PLAYING DICE: Why Does the Taxation of Financial Derivative Instruments Worry Us? (Part Two)

TAX COURT JURISPRUDENCE REGARDING FDI

It is essential to consider the jurisprudential opinion, especially regarding evidentiary aspects. In this section, we analyze how the Tax Court evaluates the deductibility of losses and the classification of instruments.

CLOSING POSITIONS IN A FUTURE AND ARTICLE 44(q) OF THE LIR

Let’s analyze the tax effect of a futures contract: If a company sells gold contracts and decides to close its position before maturity by purchasing equivalent contracts, the generated profit is taxable and has accrued according to the rule of Article 57 of the LIR (Income Tax Law).

Loss Effect: If the FDI is classified as a hedging instrument, the loss is deductible. Otherwise, it will only be deductible against gains of the same nature or from predetermined transactions in organized markets.

HEDGING A PLANNED GAS PURCHASE WITH A FUTURES CONTRACT

In this practical case, a gas distributor acquires futures to hedge against the projected price increase for December.

• Hedged item: The estimated gas purchase.
• Instrument: Four futures contracts.
• Effectiveness: The hedge is effective if the changes in the fair value of the derivative offset the cost of the planned purchase.

Tax Impact: Although there is no liability at the start of the contract (as it is a planned purchase), FDIs accepted by financial practices are valid for the LIR. If valuations impact equity before maturity, it is not necessary to adjust taxable income until the final settlement.

KEY CONCLUSIONS

1. The Peruvian LIR has sufficient rules to calculate the tax effects of FDIs.
2. The treatment of an FDI cannot be equated to that of an insurance contract.
3. Accrual in FDIs covering currency implies that valuations prior to settlement may be taxable or deductible.
4. The reviewer should not demand an exact association between the underlying and the maturity to qualify the hedge, as demonstrated in the early closing of positions.
5. The Causality Principle is required only for hedging FDIs that intend to deduct the loss when incurred.

Originally published in Thomson Reuters Global Resources on 12/23/2020.