CCA 1028039: Chief Counsel applied hedge-timing rules to a floating-to-fixed swap

Plain-English summary

Chief Counsel Advice addressed the timing of gain or loss from a floating-to-fixed interest-rate swap that hedged floating-rate debt. The advice concluded that the hedge gain or loss should be spread over the life of the variable-rate debt because Treas. Reg. § 1.446-4 requires reasonable matching between a hedging transaction and the item hedged. The advice explained that the same principle applies whether the issued debt carries a fixed or qualified floating rate. It did not express an opinion on matters outside the question addressed.

Ruling snapshot

• Question: How should gain or loss from a floating-to-fixed swap hedging issued floating-rate debt be timed?
• Outcome: advice given
• Key authorities: IRC § 446; Treas. Reg. § 1.446-4, including § 1.446-4(e)(4); Rev. Rul. 2002-71

Full text (IRS public release)

ID: CCA_2010061410584017 Number: 201028039
Release Date: 7/16/2010
Office: ----------------
UILC: 446.33-00

From: -------------------
Sent: Monday, June 14, 2010 10:58:45 AM
To: ------------------------------------
Cc:
Subject: Hedge Accounting For Floating-To-Fixed Swap

This responds to your inquiry regarding Taxpayer’s claim that it can deduct the loss it
incurred in the year that it terminated a notional principal contract that hedged its
interest rate risk on issued floating rate debt. The notional principal contract hedged the
entire term of the floating rate debt. Taxpayer’s issued debt remains outstanding.
Although Taxpayer apparently concedes that the section 1.446-4 hedge timing rules
govern, it has suggested that gain or loss on a hedge of floating rate debt is not required
to be spread over the period to which the hedge is related. Taxpayer asserts that its
accounting treatment is not governed by Rev. Rul. 2002-71 or the principles stated
therein.

Whether or not Rev. Rul. 2002-71 directly bears on the treatment of the floating-to-fixed
swaps in this case, the revenue ruling is illustrative of broader matching principles that
are specifically set forth in the hedge timing regulation and bear directly on the matter
here. Section 1.446-4 provides that taxpayers must clearly reflect income on hedging
transactions by reasonably matching income, deduction, gain, or loss from a hedging
transaction with the timing of income, deduction, gain or loss from the item or items
hedged. Section 1.446-4(e)(4) contains more particular guidance for hedges of debt
instruments. It states that gain or loss from a transaction that hedges a debt instrument
issued or to be issued must be accounted for by reference to the terms of the debt
instrument and the period or periods to which the hedge relates. The regulation goes
on to make it clear that this principle applies whether or not the issued debt is fixed or
floating in nature. It states, “A hedge of an instrument that provides for interest to be
paid at a fixed rate or a qualified floating rate, for example, generally is accounted for
using constant yield principles. Thus, assuming that a fixed rate or qualified floating
rate instrument remains outstanding, hedging gain or loss is taken into account in the
same periods it would be taken into account if it adjusted the yield of the instrument
over the term to which the hedge relates.”

Thus, in the instant case, we agree with you that hedging gain or loss on the floating-to-
fixed swap is spread over the life of the variable rate debt that the swap served to
hedge.

No opinion is expressed on any matter not specifically addressed herein.

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