US companies may unwittingly create “straddles,” with adverse tax results, by borrowing in a foreign currency and on lending in the same currency to a foreign affiliate
A “straddle” is where a company has two offsetting positions in foreign currency, a commodity or similar property. US companies use the dollar as their functional currency. If the foreign currency appreciates in value against the dollar, then the US company has a loss on its own borrowing. The loss might be triggered when the parent refinances. However, the US parent has an offsetting gain from the on lending to its foreign affiliate. The US tax laws deny losses in straddle transactions until the offsetting gain is reported.
The IRS addressed the situation in an old “field service advice” it made public in early March. A US company refinanced its own foreign currency borrowing. In the process, it had an exchange rate loss. However, the IRS said it could not claim the loss because of on offsetting loan in the same currency to an affiliate.
Congress enacted the straddle rules in 1982 to prevent games in the commodity markets. A taxpayer would go “short” and “long” in the same commodity. He would liquidate the loss position on December 31 and then liquidate the offsetting gain position a few days later. In the process, he was able to roll income forward to the next tax year.