Proposed hedging regulations under Sections 446 and 1221.

On November 1, 1994, Tax Executives Institute submitted the following comments to IRS Commissioner Margaret M. Richardson on the proposed regulations relating to hedging of property by a consolidated group. The comments, in the form of a letter from TEI President Linda B. Burke, was prepared under the aegis of TEI's Federal Tax Committee, whose chair is Michael A. DeLuca of Household International, Inc.

On behalf of Tax Executives Institute, I am pleased to submit these comments on the proposed regulations under sections 446 and 1221, relating to the treatment of hedging transactions entered into by members of consolidated groups.

Background

Tax Executives Institute is the principal association of business tax executives in North America. The Institute's approximately 5,000 members represent more than 2,800 of the largest companies in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike. TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply.

TEI members are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations relating to the income tax treatment to be accorded to hedging transactions effected on a consolidated, and generally, "net" basis.

Overview

On July 13, 1994, the Internal Revenue Service issued Treasury Decisions 8554 and 8555,(1) promulgating final regulations under sections 446, 461, and 1221, of the Internal Revenue Code. The regulations, which relate to business hedging transactions are generally consistent with the temporary and proposed regulations issued on October 18, 1993. Thus, assuming certain administrative requirements are met, the regulations treat gain or loss arising from defined business "hedging transactions" as ordinary in character under section 1221 and prescribe timing rules for recognition of gain or loss for the hedge transaction. The temporary and proposed regulations were generally effective with respect to hedging transactions entered into in all previous open tax years, provided certain identification requirements were met. The final regulations retain the timing, character, and transition rules and add a further transition rule for hedging transactions entered into or maintained during calendar year 1994.

Concurrently with the issuance of the regulations, the IRS issued a notice of proposed rulemaking (FI-34-94),(2) relating to the character and time for recognition of certain hedging transactions entered into by members of an affiliated group filing consolidated returns. The proposed regulations respond to numerous taxpayer requests for guidance on relatedparty hedging transactions, especially within the context of consolidated groups. A public hearing on the proposed regulations was held on October 18, 1994.

General

In TEI's comments on the temporary and proposed regulations for hedging transactions, the Institute summarized the history of the development of the tax law affecting hedging. While we have no desire to recapitulate the tortuous path leading to the issuance of the hedging regulations, we do, nonetheless, reprise our congratulations to the government for providing guidance to quell many disputes concerning "plain-vanilla" hedging transactions for which controversy had reached Brobidingnagian proportions. In addition, the final regulations take account of the many taxpayer and practitioner comments--especially in respect of the treatment of hedges of non-inventory supplies--and, as a result, represent an improvement over the temporary and proposed hedging regulations. Equally important, the expansion of the rules to include hedges of non-inventory supplies is retroactive to all open tax years.

Effective Date for Consolidated Group Hedges

The proposed regulations with respect to hedges by members of consolidated groups are to be effective for transactions entered into on or after the date that is 60 days after the publication of final regulations in The Federal Register.(3) As the preamble correctly notes, however, these "regulations are needed because related-party hedging is a common business practice and the existing regulations treat as hedging transactions only hedges entered into by a taxpayer to reduce its own risk."(4) In view of the common business practice of employing centralized hedging centers to facilitate net hedges, we urge that taxpayers be permitted to apply the rules retroactively for all open tax years. By permitting taxpayers to so elect, hedging transactions entered into before and after the effective date will be treated in a consistent fashion. Indeed, under the proposed rule, transactions entered into one day apart within the same taxable year may have wholly different character and timing consequences. More important, by making the proposed regulations for consolidated hedging transactions retroactive, the government will facilitate the resolution of the treatment of hedging transactions for prior taxable years--an implicit objective (with which we heartily concur) in issuing the hedging regulations. By permitting the adoption of a retroactive effective date, which we believe the IRS is authorized to permit, final regulations will enable taxpayers and the IRS to reach agreements that promote a proper matching of the character and timing of recognition of gain or loss with respect to a hedge and the hedged item, regardless of which legal entity within the group enters the hedge or holds the hedged property or obligation.

Conclusion

TEI is pleased to have the opportunity to submit its views on the subject of the proposed regulations relating to consolidated business hedging transactions. These comments were prepared under the aegis of TEI's Federal Tax Committee whose chair is Michael A. DeLuca. If you have any questions concerning these comments, please call either Mr. DeLuca of Household International, Inc. at [phone] or Jeffery P. Rasmussen of the Institute's professional tax staff at [phone].

(1)1994-33 I.R.B. 4 and 9.

(2)1994-33 I.R.B. 19.

(3)Prop. Reg. [section] 1.12221-2(g)(4).

(4)1994-33 I.R.B. 19.