2004 List of Foreign Currency Contracts
  Subject to Section 1256
  By Richard Shapiro
   Originally published in Derivatives Financial Products Report, a publication of
   Warren, Gorham & Lamont, division of RIA, New York, NY, August 2004. pp 7-8.

Forward contacts involving 16 foreign currencies that may need to be market to market under Section 1256(a)(1)

This article provides a list of foreign currencies that are trade in futures markets for purposes of determining whether a forward contract with respect to those currencies should be marked to market under Section 1256.¹

Section 1256

Under Section 1256(a)(1), Each Section 1256 contract held by a taxpayer at the close of the tax year must be marked to market.  A "Section 1256 contract" includes, among others, any foreign currency contract.²  A "foreign currency contract" is defined under Section 1256(g)(2)(A) as a contract that:

(i) requires delivery of, or the settlement of which depends on the value of, a foreign currency [that] is a currency in which positions are also traded through regulated futures contracts,

(ii) is traded in the interbank market, and

(iii) is entered into an arms' length at a price determined by reference to the price in the interbank market [emphasis added].

The statutory definition is intended to describe the characteristics of bank forward contracts used for trading currency.

Although Section 1256 may govern the timing of gains and losses on foreign currency contracts, Section 988 generally controls the character of those contracts.³  Under Section 988, any gains or losses with respect to forward contracts on foreign currency generally should be ordinary.⁴

Foreign Currency Forward Contracts

The following is a list of currencies in which positions are traded through regulated futures contracts as of July 15, 2004:

Updated List October 7, 2008 1.  Australian dollar 2.  Brazilian real 3.  British pound 4.  Canadian dollar 5.  Chinese renminbi 6.  Columbian peso 7.  Czech koruna 8.  Euro 9.  Hungarian forint 10. Israeli shekel 11. Japanese yen 12. Korean won 13. Mexico peso 14. New Zealand dollar 15. Norwegian krone 16. Polish zloty 17. Russian ruble 18. South African rand 19. Swedish krona 20. Swiss franc Source: Ernst & Young International Tax Alert

1.  Australian dollar
2.  Brazilian real
3.  British pound
4.  Canadian dollar
5.  Czech koruna
6.  Euro
7.  Hungarian forint
8.  Japanese yen
9.  Mexico peso
10. New Zealand dollar
11. Norwegian krone
12. Polish zloty
13. Russian ruble
14. South African rand
15. Swedish krona
16. Swiss franc

Thus, provided that the additional conditions described in Section 1256(g)(2)(A) are satisfied, forward contracts with respect to these 16 foreign currencies may need to be marked to market under Section 1256(a)(1).  There is, however, an argument that Section 1256 does not apply if the foreign currency is so thinly traded in regulated futures contracts with respect to the Swedish krona, Norwegian krone, Czech koruna, Hungarian forint, and Polish zloty has been particularly thin.  however, a tax advisor should be consulted before adopting the position that Section 1256 does not apply due to thin trading.

Cross-Currency Forward Contracts

Cross-currency forward contracts generally should also be marked to market under Section 1256 if both currencies are individually traded in regulated futures contracts.⁵  There is, however, an argument that cross-currency forward contracts should be subject to Section 1256 only if the cross-currency is also traded in regulated futures contracts.  gain, a tax advisor should be consulted before adopting this argument.  if this position is adopted, it should be applied consistently to a taxpayer's cross-currency forward contracts both within the tax year and from year to year.  If only one leg of a cross-currency forward contracts is traded in regulated futures contracts, the forward contract should not be subject to Section 1256.

The following is a list of cross-currency contracts in which positions are traded through regulated futures contracts as of July 15, 2004:

Updated List October 7, 2008 1.   Australian dollar/ Canadian dollar 2.   Australian dollar/ Japanese yen 3.   Australian dollar/ New Zealand dollar 4.   British pound/ Australian dollar 5.   British pound/Canadian dollar 6.   British pound/ Japanese yen 7.   British pound/New Zealand dollar 8.   British pound/Norwegian krone 9.   British pound/South African rand 10. British pound/Swedish krona 11. British pound/Swiss franc 12. Canadian dollar/Japanese yen 13. Chinese renminbi/Japanese yen 14. Euro/Australian dollar 15. Euro/British pound 16. Euro/Canadian dollar 17. Euro/Chinese renminbi 18. Euro/Czech koruna 19. Euro/Hungarian forint 20. Euro/Japanese yen 21. Euro/Norwegian krone 22. Euro/South African rand 23. Euro/Swedish krona 24. Euro/Swiss franc 25. New Zealand dollar/Japanese yen 26. Norwegian krone/Japanese yen 27. Norwegian krone/Swedish krona 28. Swedish krona/Japanese yen 29. Swiss franc/Japanese yen Source: Ernst & Young International Tax Alert

1.   Australian dollar/Canadian dollar
2.   Australian dollar/Japanese yen
3.   Australian dollar/New Zealand dollar
4.   British pound/Japanese yen
5.   British pound/Swiss franc
6.   Canadian dollar/Japanese yen
7.   Euro/Australian dollar
8.   Euro/British pound
9.   Euro/Canadian dollar
10. Euro/Czech koruna
11. Euro/Hungarian forint
12. Euro/Japanese yen
13. Euro/Norwegian krone
14. Euro/Polish zloty
15. Euro/Swedish krona
16. Euro/Swiss franc
17. Norwegian krone/Swedish krona
18. Swiss franc/Japanese yen

The same arguments regarding thin trading noted above with respect to foreign currency forward contracts would also apply to cross currency forward contracts.

Use of List

The list of foreign currencies is subject to change on an ongoing basis as new foreign currencies being to trade in the regulated futures market and trading in old foreign currencies become thin or nonexistent.  The list should be used with these limitations in mind.

Endnotes:

1. In Notice 2003-81, 2003-51 IRB 1223, the IRS implied that over-the-counter (i.e., nonlisted) options, as well as listed options, on exchange-traded foreign currencies are considered Section 1256 contracts.
2. Section 1256(b)(2).
3. Section 1256(f)(2).
4. Under Section 988(a)(1)(A), any foreign currency gain or loss is treated as ordinary income or loss.  Under Section 988(b)(3), any gain or loss from a forward contract on foreign currency must be treated as foreign currency gain or loss.  Section 988(a)(1)(B), however, provides for an election to treat any foreign currency gain or loss attributable to a forward contract on foreign currency as capital gain or loss rather than ordinary gain or loss.
5. A cross-currency contract is a forward contract in which both legs of the contract are foreign currencies., e.g., a forward contract in which the parties agree to exchange a fixed amount of Euros for a fixed amount of British pounds.


Richard Shapiro is a partner in the Capital Markets Financial Services Industries Group of Ernst & Young LLP (New York).  For further information, contact him at 212-773-2740; or call other members of the Capital Markets Group: Richard Larkins (202-327-7808, Douglas Chestnut (202-327-5780) or Elizabeth Hale (202-327-8070).