Global Tax Alert | 17 January 2013

Updated US list of foreign currency contracts subject to IRC Section 1256

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This International Tax Alert provides an updated list of foreign currencies that are traded on futures markets for purposes of determining whether a forward contract with respect to those currencies should be marked-to market under section 1256.1 The list contained in this Alert updates the list of foreign currencies that was provided in an International Tax Alert dated 17 January 2013, Updated list of foreign currency contracts subject to Section 1256.

Under Section 1256(a)(1), each Section 1256 contract held by a taxpayer at the close of the tax year must be marked-to-market. The term Section 1256 contract includes, among other things, any foreign currency contract.2 The term foreign currency contract is defined under Section 1256(g)(2)(A) as a contract that:

1. Requires delivery of, or the settlement of which depends on the value of, a foreign currency that is a currency in which positions are also traded through regulated futures contracts,

2. Is traded in the interbank market, and

3. Is entered into at arm’s length at a price determined by reference to the price in the interbank market.

The statutory definition is intended to describe the characteristics of bank forward contracts used for trading currencies.

Although Section 1256 may govern the timing of gains and losses on foreign currency contracts, Section 988 generally governs the character of those contracts.3 Under Section 988, any gains or losses with respect to those forward contracts on foreign currency generally should be ordinary in character.4

The following is a list of currencies in which positions are traded through regulated futures contracts as of the date of this Alert:

1. Australian dollar

2. Brazilian real

3. British pound

4. Canadian dollar

5. Chinese renminbi

6. Czech koruna

7. Euro

8. Hungarian forint

9. Israeli shekel

10. Indian rupee

11. Japanese yen

12. Korean won

13. Mexico peso

14. New Zealand dollar

15. Norwegian krone

16. Polish zloty

17. Russian ruble

18. South African rand

19. Swedish krona

20. Swiss franc

21. Turkish lira

As described above, provided that the additional conditions described in Section 1256(g)(2)(A) are satisfied, forward contracts with respect to these foreign currencies should be marked-to-market under Section 1256(a)(1).

In certain cases, it may be possible to make an argument that Section 1256 does not apply where the foreign currency is so thinly traded in regulated futures contracts that a market price is not available. Please, however, consult with one of the individuals listed below before adopting the position that Section 1256 does not apply due to thin trading.

Generally, cross-currency forward contracts should also be marked-to-market under Section 1256 if such contracts are traded in the futures markets. Even if the specific contracts are not themselves traded, if each of the underlying currencies to a particular contract are individually traded in the markets, cross-currency forward contracts made up of those currencies may also be subject to Section 1256(a).5 If only one leg of a cross-currency forward contract is traded in regulated futures contracts, then that forward contract should not generally be subject to Section 1256. The following is a list of cross-currency contracts in which positions are traded through regulated futures contracts as of the date of this Alert:

1. Australian dollar/Canadian dollar

2. Australian dollar/Japanese yen

3. Australian dollar/New Zealand dollar

4. British pound/Australian dollar

5. British pound/Canadian dollar

6. British pound/Japanese yen

7. British pound/New Zealand dollar

8. British pound/Norwegian krone

9. British pound/South African rand

10. British pound/Swedish krona

11. British pound/Swiss franc

12. Canadian dollar/Japanese yen

13. Chinese renminbi/Japanese yen

14. Euro/Australian dollar

15. Euro/British pound

16. Euro/Canadian dollar

17. Euro/Chinese renminbi

18. Euro/Czech koruna

19. Euro/Hungarian forint

20. Euro/Japanese yen

21. Euro/Norwegian krone

22. Euro/South African rand

23. Euro/Swedish krona

24. Euro/Swiss franc

25. Euro/Polish zloty

26. Euro/Turkish lira

27. New Zealand dollar/Japanese yen

28. Norwegian krone/Japanese yen

29. Norwegian krone/Swedish krona

30. Swedish krona/Japanese yen

31. Swiss franc/Japanese yen

The same arguments regarding thin trading referenced above with respect to foreign currency forward contracts would apply to cross-currency forward contracts as well.

Scope

This list is subject to change on an ongoing basis as new foreign currencies begin to trade in the regulated futures market and as trading in other foreign currencies becomes thin or nonexistent. Newly listed and traded in 2013 was the Indian rupee. By contrast, in both 2012 and 2013, the Colombian peso was listed for trading but was not the subject of any trades and so has not been included on the list. Also, this past year, the Chinese renminbi/Japanese yen cross currency pair was listed for trading but was not the subject of any trades. Certain other currencies also saw a decrease in volume over the past year, although not as significant as having no trading. Please note this list may not immediately reflect changes in the status of foreign currencies, but is instead generally updated only annually. Please contact one of the individuals listed below before adopting or changing a position with respect to whether Section 1256 applies to a particular currency.

Endnotes

1. See Notice 2007-71 in which the IRS states that it and the Treasury Department do not believe that foreign currency options are foreign currency contracts as defined in Section 1256(g)(2).

2. Section 1256(b)(1)(B).

3. Section 1256(f)(2).

4. Under Section 988(a)(1)(A), any foreign currency gain or loss is treated as ordinary income or loss. Under Section 988(b)(3), in the case of a forward contract on foreign currency, any gain or loss from that contract will be treated as foreign currency gain or loss. Section 988(a)(1)(B) does, however, provide for an election to treat any foreign currency gain or loss attributable to a forward contract on foreign currency as capital gain or loss rather than ordinary gain or loss.

5. A cross currency contract is a forward contract in which both legs of the contract are foreign (i.e., non-US dollar) currencies. For example, a forward contract in which the parties agree to exchange a fixed amount of euros for a fixed amount of British pounds is a cross-currency contract.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services/Capital Markets, Washington, DC
  • David Golden
    +1 202 327 6526
    david.golden@ey.com
  • Alan Munro
    +1 202 327 7773
    alan.munro@ey.com
  • Liz Hale
    +1 202 327 8070
    liz.hale@ey.com
Ernst & Young LLP, International Tax Services, San Francisco, CA
  • Joy Harper
    +1 415 894 8000
    joy.harper@ey.com

EYG no. CM4113