FSA 200025020 addressed OTC currency options. While acknowledging that FX options could fit the section 1256(g)(2) definition, the field service advice states that the options should not be governed by that section. The reasons given are: (1) FX options are not specifically mentioned in the legislative history and so must not have been meant to be included, and (2) including FX options under section 1256(g)(2) overrides the limitations of those parts of section 1256 dealing with exchange-traded options.
LTR 8818010 and FSA 200025020 have acquired statutory status for practitioners. Thus, the IRS put the cat among the pigeons in publishing Notice 2003-81,46 which has a higher status than either the letter ruling or the field service advice and is contrary in its conclusion. The subject of the notice was a tax shelter that used OTC currency options. In describing the shelter, the notice says regarding the OTC options: ‘‘The currency [which is the subject of one set of options in the shelter] is one in which positions are traded through regulated futures contracts, and the purchased options, therefore, are foreign currency contracts within the meaning of section 1256(g)(2)(A) of the Internal Revenue Code and section 1256 contracts within the meaning of section 1256(b).’’
Once the IRS published substantial authority-level guidance requiring mark-to-market treatment for OTC currency, taxpayers became anxious about the conclusions in the old letter ruling and field service advice. What were they to do about swaps and other FX derivatives?
The anxiety continued until 2007, when the IRS issued a notice contradicting the 2003 notice. Notice 2007-7147 states: ‘‘Although as a general matter the ‘Facts’ portion of Notice 2003-81 correctly describes the transaction at issue, it includes an erroneous conclusion of law.’’ After quoting the sentence regarding the treatment of FX options excerpted above, the notice says, ‘‘This sentence should have stated ‘The taxpayer takes the position that the purchased contracts are foreign currency contracts within the meaning of section 1256(g)(2)(A).’‘‘ (Emphasis