United States: Proposed Regulations Favorably Affect Foreign Currency Hedging Transactions


United States shareholders of controlled foreign corporations ("CFCs") are required to include certain forms of passive income in their taxable income. This is referred to as "subpart F income" by reference to its position in the Internal Revenue Code. Subpart F income is includable as ordinary income. Until the enactment of recent tax reform legislation, if income of a CFC was not subpart F income, the U.S. shareholders did not have to include it when calculating their income for the current year and the tax was effectively deferred. This has changed with the adoption of the Global Intangible Low-Taxed Income ("GILTI") regime, as part of the Tax Cuts and Jobs Act, which will require non-subpart F income to be taxed currently but at a lower rate than regular income. We will turn to that at the end of this note. Prior to the enactment of the Tax Cuts and Jobs Act, on December 19, 2017, the Treasury and the Internal Revenue Service proposed regulations under sections 446, 988 and 954 (the "Proposed Regulations") that favorably impact the treatment of foreign currency hedges of the activities of a CFC, some of which we will describe below.

The Business Needs Exclusion

Treasurers often hedge foreign currency risk related to their business operations. For example, if a company expects to incur a euro-denominated liability, it might hedge this liability by buying a euro forward. When a CFC generates currency gains in excess of currency losses, the net amount is usually considered foreign personal holding company income ("FPHCI") and is included in subpart F income (i.e., is currently included in the income of the owner of the CFC's income). There is an exception for transactions entered into in the ordinary course of the taxpayer's business, including items that hedge those transactions – that is, "bona fide hedges" – that generate currency gains but not other types of subpart F income. The exception for currency gain or loss on the underlying transaction and on hedges of those transactions is referred to as the "business needs exclusion," and any foreign currency gain on the hedges will not be included in subpart F income, as long as none of the underlying transactions being hedged generate subpart F income. The result of failing the requirement that none of the gain be subpart F income is that all of the gain is included in subpart F income. Because of this, it is said that there is a "cliff effect" in failing the requirement. For example, where a CFC hedges an aggregation of subpart F and non-subpart F exposures, the hedge may not be a bona fide hedge – i.e., the entire amount of gain realized on the hedge will be subpart F income.

A second situation many treasurers will find familiar is the case in which a CFC serves as a treasury center for intercompany loans. For example, consider a French subsidiary with excess cash that is needed by an affiliate in Italy. The treasury center CFC may intermediate the loan by borrowing from the French affiliate and lending to the Italian affiliate. The activities of the treasury center may cause it to be considered a dealer for U.S. tax purposes, which will result in its loan (the cash loan to the Italian affiliate) being marked to market. However, current regulations do not permit liabilities (here, the cash being borrowed from the French entity) to be marked to market. While some taxpayers believe that the borrowing is a short-position, there is uncertainty.

A third situation is that in which a CFC seeks to hedge its investment in the stock of another CFC. These hedges are commonly referred to as "net investment hedges." While these hedges often qualify as investment hedges under financial statement rules, they typically do not qualify as hedges under the applicable tax rules since the asset being hedged is a capital asset. A similar situation, perhaps more common, arises when the hedge is at the level of a U.S. parent company and the investment being hedged is the parent company's stock in a CFC.

A fourth situation involves hedges of entities that are treated as disregarded entities under the check-the-box-regime of the Treasury Regulations.

For example, consider a U.S. parent company that wholly owns a CFC that uses the euro as its functional currency. The CFC, in turn, wholly owns another entity (which has elected disregarded-entity status) that uses the British pound as its functional currency and operates a business that generates both subpart F and non-subpart F income. This disregarded entity is a qualified business unit (or "QBU").

This example illustrates the differences between the tax and accounting treatment of these hedges. The subsidiary using the British pound is a disregarded entity for U.S. tax purposes, but it is treated as a subsidiary for financial accounting purposes. Because the subsidiary using the British pound generated some subpart F income – if the intermediate CFC decided to hedge the currency risk of the QBU – the business needs exclusion would not be available. The result of these transactions is (i) the inclusion in the parent's income (as subpart F income) of any foreign currency gain on the hedge, even though the underlying transactions (the business operations of the QBU) would have generated some non-subpart F income that would not be currently included in the U.S. parent's income and (ii) if there were any losses on the underlying transactions, they would not reduce subpart F income.

The Proposed Regulations

The Proposed Regulations make a number of important changes. Overall, the changes are quite favorable to taxpayers.

