ABCs Of Cross-Border Derivatives

Article by Linda Z. Swartz *

I. INTRODUCTION

This outline examines the U.S. tax consequences produced by derivative instruments in international financing transactions and highlights the inconsistent U.S. tax treatment that results from the use of different derivative financial instruments with the same economic results in cross-border financing transactions. The final section of the outline, which analyzes the tax provisions contained in the 1992 ISDA master multi-currency cross-border agreement, provides a practical illustration of these tax consequences.

As discussed below, the disparate results in the taxation of cross-border derivatives are in large part attributable to the historical development of separate U.S. tax rules governing each specific derivative instrument.¹ A specific example of this inconsistent treatment is illustrated by the comparison below of the tax consequences of certain notional principal contracts and substitute payments under