Proposed Rule2023-24649
Income and Currency Gain or Loss With Respect to a Qualified Business Unit
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
November 14, 2023
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains proposed regulations relating to the determination of taxable income or loss and foreign currency gain or loss with respect to a qualified business unit. These proposed regulations include an election to treat all items of a qualified business unit as marked items (subject to a loss suspension rule), an election to recognize all foreign currency gain or loss with respect to a qualified business unit on an annual basis, and a new transition rule.
Full Text
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[Federal Register Volume 88, Number 218 (Tuesday, November 14, 2023)]
[Proposed Rules]
[Pages 78134-78210]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-24649]
[[Page 78133]]
Vol. 88
Tuesday,
No. 218
November 14, 2023
Part III
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Income and Currency Gain or Loss With Respect to a Qualified Business
Unit; Proposed Rule
Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 /
Proposed Rules
[[Page 78134]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-132422-17]
RIN 1545-BO07
Income and Currency Gain or Loss With Respect to a Qualified
Business Unit
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and partial withdrawal of notice
of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to the
determination of taxable income or loss and foreign currency gain or
loss with respect to a qualified business unit. These proposed
regulations include an election to treat all items of a qualified
business unit as marked items (subject to a loss suspension rule), an
election to recognize all foreign currency gain or loss with respect to
a qualified business unit on an annual basis, and a new transition
rule.
DATES: Written or electronic comments and requests for a public hearing
must be received by February 12, 2024.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically via the Federal eRulemaking Portal at <a href="https://www.regulations.gov">https://www.regulations.gov</a> (indicate IRS and REG-132422-17) by following the
online instructions for submitting comments. Requests for a public
hearing must be submitted as prescribed in the ``Comments and Requests
for a Public Hearing'' section. Once submitted to the Federal
eRulemaking Portal, comments cannot be edited or withdrawn. The
Department of the Treasury (Treasury Department) and the IRS will
publish for public availability any comments submitted to the IRS's
public docket. Send paper submissions to: CC:PA:01:PR (REG-132422-17),
Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations
generally, Raphael J. Cohen at (202) 317-6938; concerning consolidated
groups, Jeremy Aron-Dine at (202) 317-6847; concerning submissions of
comments, requests for a public hearing, and access to a public
hearing, Vivian Hayes at (202) 317-5306 (not toll-free numbers) or by
email to <a href="/cdn-cgi/l/email-protection#265653444a4f454e4347544f484155664f545508414950"><span class="__cf_email__" data-cfemail="45353027292c262d2024372c2b2236052c37366b222a33">[email protected]</span></a> (preferred).
SUPPLEMENTARY INFORMATION:
Background
I. Overview
This document contains proposed regulations (the ``proposed
regulations'') under section 987 and related provisions under sections
861, 985 through 989, and 1502 of the Internal Revenue Code (``Code'').
Section 987 applies to any taxpayer that has a qualified business unit
(``QBU'') with a functional currency other than the dollar. Section
987(1) and (2) provide rules for determining and translating taxable
income or loss (``section 987 taxable income or loss'') with respect to
the QBU. In addition, foreign currency gain or loss must be determined
under section 987(3) (``section 987 gain or loss''), which requires
proper adjustments (as prescribed by the Secretary) for transfers of
property between QBUs of the taxpayer having different functional
currencies. Section 989(c) authorizes the Secretary to prescribe
necessary and appropriate regulations, including regulations limiting
the recognition of foreign currency loss on certain remittances from
QBUs.
II. Regulations Addressing the Application of Section 987
A. 1991 Proposed Regulations and Notice 2000-20
On September 25, 1991, the Treasury Department and the IRS
published in the Federal Register proposed regulations under section
987 (56 FR 48457, September 25, 1991) (``1991 proposed regulations'').
The 1991 proposed regulations provided that section 987 taxable income
or loss is computed in the QBU's functional currency and is translated
into the taxpayer's functional currency at the weighted average
exchange rate for the taxable year. For purposes of determining section
987 gain or loss, taxpayers were required to maintain an equity pool in
the QBU's functional currency and a basis pool in the taxpayer's
functional currency. The equity and basis pools were increased by the
QBU's earnings and by capital contributed to the QBU, and they were
reduced by remittances, losses, and other transfers from the QBU.
Taxpayers recognized section 987 gain or loss at the time of a
remittance or upon a termination of the QBU. The amount of section 987
gain or loss recognized was equal to the difference between the value
of the remittance in the taxpayer's functional currency (translated at
the applicable spot rate) and the portion of the basis pool
attributable to the remittance. Thus, under the 1991 proposed
regulations, section 987 gain or loss was determined by reference to a
taxpayer's entire equity interest in a QBU. The 1991 proposed
regulations reserved on the treatment of partnerships.
