United States: Integrating Foreign Currency Hedges With Respect To Stock Purchase And Sale Agreements

Last Updated: May 15 2013
Article by Steven Bortnick

Investment funds that invest globally must deal with volatility in the currency in which they agree to invest. Investment funds entering into obligations to purchase stock in a currency other than the primary currency of the investment fund have become increasingly interested in hedging these obligations to minimize the volatility risk.1 Similarly, an investment fund entering an agreement to sell stock in a currency other than that of the investment fund may be interested in hedging its right to receive cash. Without planning, these hedges may give rise to ordinary income or loss. In the case of a new investment, this income may not be reflected by the receipt of cash (i.e., "dry" or "phantom" income would result). In the case of a sale of stock, this income would be taxed as ordinary income, rather than long-term capital gain. (Ordinary income derived by individuals is taxed at significantly higher rates than long-term capital gains.) These adverse U.S. tax issues may be avoided, however, if the hedge and the purchase/sale agreement are "integrated" under the applicable rules, discussed herein. This article discusses some of the U.S. tax consequences of hedging stock purchase/sale agreements, and identifies certain practical issues and fixes.

An Example to Illustrate the Issues

On July 25, 2012, XYZ fund entered into a stock purchase agreement to purchase all of the stock of ABC, Inc. for €50 million. XYZ is a Delaware partnership and keeps its books in U.S. dollars. Most of XYZ's transactions are denominated in U.S. dollars. On July 25, 2012, €50 million would cost $60,310,000, based on the exchange rate on that date. The sale closed on February 4, 2013, when €50 million cost $68,245,000. Had XYZ not entered into a hedge, the purchase would have cost XYZ $7,935,000 more than anticipated entirely due to the increase in the value of the euro compared to the U.S. dollar.

Thankfully, on July 25, 2012, XYZ entered into a forward contract, pursuant to which it agreed to acquire €50 million for $60,310,000 on March 29, 2013. Thus, XYZ avoided a large additional cash outlay for the same investment. It also realized a $7,935,000 foreign currency exchange gain (FX gain) on the settlement of the forward contract. Absent further planning at the time of the hedge, this FX gain would be taxable as ordinary income to U.S. taxable investors in XYZ, even though all of this gain was invested into the stock of ABC, Inc. The additional planning of which we speak, and which is the subject of this article, is the integration of hedge (here, the foreign currency futures contract) with an executory contract (here the stock purchase agreement).2

Integration Can Avoid the Recognition of FX Gain or Loss

Regulations3 provide that "if a taxpayer enters into a hedged executory contract, amounts paid or received under the hedge by the taxpayer are treated as paid or received by the taxpayer under the executory contract or any subsequent account payable or receivable." Moreover, "the taxpayer recognizes no exchange gain or loss on the hedge" for U.S. income tax purposes. The meaning of italicized words, as well as other detailed requirements, are discussed, below. However, the key consequence of this type of planning is that the hedge and the transactions effected pursuant to the executory contract are treated as a single transaction.

Turning back to our example, if the foreign currency forward contract and the stock purchase agreement had been properly identified as part of a hedged executory contract, XYZ would not have recognized foreign currency gain or loss upon receipt of the euros; and XYZ would have been treated as having paid $60,310,000 for the stock of ABC, Inc. acquired pursuant to the stock purchase agreement.

Hedged Executory Contract Definitions and Requirements

The term "hedged executory contract" is defined in the Treasury Regulations. The term itself includes several additional definitions and requirements.

Executory Contract – An executory contract is an agreement entered into before the "accrual date" (defined below) to pay nonfunctional currency (or an amount determined with reference thereto) in the future with respect to the purchase of property used in the ordinary course of the taxpayer's trade or business, or the acquisition of services in the future, or to receive nonfunctional currency (or an amount determined with reference thereto) in the future with respect to the sale of property used or held for sale in the ordinary course of the taxpayer's trade or business, or the performance of services in the future. The purchase/sale of stock and securities for investment purposes generally is not considered a trade or business. However, the regulations specifically indicate that a contract to buy or sell stock shall be considered an executory contract.4 Thus, a private equity fund may well integrate its stock purchase/sale transactions, even though its activities typically would not rise to the level of a trade or business.

For purposes of these rules, the accrual date is the date that the income, expense or capital expenditure would be accrued under the taxpayer's method of accounting. The functional currency of a business unit generally is the currency in which a significant part of such unit's activities are conducted, and which is used by the unit in keeping its books and records. Any other currency would be considered a nonfunctional currency. In our example, XYZ keeps its books in U.S. dollars, and a significant part of its activities are conducted in U.S. dollars. Thus, the U.S. dollar would be XYZ's functional currency, and the euro (i.e., the currency with which stock of ABC, Inc. was acquired) was a nonfunctional currency.

