A parent company may designate either a derivative instrument or a non-derivative instrument (e.g., a foreign currency denominated loan) as a hedge of its net investment in a foreign subsidiary. Any gains or losses associated with this designated hedge are recognized in CTA under ASC 815-35-35-1. Refer to FX 4.4.3 for further information regarding foreign currency transaction gains and losses not recognized in the income statement.

Consistent with the treatment of gains and losses associated with the designated hedge, the tax effects of temporary differences created by this designated hedge generally are credited or charged to CTA under ASC 830-30-45-21 and ASC 740-20-45-11(b). Unlike indefinitely reinvested earnings of a foreign subsidiary, the instrument serving as the hedging instrument may be owned by the group parent and thus subject to tax in the parent’s US return. Thus, the parent should provide for the tax effects of any temporary differences resulting from the designated hedge because the instrument used to hedge will have tax consequences upon its settlement (or at the end of the taxable year if the hedge is subject a mark-to-market method of accounting).

In such situations, a deferred tax asset or liability would be recognized on any unrealized gains or losses associated with the hedging instrument, with corresponding entries for CTA. A resulting deferred tax asset would be assessed for realizability, particularly giving consideration to whether the hedging instrument would give rise to a capital loss. The net tax effects of the hedging instrument would remain in CTA until the investment in the foreign entity was sold or completely or substantially liquidated. At that time, the remaining net tax effects of the hedging instrument within CTA would be reversed and a corresponding tax expense or benefit would be recorded in continuing operations.