On April 3, 2000, the Treasury Department and the IRS issued Notice
2000-20, 2000-1 C.B. 851. The Notice expressed concern that the 1991
proposed regulations may not have achieved their goal of providing
administrable rules that result in foreign currency gain and loss
recognition under the appropriate circumstances. The Notice also
identified certain abusive transactions that could inappropriately
accelerate recognition of section 987 loss under the 1991 proposed
regulations.
B. 2006 Proposed Regulations
1. Concerns Relating to the 1991 Proposed Regulations
On September 7, 2006, the Treasury Department and the IRS withdrew
the 1991 proposed regulations and published in the Federal Register new
proposed regulations under section 987 (71 FR 52876, September 7, 2006)
(``2006 proposed regulations''). The preamble to the 2006 proposed
regulations explained that the IRS had identified many cases in which
taxpayers inappropriately claimed substantial section 987 losses
resulting from the application of the 1991 proposed regulations when a
QBU's functional currency depreciated relative to the functional
currency of its owner. The 1991 proposed regulations also could create
a ``trap for the unwary'' by requiring recognition of large section 987
gains when a QBU's functional currency appreciated.
These results arose because the 1991 proposed regulations imputed
section 987 gain or loss to all assets and liabilities of a QBU,
regardless of whether those assets and liabilities were economically
exposed to currency fluctuations or had been subject to a realization
event, and because the 1991 proposed regulations did not limit the
selective recognition of section 987 losses. Consequently, under the
1991 proposed regulations, exchange rate fluctuations that, at most,
had only an uncertain and remote effect on the economic results
experienced by the owner of a QBU could give rise to substantial
section 987 gains and losses that taxpayers could selectively recognize
by strategically timing remittances or causing a termination of the
QBU. For example, the 1991 proposed regulations provided taxpayers with
substantial flexibility to
[[Page 78135]]
recognize section 987 losses selectively by causing QBUs with a weak
functional currency to make remittances while avoiding remittances from
QBUs with a strong functional currency that would give rise to gains.
2. Foreign Exchange Exposure Pool Method
To address the concerns relating to the 1991 proposed regulations,
the 2006 proposed regulations provided a new method of applying section
987, referred to as the foreign exchange exposure pool (``FEEP'')
method. Under the FEEP method, the owner of a QBU that is subject to
section 987 (``section 987 QBU'') determines all items of income, gain,
deduction, and loss attributable to the QBU in the QBU's functional
currency, and then translates those items into the owner's functional
currency. For this purpose, the basis of certain assets (referred to as
``historic assets'') is translated at the exchange rate for the date on
which the asset was acquired (the ``historic rate''). For example, cost
recovery deductions, such as depreciation, in respect of historic
assets are translated at the historic rate. Other items (including the
amount realized on a sale or exchange of a historic asset) are
translated into the owner's functional currency at the average exchange
rate for the taxable year.
In addition, the owner of a section 987 QBU must determine the pool
of unrecognized section 987 gain or loss (``net unrecognized section
987 gain or loss'') based on the annual increase or decrease to the
section 987 QBU's balance sheet that is attributable to foreign
exchange rate fluctuations. The amount of section 987 gain or loss that
is added to the pool each year is equal to the increase or decrease in
the basis of assets (net of the amount of liabilities) of the section
987 QBU, measured in the owner's functional currency and adjusted for
transfers between the section 987 QBU and its owner and section 987
taxable income or loss. See Sec. 1.987-4(d) of the 2006 proposed
regulations. For this purpose, certain assets and liabilities (referred
to as ``historic items'') are translated into the owner's functional
currency at the historic rate, while others (referred to as ``marked
items'') are translated into the owner's functional currency at the
applicable spot rate. As a result, when translated into the owner's
functional currency, the balance sheet value of marked items fluctuates
when the QBU's functional currency strengthens or weakens, but the
balance sheet value of historic items does not.
Marked items and historic items are defined by reference to section
988. A marked item is an asset or liability that would generate gain or
loss under section 988 if it were held or entered into directly by the
owner of the section 987 QBU but is not a section 988 transaction with
respect to the QBU itself. A historic item is an asset or liability
that is not a marked item. Thus, under the FEEP method, section 987
gain or loss reflects currency fluctuations with respect to marked
items, which would be subject to section 988 in the hands of the QBU's
owner. By contrast, section 987 gain or loss is not imputed to historic
items that are not subject to section 988.
As a result of the use of a balance sheet approach, together with
the use of historic rates for historic items, the FEEP method
distinguishes between those items whose value is highly correlated with
exchange rates and those items for which exchange rate fluctuations
have no effect on value, or only an uncertain or remote effect that is
more appropriately recognized upon a realization event with respect to
that item. Unlike the 1991 proposed regulations, which imputed section
987 gain or loss to all assets and liabilities of a QBU, section 987
gain or loss under the FEEP method relates to those assets and
liabilities that are economically exposed to currency fluctuations. The
FEEP method also minimizes a taxpayer's ability to recognize large
section 987 losses unrelated to its economic exposure and, thus, the
need for a limitation on the selective recognition of such losses.