First, they eliminate the cliff effect that might otherwise apply in analyzing the business needs exclusion. This means that the hedge will qualify for the business needs exclusion to the extent the gain relates to property that does not generate subpart F income. In other words, at least part of the hedge gain will not have to be currently included in income under subpart F. However, it is not totally clear whether aggregate hedges will be covered by these new rules. The Proposed Regulations refer to bona fide hedges of a "transaction," as opposed to "transactions." If the provision isn't changed before the Proposed Regulations are finalized, this could leave open an argument that aggregate hedges of property (or net exposure from assets and liabilities) are excluded from the definition of "bona fide hedges." The Proposed Regulations make it clear that the currency gain or loss on a "bona fide hedge" of an intercompany loan is apportioned between subpart F income and non-subpart F income in the same manner as the currency gain or loss on the loan. This creates symmetry between the loan and the related hedge.

Second, the Proposed Regulations permit taxpayers to elect to mark to market currency gain or loss, regardless of whether the foreign gain is on an asset or a liability. This is achieved through the addition of Proposed Treasury Regulation 1.988-7. The remeasurement of the currency gain or loss does not account for changes in interest rates or credit ratings, so it is not a true mark to market because it is not marked to fair market value. However, it is consistent with the remeasurement process under GAAP and helps resolve the treasury center mismatch issue described above. The Proposed Regulations also state that the acquisition of a debt instrument can be treated as a "bona fide hedge" of an interest-bearing liability.

Third, the Proposed Regulations allow application of the business needs exclusion to a net investment hedge in a foreign branch to the extent the gain is allocable to non-subpart F income. This type of hedge is referred to as a financial statement hedge. To qualify, the hedge must qualify under GAAP rules as a net investment hedge, the results of which are reflected in the cumulative translation account ("CTA") associated with the QBU. If the position qualifies, the taxpayer then allocates the gain on the hedge to non-subpart F income in the same way it allocates section 987 gain (the proportion of assets that do and do not produce subpart F income).

Fourth, the IRS and the Treasury Department in the preamble to the Proposed Regulations request comments on whether the business needs exclusion should apply to hedges of a foreign-subsidiary corporation (in addition to foreign branches). The existing rules do not permit gains related to hedges of the stock of a CFC to qualify for the business needs exclusion because the business needs exclusion only applies to "ordinary property," and stock in a corporation is never ordinary property for this purpose. The IRS and Treasury Department also request comment on whether the hedge of an intercompany loan to a disregarded entity qualifies for the business needs exclusion.

Open Issues

A few important issues remain under the Proposed Regulations.

Who Makes the Election? There is a question of who can make the election under Proposed Regulations section 1.988-7 – specifically, whether making the election for one subsidiary will affect the ability of another subsidiary to make the election. What if the subsidiaries are all disregarded entities for tax purposes?

Clarification of the Allocation Rule in the Business Needs Exclusion. There is a question about how to compute the amount of foreign currency gain or loss to allocate to non-subpart F income where there is foreign currency gain or loss because of a transaction from property that gives rise to (1) subpart F income (other than foreign currency gain or loss) and (2) non-subpart F income, or a bona fide hedging transaction with respect to such transaction or property, and it otherwise satisfies the requirements of the business needs exclusion.

Effective Date Issues. The Proposed Regulations suggest that a calendar year taxpayer could apply them to the 2017 tax year without consent. Yet, a question arises of what taxpayers should do if the Proposed Regulations are not finalized by the date their tax return is due. There have been conflicting public statements by Treasury officials on this issue. Many commentators believe that the election can be made in 2018 on a retroactive basis for years ending in 2017.


One consequence of an effective election under the business needs exclusion is that the income that qualifies for the exclusion is not subpart F income. In such a case, the hedging income will be considered GILTI. GILTI generally captures all non-subpart F income and taxes it at a 10.5% rate. This means that, although the rate is more favorable under GILTI than when income is included in subpart F income, the tax deferral that existed before tax reform is now gone. Yet, because of the whipsaw potential, there is considerable value in identifying hedging transactions, even though the deferral associated with such hedging transactions is no longer available.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
16 Oct 2019, Speaking Engagement, Dusseldorf, Germany

EQS Group in cooperation with Orrick, Herrington & Sutcliffe LLP invites you to their event on investor relations and compliance. Topics include ESEF reporting and how to meet the challenges of the Europe-wide XBRL format from 2020 onwards.

16 Oct 2019, Webinar, New York, United States

Two years after the start of the #MeToo movement, multinational companies are still navigating the movement's impact on the workplace and corporate reputational risk.

29 Oct 2019, Speaking Engagement, Washington, United States

On Friday, November 1, 2019 from 11:45 AM - 12:45 PM, Lorraine McGowen will speak on the “When the Weak Link Breaks: Supply Chain Insolvencies – Automotive and Elsewhere” panel.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions