rr-08-01.pdf

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Part I

Section 988.--Treatment of Certain Foreign Currency Transactions

26 CFR 1.988-1: Certain definitions and special rules.
(Also § 1.988-2.)

Rev. Rul. 2008-1

ISSUE
What is the characterization for U.S. federal tax purposes of an instrument
(described further below) that is issued and redeemed for U.S. dollars, but that
provides an economic return that is determined by reference to the euro and
market interest rates in respect of the euro?
FACTS

Assume that on January 1, 2007, the spot rate of exchange of U.S. dollars
for euros was $1 = €0.75. On January 1, 2007, Holder delivered $100 to Issuer
in exchange for the Issuer’s obligation (the “Instrument”) to deliver to Holder, on
January 1, 2010, the U.S. dollar equivalent of an amount of euros (the “U.S.
Dollar Equivalent Amount”). The U.S. Dollar Equivalent Amount is determinable
on January 1, 2010, and is the sum of the following amounts translated into U.S.
dollars at the spot rate on January 1, 2010: (i) €75, and (ii) an amount of euros
calculated by reference to a compound stated rate of return applied to €75 from
January 1, 2007, until January 1, 2010. The compound stated rate of return is

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the excess of a rate based on euro interest rates over a rate labeled as a “fee” for
the benefit of the Issuer. (The U.S. Dollar Equivalent Amount to be paid by
Issuer to Holder on January 1, 2010, may also be determined by reference to a
mathematical formula that generates the same substantive effect as the
methodology described above.)
Holder and Issuer expect that Issuer will pay the U.S. Dollar Equivalent
Amount on January 1, 2010. The legal remedies provided in the Instrument are
not materially different than legal remedies associated with instruments that are
debt for federal tax purposes.
The U.S. dollar is the functional currency of Holder.
There is a significant possibility that the U.S. Dollar Equivalent Amount
payable by Issuer to Holder on January 1, 2010, may be significantly less than
$100.
ANALYSIS
An instrument that requires payments to be made in a foreign currency
(that is, nonfunctional currency) can be debt for U.S. federal income tax
purposes. See, e.g.
, section 988(c)(1)(B)(i) of the Internal Revenue Code.
Thus, although nonfunctional currency is considered to be “property” for U.S.
federal tax purposes (see, e.g.
, Philip Morris Inc. v. Commissioner, 71 F.3d 1040
(2d Cir. 1995), aff’g 104 T.C. 61 (1995); National-Standard Company v.
Commissioner, 749 F.2d 369 (6th Cir. 1984), aff’g 80 T.C. 551 (1983)), it is
treated like money for purposes of determining the amount and timing of interest
that accrues on debt. See
§1.988-2(b)(2) of the Income Tax Regulations; S.

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Rep. No. 313, 99
th
Cong., 2d Sess., 1986-3 (Vol. 3) C.B. 461-463 (1986).
Section 988 and regulations thereunder also provide that the acquisition of a debt
instrument or becoming the obligor under a debt instrument is a section 988
transaction if the amount that a taxpayer is entitled to receive or is required to
pay is determined by reference to the value of a nonfunctional currency. See,
e.g., section 988(c)(1); §§ 1.988-1(a)(1) (flush language), 1.988-2(b)(2)(i)(B)(2).
These provisions indicate that a financial instrument all the payments of which
are determined by reference to a single currency can be debt, notwithstanding
the fact that (i) all actual payments due under the instrument are made in a
different payment currency, and (ii) the amount of the different payment currency
that the issuer pays at maturity may be less than the amount of the different
payment currency that was initially advanced. Indeed, section 988 was adopted,
in part, to negate suggestions “that U.S. tax consequences can be manipulated
by arranging to repay a foreign-currency denominated loan in U.S. dollars
equivalent in value at repayment to the foreign currency borrowed.” S. Rep. No.
313, 99
th
Cong., 2d Sess., 1986-3 (Vol. 3) C.B. 451 (1986). See also H.R. Rep.
No. 426, 99
th
Cong. 1
st
Sess. 1986-3 (Vol. 2) C.B. 466 (1985) and General
Explanation of the Tax Reform Act of 1986, 100
th
Cong., 1
st
Sess., 1087 (1987).
The Instrument, in form, resembles a U.S. dollar denominated derivative
contract in which the Holder prepays its obligations under the contract, and is
entitled to receive a return based exclusively on the value of property at maturity.
(See
Notice 2008-2, 2008-2 I.R.B., dated January 14, 2008, requesting
comments with respect to these types of derivative contracts.) However, the

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U.S. Dollar Equivalent Amount that is payable at maturity by the Issuer under the
terms of the Instrument is determined exclusively by reference to (i) the U.S.
dollar value of the euros at issuance and at maturity, and (ii) market interest rates
in respect of the euro. At inception (on January 1, 2007), the Holder delivers the
U.S. dollar equivalent of €75, and at maturity (on January 1, 2010) the Issuer is
required to pay the U.S. dollar equivalent of €75, plus the U.S. dollar value at
maturity of a return based on euro interest rates. The fact that intervening
currency fluctuations may cause the amount of U.S. dollars that Holder receives
at maturity (on January 1, 2010) to be less than the amount of U.S. dollars that
the Holder paid for the Instrument (on January 1, 2007) does not affect the
characterization of the Instrument as debt, which is based on an analysis of
payments with respect to the euro. The Issuer’s translation of U.S. dollars into
euros (on January 1, 2007) and euros into U.S. dollars (on January 1, 2010) is
not relevant to the Instrument’s characterization.
HOLDING
For U.S. federal tax purposes, the Instrument is euro-denominated
indebtedness of Issuer. This result is not affected if the Instrument is (i) privately
offered, (ii) publicly offered, or (iii) traded on an exchange.
DRAFTING INFORMATION
The principal authors of this revenue ruling are John W. Rogers III of the
Office of the Associate Chief Counsel (Financial Institutions & Products) and
Margaret Harris of the Office of Associate Chief Counsel (International). For

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further information regarding this revenue ruling contact Mr. Rogers at (202) 622-
3950 or Ms. Harris at 202-622-3870 (not toll-free calls).