3. Partnerships
The 2006 proposed regulations applied section 987 to partnerships
using an aggregate approach. Under this approach, an individual or
corporation that is a partner in a partnership is treated as an
indirect owner of a portion of the assets and liabilities of the
partnership for purposes of section 987. If the partner indirectly owns
a QBU with a functional currency different from that of the partner,
the QBU is a section 987 QBU, and the partner determines and recognizes
section 987 gain or loss with respect to the section 987 QBU under the
FEEP method. An elective de minimis exception was provided for partners
with a less than five percent interest in a partnership.
4. Transition Rules
The 2006 proposed regulations provided two alternative methods for
taxpayers to transition from their prior method of applying section
987: the ``deferral transition method'' and the ``fresh start
transition method.'' Under both transition methods, all the taxpayer's
section 987 QBUs were deemed to terminate on the day before the
transition date, and the owner was treated as having transferred each
section 987 QBU's assets and liabilities to a new section 987 QBU on
the transition date. The transition date was defined as the first day
of the first taxable year to which the 2006 proposed regulations apply
to a taxpayer.
Under the deferral transition method, section 987 gain or loss
determined on the date of the deemed termination (under the taxpayer's
prior method) was treated as net unrecognized section 987 gain or loss
of the new section 987 QBU, which could be recognized on a remittance
(or termination) in subsequent taxable years. The assets and
liabilities that were deemed transferred to the section 987 QBU on the
transition date (including marked assets and liabilities) were
translated using historic rates, increased or decreased to take into
account any amount treated as net unrecognized section 987 gain or loss
determined with respect to the deemed termination. The deferral
transition method thus preserved the taxpayer's section 987 gain or
loss computed under its prior method and adjusted the applicable
exchange rates to avoid double counting.
Under the fresh start transition method, section 987 gain or loss
that would have been recognized under the taxpayer's prior method as a
result of the deemed termination was neither recognized nor carried
forward as net unrecognized section 987 gain or loss. The assets and
liabilities that were deemed transferred to the section 987 QBU on the
transition date (including marked assets and liabilities) were
translated using historic rates without adjustment.
The fresh start transition method was designed to prevent
recognition of non-economic section 987 gain or loss that was not
recognized before the transition date. Because marked assets and
liabilities were translated at historic rates under the fresh start
transition method, any section 987 gain or loss inherent in those
assets and liabilities would be added to the pool of net unrecognized
section 987 gain or loss in the taxable year beginning on the
transition date. However, exchange rate fluctuations with respect to
historic items would not give rise to section 987 gain or loss. In
addition, section 987 gain or loss attributable to items that were no
longer reflected on the section 987 QBU's balance sheet on the
transition date (for example, assets that
[[Page 78136]]
had been sold before the transition date) would never be taken into
account.
Only taxpayers that were applying section 987(3) using a reasonable
method before the transition date were permitted to use the deferral
transition method. A taxpayer whose prior method was unreasonable, or
that failed to make required determinations under section 987 in prior
years, was required to use the fresh start transition method.
For this purpose, the preamble to the 2006 proposed regulations
explained that the method of applying section 987 provided in the 1991
proposed regulations would be treated as a reasonable method. The
preamble to the 2006 proposed regulations further stated that the use
of an ``earnings only'' method would be treated as a reasonable method.
Under an ``earnings only'' method, section 987 gain or loss is
recognized on a distribution out of a QBU's earnings, but not on a
distribution in excess of earnings (which represents a return of
capital).
C. 2016 Final Regulations
On December 8, 2016, the Treasury Department and the IRS published
final regulations (TD 9794) in the Federal Register (81 FR 88806,
December 8, 2016) (the ``2016 final regulations''). The 2016 final
regulations largely adopt the FEEP method contained in the 2006
proposed regulations but modify those regulations to make the FEEP
method easier for the IRS to administer and for taxpayers to apply. For
example, the 2016 final regulations permit taxpayers to use the yearly
average exchange rate as the historic rate applicable to historic
items. See Sec. 1.987-3(c)(3). The 2016 final regulations also modify
the computation of net unrecognized section 987 gain or loss for a
taxable year by requiring adjustments for nondeductible expenses and
tax-exempt income. See Sec. 1.987-4(d)(7) and (8).
The 2016 final regulations maintain the aggregate approach of the
2006 proposed regulations for partnerships. However, in response to
comments relating to the complexity of the aggregate approach, the 2016
final regulations apply only to partnerships that are wholly owned by
related persons (``section 987 aggregate partnerships''). The preamble
to the 2016 final regulations indicated that the treatment of other
partnerships under section 987 would be addressed separately and such
partnerships might be subject to a different approach.
