News › Weekly Alert Article

Hedging The Risk


With the continued volatility of today's business and economic environment, hedging strategies designed to deal with these uncertainties remain a smart business move. With fuel and raw material prices fluctuating widely over the past few years and in many cases reaching record highs, businesses are recognising the increased need for managing their price risk, not to mention currency and interest rate risk. Taxand US reccommends how to hedge your risks.

Due to the complexity of the associated tax rules, many tax departments do not have the time to fully appreciate the need to put in place the hedge identification and documentation processes required under the Internal Revenue Code (the "IRC"). In fact, even sophisticated tax departments might not be fully aware of the hedging activity that is occurring at their company.

If yours is not well-versed in the regulations governing the identification and documentation of hedges for tax purposes or is not aware of the hedging activity that is being conducted, your company's hedging may actually be creating a substantial tax exposure. Such exposure makes developing an adequate tax risk management policy for your company's hedges another smart business move. Although hedge identification for tax purposes appears to be a relatively simple matter in theory, companies with very active trading operations can be faced with significant challenges from a practical standpoint. Nevertheless, tax departments must take heed of the hedge identification and documentation rules and convey to their trading and executive brethren the importance of complying with the tax requirements.

For more information on hedging basics, hedging benefits and potential pitfalls, risk management policy considerations and identification and documentation rules:

Read the full article from Taxand US here.

Taxand's Take

Highly volatile commodity prices and swinging currency and interest rates suggest that businesses will continue to hedge risk and more will likely join the ranks.

In order to make sure that you are fully hedging your risks, it is important to ensure that your hedge transactions are properly identified and documented for tax purposes. The best bet for effectively doing so is incorporating such policies and procedures into your company's risk management policy and educating your trading and executive management of the importance of meeting these requirements.

In particular, we recommend the following:
  • make the tax department part of the risk management process
  • confirm that the requisite tax identification and documentation requirements are addressed in the company's risk management policy
  • review (and revise) the risk management policy on a regular basis to ensure compliance and understand the trading activity occurring within the company
  • review exceptions to the risk management policy and determine whether they are covered by the existing tax identification processes
  • make updates/changes to tax identification procedures as necessary.

Although the process can be complex, ensuring timely identification and proper documentation of hedges for tax purposes can make sure that, when your company decides to hedge its risk, the tax department isn't risking substantial tax exposures.

Your Taxand contact for further queries is:
Mark Young
T. +1 713 221 3932

Taxand's Take Author