Hedge – The term hedge means a deposit of nonfunctional currency in a hedging account, a forward or futures contract, or a combination thereof, which reduces the risk of exchange rate fluctuations by reference to the taxpayer's functional currency with respect to nonfunctional currency payments made or received under the executory contract. Returning to our example, the forward contract to purchase euros (i.e., the currency of payment under the stock purchase agreement) reduces the risk of exchange fluctuations by reference to XYZ's functional currency (i.e., the U.S. dollar). An option to purchase a nonfunctional currency also may qualify as a hedge if the expiration date is no later than the accrual date. (In this case, the premium paid for the option also would be integrated with the executory contract.) Additionally, a series of hedges may qualify as a hedge.

Additional Requirements – An executory contract that is the subject of a hedge will be considered to be a hedged executory contract only if the following additional requirements are satisfied:

  1. Identification. The executory contract and the hedge must be identified as a hedged executory contract. Although no special form is required for this, a record must be made before the close of the date the hedge is entered into, must record a clear description of the executory contract and the hedge, and indicate that the transaction is being identified in accordance with Treasury Regulation Section 1.988-5(b)(3).
  2. Timing. The hedge must be entered into on or after the date the executory contract is entered into and before the accrual date.
  3. Permanent hedge. The executory contract must be hedged in whole or part5 throughout the period beginning with the date the hedge is identified and ending on or after the accrual date.
  4. No related parties. None of the parties to the hedge may be related. Existing rules in the Code determine the relationships, and include entity relationships.
  5. Proper reflection. If the business unit resides outside the United States, both the executory contract and the hedge must be properly reflected on the books of the same business unit.
  6. Identity of parties. Both the executory contract and sale hedge are entered into by the same individual, partnership, trust, estate or corporation. It is not sufficient that the parties to the respective agreements are related – they must be identical.

Certain Practical Issues

The various definitions and special rules raise certain practical issues that must be taken into account in order to ensure that a hedge will be considered part of a hedge executory contract, and, thus, will not generate foreign currency exchange gain or loss. Below are some of the issues, as well as some practical tips as to how to deal with these issues.

Same-Day Identification – One of the requirements is that the hedge and the executory contract be identified as part of the hedged executory contract on the date of the hedge. In our experience, different personnel are responsible for executing hedges from those responsible for the tax function. As the identification must be made so quickly, it is very easy for this requirement to be missed. In order to avoid this, we attempt to include the identification in a long-form confirmation of the hedge, as well as the executory contract itself. It is important that the confirmation be issued the same day.

The Holding Structure Has To Be Funded in Advance – Many private equity transactions include complex holding company structures. It may not be practical to convert dollars to euros and flow the cash down a chain of holding companies on a single day in time for closing. However, once the executory contract is hedged, it must remain hedged continuously until the accrual date. This issue may be dealt with by having the nonfunctional currency deposited into a separate account that itself is identified as part of the hedged executory contract.

The Acquisition Vehicle May Not Be Able to Hedge – As mentioned above, many private equity transactions include holding company structures. It may appear that the best entity to enter into the hedge would be the company acquiring the stock of the target company. However, a hedge at that level may trigger taxable foreign currency gain or loss in that country. Moreover, as the functional currency of the acquisition vehicle may well be the currency in which payments are to be made under the stock purchase agreement, integration may not be available (which could generate earnings and profits that would support a dividend in the case of a subsequent distribution, or trigger gain if the holding company is a pass-through entity for U.S. tax purposes). To deal with these issues, a fund may enter into an agreement to purchase stock of the acquisition vehicle, and hedge this obligation, identifying such agreement and hedge as parts of the hedged executory contract.


Foreign currency hedging may make business sense for investment funds that invest globally. To avoid the recognition of foreign currency gain for U.S. income tax purposes, it often is useful to integrate these hedges with the stock purchase agreement to which the hedge relates. As identification of the hedge as part of a hedged executory contract must be done on the same day the hedge is entered into, and because there are various practical issues present in the typical investment structure, it is important to think about the hedging process well in advance of the time of the hedge. Notably, one cannot rush into the hedge and assume that the tax department can make things work from a tax standpoint after the fact.


1 Corporations making strategic stock purchases or sales also may have the same interests in hedging, and integrating their hedges. The focus of this article, however, is on investment funds that invest globally.

2 The discussion herein is equally relevant to funds based outside the United States. Investment funds typically are formed as partnerships. The income, gain, loss and expenses of partnerships flows through to investors. Accordingly, U.S. investors in foreign funds would be taxed on FX gain, and be entitled to a deduction for FX loss. We regularly advise non-U.S. investment funds regarding the integration of currency hedges to avoid adverse consequences to the U.S. investors.

3 Unless otherwise stated, all references to a "Section" are to the Internal Revenue Code of 1986, and all references to a "Regulation" are to the Treasury Regulations promulgated thereunder.

4 Interestingly, the Regulation does not refer to an agreement to purchase an interest in a partnership or limited liability company. Consider whether the general rule that a partnership is treated as the aggregate of its partners would apply in this case such that a contract to purchase/sell an interest in a partnership or limited liability company taxed as a partnership would be treated as a contract to purchase/sell the underlying assets. Unfortunately, there is no direct authority on this question.

5 I.e., the same part of the executory contract that was originally hedged.

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.

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