The 2016 final regulations require taxpayers to transition using
the fresh start transition method. See Sec. 1.987-10. The Treasury
Department and the IRS were concerned that an election between two
transition methods (as permitted under the 2006 proposed regulations)
would result in a whipsaw to the fisc, because each taxpayer could
choose the method that produces more section 987 loss and less section
987 gain (as was noted by comments on the 2006 proposed regulations).
The Treasury Department and the IRS were also concerned about
administrative difficulties and planning opportunities associated with
adjustments to the translation rate under the deferral transition
method.
Section 1.987-11(a) provides that the 2016 final regulations
generally apply to taxable years beginning on or after one year after
the first day of the first taxable year following December 7, 2016.
However, taxpayers could choose to apply them to an earlier taxable
year under Sec. 1.987-11(b).
D. 2016 Temporary and Proposed Regulations
On December 8, 2016, the Treasury Department and the IRS published
Treasury Decision 9795 (the ``temporary regulations'') in the Federal
Register (81 FR 88854, December 8, 2016) and published a notice of
proposed rulemaking (81 FR 88882, December 8, 2016) (the ``2016
proposed regulations'') in the Federal Register by cross-reference to
the temporary regulations. The temporary regulations (other than Sec.
1.987-12T) had the same applicability date as the 2016 final
regulations.
The temporary regulations and the 2016 proposed regulations
include: (1) rules relating to the recognition and deferral of section
987 gain or loss in connection with certain QBU terminations and
certain other transactions involving partnerships; (2) an annual deemed
termination election; (3) an elective method, available to taxpayers
that make the annual deemed termination election, for translating all
items of income or loss with respect to a section 987 QBU at the yearly
average exchange rate; (4) rules regarding the treatment of section 988
transactions of a section 987 QBU; (5) rules regarding QBUs with the
U.S. dollar as their functional currency; (6) rules regarding
combinations and separations of section 987 QBUs; (7) rules regarding
the translation of income used to pay creditable foreign income taxes;
(8) rules regarding the allocation of assets and liabilities of certain
partnerships for purposes of section 987; and (9) rules requiring the
deferral of certain section 988 loss that arises with respect to
related-party loans.
Under the annual deemed termination election provided in the
temporary regulations, a taxpayer could elect to deem all of its
section 987 QBUs to terminate on the last day of each taxable year,
resulting in the recognition of all net unrecognized section 987 gain
or loss on an annual basis. See Sec. 1.987-8T(d). The assets and
liabilities of a section 987 QBU subject to the election were deemed to
be distributed to the owner pursuant to the deemed termination on the
last day of each taxable year and recontributed on the first day of the
following taxable year. The temporary regulations further provided that
a taxpayer who made an annual deemed termination election could elect
to translate all items of section 987 taxable income or loss at the
yearly average exchange rate. See Sec. 1.987-3T(d).
The temporary regulations (other than those finalized or withdrawn
in 2019, as described in part II.E of this Background section) expired
on December 6, 2019. The Treasury Department and the IRS intend to
remove the temporary regulations from the Federal Register when the
proposed regulations are finalized.
The following parts of the 2016 proposed regulations remain
outstanding: (1) rules regarding the treatment of section 988
transactions of a section 987 QBU (see Sec. Sec. 1.987-1, 1.987-3, and
1.988-1 of the 2016 proposed regulations); (2) rules regarding QBUs
with the U.S. dollar as their functional currency (see Sec. Sec.
1.987-1 and 1.987-6 of the 2016 proposed regulations); (3) rules
regarding the translation of income used to pay creditable foreign
income taxes (see Sec. 1.987-3 of the 2016 proposed regulations); and
(4) rules requiring the deferral of certain section 988 loss that
arises with respect to related-party loans (see Sec. 1.988-2 of the
2016 proposed regulations). A notice reopening the comment period for
the parts of the 2016 proposed regulations that remain outstanding is
published in this issue of the Federal Register.
E. 2019 Final Regulations
On May 13, 2019, the Treasury Department and the IRS published
Treasury Decision 9857 (84 FR 20790, May 13, 2019) (the ``2019 final
regulations'' and, collectively with the 2016 final regulations, the
``final regulations'') in the Federal Register. The 2019 final
regulations finalized parts of the 2016 proposed regulations relating
to combinations and separations of section 987 QBUs and the recognition
and deferral of section 987 gain or loss in connection with certain QBU
terminations and certain other transactions involving partnerships. The
2019 final regulations also withdrew
[[Page 78137]]
Sec. 1.987-7T of the temporary regulations, relating to the allocation
of assets and liabilities of a section 987 aggregate partnership to its
partners for purposes of section 987, in response to comments noting
that these rules could cause distortions in the computation of section
987 gain or loss. The 2019 final regulations (other than Sec. 1.987-
12) have the same applicability date as the 2016 final regulations.
III. Executive Order 13789 and Interim Report to the President
Executive Order 13789, issued on April 21, 2017, instructs the
Secretary of the Treasury (the ``Secretary'') to review all significant
tax regulations issued on or after January 1, 2016, and to take action
to mitigate the burden of regulations that, in relevant part, impose an
undue financial burden on U.S. taxpayers or add undue complexity to the
Federal tax laws. The Executive order further instructs the Secretary
to submit two reports to the President: an interim report that
identifies regulations that meet the criteria described in the
Executive order; and a report that recommends specific actions to
mitigate the burden imposed by regulations identified in the interim
report.
In an interim report to the President dated June 22, 2017, the
Treasury Department identified eight regulations, including the 2016
final regulations, as meeting at least one of the criteria described in
the Executive order. In Notice 2017-38, 2017-30 I.R.B. 147, which was
published on July 24, 2017, the Treasury Department and the IRS
requested comments on whether the regulations identified in the interim
report (including the 2016 final regulations) should be rescinded or
modified and, if not rescinded, how the regulations should be modified
to reduce the burden and complexity.
The Treasury Department and the IRS received several comments in
response to Notice 2017-38. In addition, one comment was submitted in
response to Notice 2017-57, 2017-42 I.R.B. 325 (which was the first of
the deferral notices described in part V of this Background section).
The comments that are relevant to the proposed regulations are
discussed in the Explanation of Provisions.
IV. Second Report to the President on Identifying and Reducing Tax
Regulatory Burdens
On October 16, 2017, the Secretary published a report (the
``Report'') in the Federal Register (82 FR 48013, October 16, 2017)
recommending specific actions to mitigate the burden imposed by the
regulations identified in the interim report. The Report stated that
the Treasury Department and the IRS intend to propose modifications to
the 2016 final regulations and to issue guidance permitting taxpayers
to elect to defer the application of Sec. Sec. 1.987-1 through 1.987-
10.
In particular, the Report stated that, in response to comments, the
Treasury Department and the IRS intend to propose rules that would
permit taxpayers to elect to adopt a simplified method of calculating
section 987 gain or loss and translating section 987 taxable income or
loss, subject to certain limitations on the recognition of section 987
loss. One simplified method discussed in the Report would allow a
taxpayer to treat all assets and liabilities of a section 987 QBU as
marked items and to translate all items of income and expense at the
average exchange rate for the taxable year. Under this method, the
amount of section 987 gain or loss would generally be consistent with
the amount determined under the 1991 proposed regulations and would
more closely conform to the applicable financial accounting rules.
The Report also noted that the Treasury Department and the IRS were
considering limitations on the recognition of section 987 loss that
would apply to taxpayers using the simplified method. Two potential
limitations were mentioned in the Report: (1) a rule that would allow
the electing taxpayer to recognize net section 987 loss only to the
extent of net section 987 gain recognized in prior or subsequent years;
and (2) a rule that would defer the recognition of all section 987 gain
or loss until the earlier of (i) the year that the trade or business
conducted by the section 987 QBU ceases to be performed by any member
of its controlled group or (ii) the year that substantially all of the
assets and activities of the QBU are transferred outside of the
controlled group.
Finally, the Report stated that the Treasury Department and the IRS
were considering alternative transition rules. One alternative would
allow taxpayers to carry forward unrealized section 987 gains and
losses (measured on the transition date with appropriate adjustments),
and a second alternative would allow taxpayers to translate all items
of the section 987 QBU at the spot rate on the transition date without
carrying forward any unrecognized section 987 gain or loss.
V. Deferral Notices
The Treasury Department and the IRS have issued several notices
stating that future guidance would defer the applicability dates of the
2016 final regulations, Sec. Sec. 1.987-2(c)(9) and 1.987-4(c)(2) and
(f) of the 2019 final regulations (the ``related 2019 final
regulations''), and Sec. Sec. 1.987-1T (other than Sec. Sec. 1.987-
1T(g)(2)(i)(B) and (g)(3)(i)(H)) through 1.987-4T, 1.987-6T, 1.987-7T,
1.988-1T, and 1.988-2T(i) of the temporary regulations. Most recently,
on August 22, 2022, Notice 2022-34, 2022-34 I.R.B. 150, announced that
future guidance would defer the applicability date of the 2016 final
regulations and the related 2019 final regulations by one additional
year to taxable years beginning after December 7, 2023. Thus, following
the amendments described in that Notice, the 2016 final regulations and
the related 2019 final regulations would first apply to the taxable
year beginning on January 1, 2024, for calendar year taxpayers. The
applicability date of Sec. 1.987-12 would not be affected by these
amendments.
