loss on currencyswap by treating each party as if it actually borrowed and lent thenotional principal amounts of the underlying reference currency.The taxpayer accrues interest on a hypothetical borrowing /lending of the notional principal, and then translates the interest forexchange gain or loss purposes based on the normally applicablerules for debt instruments. This translated interest income orexpense determines the amount of currency gain or loss on theperiodic payments. Further, the taxpayer recognizes currency gainor loss with respect to the swap principal at the termination of thetermination of the swap.E. Character and Source of Section 988 Gain or Loss.(1) General Rule of Ordinary Character.(a)Foreign currency gain or loss under § 988 is generally ordinary incharacter. See § 988(a)(1)(A). Gain or loss on a § 988 transactionnot attributable to currency gain or loss (i.e., market gain or loss)remains capital gain or loss. However, such capital gain or lossmay be offset by ordinary income or deduction attributable tocurrency movements under the netting rule. See Reg. § 1.988-2(b)(8) (discussed above).(2) General Rule of Residence Sourcing.(a)Gain or loss from a § 988 transaction is generally sourced to theresidence of the relevant QBU. See § 988(a)(3)(A).Residence of a corporation or a partnership is generally its place oforganization. Reg. § 1.988-4(d). Thus, residence of a foreignpartnership generally is determined on an entity basis. See Reg.§ 1.988-4(d)(2). However, where a partnership is formed or18© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com