By now, most observers of, and participants in, the European economy are familiar with the drama playing out in Greece. Swamped by large debts and a seemingly uncontrollable fiscal deficit, the Greek government is facing the possibility of defaulting on its sovereign debt obligations. Even if Greece’s monetary partners (and the IMF) come to its rescue, questions will remain about the ability of the Greek government to reorganize its fiscal affairs to avoid a repeat of this scenario one, two, or more years in the future.
Adding a new wrinkle to this fiscal crisis is Greece’s inability to use monetary policy to resolve the problem. Historically, nations faced with unmanageable sovereign debt have often simply printed more money, thereby creating inflation, which reduces the real value of the government’s typically fixed-rate debt. As a member of the European Monetary Union, however, Greece does not have this option. As a result, an increasing chorus of commentators and public officials have been asking whether Greece might be forced to take a “holiday” from the Monetary Union or, even worse, whether the “Greek Tragedy” presages the eventual collapse of the entire Monetary Union. (For recent coverage of this possibility, see here.)
As a blawg dedicated to “tax talk for tax pros,” the situation naturally causes us to ask: what federal tax consequences would result if Greece took a “holiday” from the euro or if the monetary union itself were to dissolve. Assuming that holders of euros received legacy currencies in exchange for their euros, would that exchange be a realization event under Code section 1001? On a more limited basis, would the exchange give rise to currency exchange gain or loss under Code section 988? Finally, if the qualified business unit (“QBU”) of a taxpayer were forced to switch its functional currency from the euro to a legacy currency, should that switch be considered a change in the taxpayer’s method of accounting for purposes of Code section 481?
Of course, the Treasury Department previously addressed these issues in 1998 and 2001 when it issued temporary and final regulations, respectively, regarding the transition from the various legacy currencies to the euro. The regulations generally treated the conversion as a non-taxable event, deferring any gain that would otherwise have been recognized under section 988. In the event that the euro were abandoned, should these rules simply be applied in reverse, allowing taxpayers to switch back to a legacy currency while deferring the recognition of any currency exchange gains or losses?
While we have not yet formed any opinions about the potential impact of these prospective events, we raise the question in the hopes of spurring discussion within the tax community. We don’t know if our colleagues at the Treasury Department have given any consideration to this issue; but it seems to us that they probably should. After all, a withdrawal of one or more members from the European Monetary Union, or a dissolution of the Monetary Union altogether, is not going to be as easily anticipated or as well planned as the its original formation.