VI. Financial Accounting Rules
The rules of the final regulations under section 987 differ from
the U.S. generally accepted accounting principles (``U.S. GAAP'')
relating to foreign currency translation gain or loss.\1\ For financial
accounting purposes, the consolidated financial statements of a
reporting entity may include operations denominated or measured in
currencies other than the reporting currency (each such operation, a
foreign entity),\2\ resulting in the need to translate those operations
into the reporting currency of the reporting entity. FASB, 2023, ASC
par. 830-10-10-1. The assets and liabilities and other elements, such
as revenues and expenses, of the financial statements of a foreign
entity are translated to the reporting currency using a current
exchange rate. FASB, 2023, ASC pars. 830-30-45-3 through 830-30-45-5.
For example, assets and liabilities of the foreign entity are
translated into the reporting currency using the spot rate on the
balance sheet date. Translation adjustments resulting from the process
of translating a foreign entity's financial statements to the reporting
currency are not included in determining net income
[[Page 78138]]
but are reported in the cumulative translation adjustment (CTA), which
is part of other comprehensive income, included in the in the equity
section of the reporting entity's consolidated balance sheet. FASB,
2023, ASC par. 830-30-45-12. Upon the sale or liquidation of the
investment in the foreign entity, the CTA attributable to that foreign
entity is removed from equity and is reported as part of the gain or
loss on the sale or liquidation of the investment. FASB, 2023, ASC par.
830-30-40-1.
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\1\ The relevant U.S. GAAP financial accounting rules are
contained in Financial Accounting Standards Board (``FASB''),
Accounting Standards Codification (``ASC''), Foreign Currency
Matters, Topic 830 (formerly known as FASB Statement No. 52, Foreign
Currency Translation).
\2\ A foreign entity is an operation, including a subsidiary,
division, and branch, whose financial statements are both (a)
prepared in a currency other than the reporting currency of the
reporting entity, and (b) combined or consolidated with or accounted
for on the equity basis in the financial statements of the reporting
entity. FASB, 2023, ASC sec. 830-10-20.
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The treatment of translation gain or loss under FASB, ASC Topic
830, under which translation gain or loss is deferred until a sale or
liquidation, differs from the requirements of section 987(3), under
which a taxpayer is required to make proper adjustments for the
transfer of property between QBUs of a taxpayer by including section
987 gain or loss in income upon a remittance. Further, in contrast to
the translation adjustments in the financial accounting rules, which
apply to all assets and liabilities of a foreign entity, the FEEP
method imputes section 987 gain or loss only to marked items of a
section 987 QBU and requires the basis of historic assets to be
translated at historic rates for purposes of computing section 987
taxable income or loss.
Explanation of Provisions
The proposed regulations retain the basic approach and structure of
the final regulations, while adopting a number of the simplifications
discussed in the Report and providing additional guidance regarding the
determination of section 987 taxable income or loss and section 987
gain or loss.
I. FEEP Method
As explained in parts II.B and II.C of the Background section, the
final regulations provide that section 987 gain or loss and section 987
taxable income or loss are determined under the FEEP method. This
method uses a balance sheet approach to determine section 987 gain or
loss. In addition, historic items are translated at historic rates
(both for purposes of determining section 987 gain or loss and for
purposes of translating recovery of basis with respect to historic
assets in computing section 987 taxable income or loss). As a result,
the FEEP method does not impute section 987 gain or loss to historic
items, for which exchange rate changes have only an uncertain or remote
effect on value that is more appropriately recognized upon a
realization event.
Several comments asserted that the FEEP method is overly complex
and presents significant compliance burdens, primarily related to the
treatment of historic items. Comments stated that, because the
requirement to use historic rates to translate historic items diverges
from financial accounting rules, taxpayers would need to keep a
separate set of books with respect to each section 987 QBU and to
develop costly reporting systems to maintain information that is not
used for any other purpose.
Comments recommended that, to reduce the complexity and
administrative burden of the final regulations, taxpayers should be
permitted to apply a method similar to that provided in the 1991
proposed regulations. Comments noted that this method could be coupled
with rules to prevent the selective recognition of section 987 losses,
as discussed in part III of this Explanation of Provisions.
The proposed regulations retain the FEEP method of the 2016 final
regulations, with modifications discussed in this Explanation of
Provisions, as the default rule for determining section 987 taxable
income or loss and net unrecognized section 987 gain and loss. See
proposed Sec. Sec. 1.987-3 and 1.987-4. The FEEP method is an
appropriate default rule because it generally provides a more precise
measure of section 987 gain or loss. Moreover, the enactment of the Tax
Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017), on
December 22, 2017, has made it even more important to accurately
calculate taxable income with respect to a section 987 QBU. For
example, section 951A, relating to global intangible low-taxed income
(``GILTI''), has significantly expanded the scope of taxable income of
a controlled foreign corporation (``CFC'') that is subject to current
U.S. taxation.\3\
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\3\ Previously, section 987 gain or loss recognized by a CFC
generally would be taken into account in determining a U.S.
shareholder's taxable income only if a portion of the section 987
gain or loss affected the calculation of subpart F income or when
the earnings of the CFC were relevant, such as on a distribution or
sale.
