International Tax Aspects of Foreign Currency Transactions

(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