International Tax Aspects of Foreign Currency Transactions

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All instruments in a particular account; all instruments of aparticular type; all instruments identified with a particularlegend or designation.§ 1256(e)(2) ID also satisfies § 1221(b)(2), althoughapparently not the other way around.(d)Killer Rule (Reg. § 1.1221-2(g)).(i)(ii)To prevent selective ID with the benefit of hindsight, if theTP makes an inadvertent ID, that is binding to treat gain asordinary. Losses remain capital. However, the taxpayercan obtain capital gain for any gains if the taxpayerestablishes inadvertent error for the improper ID. Thetaxpayer must treat all transactions consistently with theerror on original or amended returns.Conversely, failure to identify is binding to treat both gainsand losses as capital, unless the taxpayer establishes therequirements of inadvertent error.(e)Inadvertent error.(i)(ii)Does § 1256(e)’s hedging exception incorporate theinadvertent error rule under § 1221(b)(2)? Compare CCA201034018 (Apr. 20, 2010) (no inadvertent error exceptionin § 1256(e)) with CCA 201046015 (July 14, 2010)(revising this advice regarding the same taxpayer).However, in the latter CCA, the IRS ultimately concludedon the facts that the taxpayer’s inadvertent error exceptionwas not satisfied.The above CCAs also provide good background on thetypes of facts that will relevant in analyzing whether thetaxpayer’s failure to identify was attributable to inadvertenterror. See also PLR 201142020, fn. 7 (advising onimportance of prior year treatment in assessing inadvertenterror).(f)Capital v. Ordinary Treatment under § 1221(b)(2) Not Critical.Since § 988 generally deems gains or losses from § 988transactions to be ordinary, obtaining ordinary treatment under§ 1221 is not necessary. Conversely, character of the gain or lossfor subpart F purposes, by contrast, may be more significant.(2) Timing of Gains and Losses on FX Hedges.57© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com
(a)(b)(c)(d)Reg. § 1.446-4 provides the tax accounting principles applicable togain or loss from hedging transactions, as described in Reg.§ 1.1221-2(b), whether or not the character from such transactionis provided under the rules of § 1221(b)(2).Rules are set forth depending on the type of transaction. Forexample: hedges of debt instruments give rise to yield adjustments;hedges of FX exposure on inventory may be rolled into inventoryaccounting; etc.Recordkeeping must be maintained to describe the taxpayer’shedge accounting methods. Reg. § 1.446-4(d). If book principlesare followed, presumably financial accounting records may sufficefor this purpose.Failure to ID may not always be fatal. The IRS has interpreted thetiming rules to be mandatory for all hedging transactions describedin § 1221(b)(2). See Rev. Rul. 2003-127; see also, e.g., PLR200510028 (Dec. 17, 2004).(i)The IRS has argued that this position will not be applied tocertain § 1256 contracts for which no ID is providedpresumably on the theory that § 1256 is mandatory, failingan identification out under § 1256(e). See CCA 201024049(June 9, 2009); ECC 201034018.Thus, the principal question for timing purposes appears to bewhether the hedged FX risk relates to § 1221(b)(2) property. If so,hedge timing (deferral of both gains and losses) should follow. Ifnot, then the straddle rules would defer losses, but requireimmediate recognition of gains under § 1001 and § 1256.(e)Reg. § 1.954-2(g)(4) election.(i)(ii)Causes all FX gains and losses of the electing CFC from§ 988 transactions and § 1256 contracts (which wouldotherwise be commodities transactions) to be taken intoaccount as passive basket subpart F income. Previously, inthe 1988 temporary regulations, the election was mandatoryfor all of the taxpayer’s CFCs. See Former Reg. § 4.954-2(g)(5).Benefit of election is to allow FX losses to be fully utilizedin reducing other categories of passive FPHC income. Inthe case of certain financial entities, the election may havesome benefits in avoiding any issues from “trapped losses.”58© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com
Page 1 and 2:
Overview of the Taxation of Foreign
Page 3 and 4:
Table of ContentsPage1. Determinat
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processes orders and maintains sepa
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(3) Examples.(a)(b)(c)Reg. § 1.985
Page 9 and 10: D. Changes in Functional Currency.(
Page 11 and 12: (1) Application of Mark-to-market.(
Page 13 and 14: (ii) Accrued foreign income tax pay
Page 15 and 16: Gain or loss is computed, without r
Page 17 and 18: (4) Rules Applicable to Debt Instru
Page 19 and 20: The obligor of a non-functional cur
Page 21 and 22: (iii) Rollover of an Existing Contr
Page 23 and 24: can rebut this presumption by showi
Page 25 and 26: (a)(b)Specifically, losses attribut
Page 27 and 28: (i)Actual distributions of PTI to t
Page 29 and 30: the paid-in-capital account under R
Page 31 and 32: (d)Taxes for which the taxpayer mak
Page 33 and 34: were typically translated at the sp
Page 35 and 36: (b)Brazilian ORTNs.During a period
Page 37 and 38: Under the profit and loss method, t
Page 39 and 40: egard to the form of enterprise thr
Page 41 and 42: D. The 2006 Proposed § 987 Regulat
Page 43 and 44: Examples:i. Cashii. Payables and Re
Page 45 and 46: 3) Owner ceases to exist in a non-
Page 47 and 48: 5) Simply following GAAP may not be
Page 49 and 50: (5) Consequences of a Change to DAS
Page 51 and 52: (a)Certain cases have addressed a M
Page 53 and 54: E. Hyperinflationary Debt Instrumen
Page 55 and 56: (c)(d)The underlying transaction is
Page 57 and 58: allow a CFC to avoid the need to tr
Page 59: (a) PLR 200813026. IRS granted a PL
Page 63: 60© 2013 William R. Skinner, Esq.F
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International Tax Aspects of Foreign Currency Transactions

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