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In addition, because the 2016 final regulations permit the yearly
average exchange rate to be used as the historic rate, a taxpayer that
knows the year in which an asset was acquired or placed in service can
determine the applicable historic rate based on publicly available
information. Information relating to the year in which an asset was
acquired or placed in service is often tracked for other reasons,
including for purposes of computing depreciation and amortization. For
example, in computing a CFC's qualified business asset investment,
section 951A(d)(3)(A) now requires the adjusted basis of assets to be
determined using the alternative depreciation system under section
168(g).
However, the Treasury Department and the IRS acknowledge that in
some cases it may be burdensome to translate the basis of each historic
asset using a different historic rate (including for purposes of
depreciation) in determining section 987 taxable income or loss.
Accordingly, as described in parts II and IV of this Explanation of
Provisions, the proposed regulations provide several simplifying
elections that permit section 987 to be applied in a way that more
closely conforms to the financial accounting rules and reduces the
compliance burden. Taxpayers who make these elections would still
compute section 987 gain or loss by reference to the year-end balance
sheet of the section 987 QBU (though the computation would be modified,
as described in part V of this Explanation of Provisions). The proposed
regulations do not include an election to use the method prescribed in
the 1991 proposed regulations, because the use of fundamentally
different computational methods by different taxpayers (or by the same
taxpayer in different years) would increase the complexity of the
section 987 regulations and make them more difficult to administer.
II. Current Rate Election
As discussed in part I of this Explanation of Provisions section,
comments noted that the compliance burden associated with the FEEP
method relates primarily to the treatment of historic items. Under the
2016 final regulations, taxpayers are required to track the historic
rate for historic items and to use the historic rate for purposes of
computing section 987 taxable income or loss and section 987 gain or
loss.
To alleviate this compliance burden, proposed Sec. 1.987-1(d)(2)
would provide an election to treat all items that are properly
reflected on the books and records of a section 987 QBU as marked items
(the ``current rate election''). If a current rate election applies,
all items of income, gain, deduction, and loss with respect to a
section 987 QBU would be translated at the yearly average exchange rate
for the current taxable year for purposes of computing section 987
taxable income or loss. See proposed Sec. 1.987-3(c)(2). In addition,
all items of a section 987 QBU would be translated at the year-end spot
rate for purposes of computing section 987 gain or loss.
The current rate election is expected to produce an amount of
section 987
[[Page 78139]]
gain or loss and section 987 taxable income or loss that is similar to
the amounts determined under the 1991 proposed regulations. If a
current rate election is made, all assets and liabilities of a section
987 QBU would generate section 987 gain or loss, in conformity with the
approach used for financial reporting purposes and the 1991 proposed
regulations.
In general, a current rate election would increase the pool of net
unrecognized section 987 gain or loss with respect to a section 987 QBU
(relative to the pool that would be determined without the current rate
election). In addition, under a current rate election amounts in the
pool may substantially exceed any economic gain or loss attributable to
currency fluctuations. The Treasury Department and the IRS are
concerned that without appropriate limitation, the current rate
election would facilitate the abuses and inappropriate outcomes that
occurred under the 1991 proposed regulations, including the potential
for taxpayers to choose to recognize significant, and potentially
uneconomic, section 987 losses while avoiding or deferring section 987
gains. Accordingly, the proposed regulations include a rule that would
suspend the recognition of section 987 loss when a current rate
election is in effect. See part III of this Explanation of Provisions.
III. Suspension of Section 987 Loss Under a Current Rate Election
Comments discussed several options for addressing the potential for
selective recognition of section 987 losses. First, comments asserted
that certain rules provided in the 2016 final regulations (for example,
the annual netting of contributions and distributions to determine the
amount of a remittance under Sec. 1.987-5(c)) would be sufficient to
prevent abuse. Alternatively, comments recommended that the recognition
of section 987 gain or loss be deferred until a QBU is terminated or
its assets are sold to an unrelated party, consistent with the
financial accounting rules. Comments also suggested that section 987
loss could be deferred until the owner recognizes an equal or greater
amount of section 987 gain from the same QBU. Finally, some comments
proposed a ``lookback'' approach, under which section 987 loss would be
deferred only to the extent that the loss exceeded section 987 gain
previously recognized with respect to the same section 987 QBU.
