“US Taxation of Foreign Currency Futures, Options and Forwards,”Tax Management Financial Products Report, August 1997 TMFPR 1997 FX
The globalization of the world economy has brought to the fore the importance of foreign currency derivatives. Corporate treasury departments use them to manage overseas investments, sales, and purchases. Investment managers use them to shield against, or increase, currency exposure in their portfolios. Financial product developers include them when tailoring securities transactions to meet the needs of specific multinational clients. Recently, with the instability in the Asian markets, the importance of a sound currency hedging (or speculation!) policy has become increasingly apparent, and we should expect to see continued growth in the use of currency derivatives both on exchanges and over the counter.
One factor that parties with a U.S presence should be aware of when developing a foreign currency posture is the U.S federal income tax consequences of using one kind of foreign exchange instrument, or combination of instruments, over another. The major U.S federal income tax issues that arise when using derivative instruments include the amount of taxable income or loss generated by the instruments and the correct timing of its inclusion; the character of the income or loss as capital or ordinary; and the source of such inclusion for withholding tax a foreign tax credit purposes. In this article, we will examine these issues separately for certain foreign currency transactions: foreign currency options, forwards, and futures.