By Martín Ramos

In a globalized economic environment, companies face risks associated with fluctuations in commodity prices, interest rates, exchange rates and other financial factors. To mitigate these risks, it is common to use derivative hedging contracts, financial instruments specifically designed to protect the stability of cash flows or the valuation of assets and liabilities. However, when these operations generate losses, a relevant question arises from a tax point of view: are these losses deductible for income tax purposes?

Hedging derivative contracts are classified as financial tools whose main objective is to minimize the impact of variations in certain specific risks. Unlike speculative derivatives, which seek to generate profits from market volatility, hedging contracts have a direct relationship with the company's underlying assets, liabilities or transactions.

For example, an industrial company may use options contracts to set the inventory value of its commodities, while a company with foreign currency borrowings may use swaps to lock in stable interest rates.

From a tax point of view, the deduction of losses on hedging derivative contracts is subject to certain requirements and conditions. These are mainly focused on demonstrating the causal and necessary nature of the transaction, as well as compliance with formal requirements established by tax regulations.

For a loss derived from a hedging contract to be deductible, it must be associated with assets and property intended to generate income taxable income or income subject to income tax and which are proper to the line of business, or with obligations and other liabilities incurred to be used in the line of business, company or activity[1].

In this sense, it must be proven that:

  • The hedging contract is associated with a risk inherent to the economic activities of the company, clearly identifiable.
  • The purpose of the derivative is to protect the financial stability of the company and therefore its results.

 

The Tax Administration usually requires the formalization and proper documentation of hedging contracts. This includes:

  • The existence of a contract detailing the terms of the derivative.
  • Clear identification of the underlying asset, liability or transaction being hedged.
  • Reports evidencing the measurement of the realization of the risk prior to contracting.
  • Accounting records that reflect the transaction in accordance with International Financial Reporting Standards (IFRS).
  • Evidence that the derivative meets the “hedging” criteria.

 

The audit procedures place an important emphasis on the specific identification of the risk, so it is necessary to define it correctly and show how its occurrence impacts on the results, and it cannot be sustained in a general way.

Although losses on hedging derivative contracts are generally deductible, there are certain risks and limitations that companies must consider:

  1. If the Tax Administration considers that the derivative does not comply with the hedging criteria detailed in numerals 1) to 3) of literal b) of Article 5°-A of the LIR.
  2. The lack of adequate documentation or the absence of sufficient evidence to justify the relationship between the derivative and the hedged risk could result in tax observations.

Conclusion

The deduction of losses in hedging derivative contracts is a technical issue that requires a detailed analysis from a tax point of view. To ensure the deduction of these losses, companies must guarantee that their contracts comply with the requirements of causality, necessity and formality established by the tax legislation, this must include reports such as: sensitivity analysis, competitiveness matrix, market intelligence, market risk models, etc.

In addition, it is essential for companies to have specialized advice to correctly interpret and apply the tax rules and minimize the risk of observations by the Tax Administration. With proper planning and compliance with the rules, hedging derivative contracts not only protect companies against market volatility, but also allow them to optimize their tax burden in a legitimate manner.