The Treasury Department and the IRS are concerned that,
notwithstanding the annual netting rule of Sec. 1.987-5(c) and the
other rules provided in the 2016 final regulations, taxpayers generally
have a significant degree of control over whether and when their
section 987 QBUs make remittances and, therefore, could still
selectively recognize section 987 losses. In addition, because
taxpayers that make a current rate election are expected to have
substantial pools of net unrecognized section 987 gain or loss, special
rules are needed to prevent the selective recognition of losses.
Accordingly, if a current rate election is in effect, the proposed
regulations generally would suspend the recognition of section 987 loss
until a taxable year in which an equal or greater amount of section 987
gain is recognized (as described in part III.A of this Explanation of
Provisions) or until the occurrence of certain recognition events (as
described in part III.B of this Explanation of Provisions).
A. General Rules Relating to Suspended Section 987 Loss
1. In General
In a taxable year in which a current rate election applies, any
section 987 loss that would otherwise be recognized as a result of a
remittance (including a deemed remittance resulting from the
termination of a section 987 QBU) is treated as suspended section 987
loss. Proposed Sec. 1.987-11(c). In general, an owner of a section 987
QBU would recognize suspended section 987 loss in a taxable year in
which the owner recognizes section 987 gain that has the same source
and character as the suspended section 987 loss (the ``loss-to-the-
extent-of-gain rule''). Proposed Sec. 1.987-11(e). Whether section 987
gain has the same source and character as suspended section 987 loss
would be determined on the basis of the initial assignment in proposed
Sec. 1.987-6(b)(2)(i). See proposed Sec. 1.987-11(e)(1) and (f).
The Treasury Department and the IRS considered applying the loss-
to-the-extent-of-gain rule at the QBU level, such that suspended
section 987 loss with respect to a section 987 QBU would be recognized
only to the extent of section 987 gain recognized with respect to the
same section 987 QBU (as was recommended by some comments). However,
the Treasury Department and the IRS were concerned that a QBU-level
limitation would be overly restrictive. Moreover, if an owner has
suspended section 987 loss with respect to one QBU, the concern of
selective loss recognition may be mitigated to the extent that the same
owner recognizes section 987 gain with respect to another QBU.
Therefore, under the proposed regulations, the loss-to-the-extent-
of-gain rule applies at the owner level. An owner of a section 987 QBU
recognizes suspended section 987 loss to the extent that it recognizes
section 987 gain, regardless of which QBU generates the gain. However,
because this rule applies at the owner level, the Treasury Department
and the IRS were concerned that an owner might trigger the recognition
of section 987 gain that is not subject to residual U.S. tax (or is
taxed at a low rate) to release suspended section 987 loss of a
different source or character. Accordingly, proposed Sec. 1.987-
11(e)(1) provides that an owner does not recognize suspended section
987 loss until it recognizes section 987 gain in the same recognition
grouping as the suspended section 987 loss.
In general, section 987 gain and suspended section 987 loss are in
the same recognition grouping if they are both initially assigned to
U.S. source income or to foreign source income in the same section 904
category. Proposed Sec. 1.987-11(f)(1). In addition, if the owner of a
section 987 QBU is a CFC, in order to be in the same recognition
grouping, section 987 gain and suspended section 987 loss must both be
initially assigned to the same statutory and residual grouping of
subpart F income, tentative tested income, income described in section
952(b) (certain income that is effectively connected with the conduct
of a trade or business within the United States (``ECI'') and excluded
from subpart F income), or other income.\4\ Proposed Sec. 1.987-
11(f)(2).
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\4\ See part VI of this Explanation of Provisions (requesting
comments concerning the treatment of section 987 gain or loss as
ECI).
---------------------------------------------------------------------------
Suspended section 987 loss that is not recognized in a taxable year
is recognized in the next taxable year in which (and to the extent
that) the owner recognizes section 987 gain in the same recognition
grouping. The Treasury Department and the IRS also considered a
lookback rule, under which suspended section 987 loss could be
recognized to the extent that section 987 gain was recognized in a
prior taxable year. However, a lookback rule would permit taxpayers to
selectively trigger section 987 gain in taxable years in which such
gain would not give rise to additional U.S. tax (for example, because
the gain is offset by losses or because the additional U.S. tax is
offset with foreign tax credits). In light of these concerns, the
Treasury Department and the IRS request comments regarding, if a
lookback rule were to be adopted, how to prevent section 987 gain that
has no
[[Page 78140]]
net effect on U.S. tax from releasing suspended section 987 loss that
reduces U.S. tax.
2. Suspension of Section 987 Loss When an Annual Recognition Election
Is Made
In general, a taxpayer who makes an annual recognition election
will recognize the full amount of net unrecognized section 987 gain or
loss that is added to the pool each year. If an annual recognition
election and a current rate election are both in effect for a taxable
year, section 987 loss generally would not be suspended under proposed
Sec. 1.987-11(c). See part IV of this Explanation of Provisions.
The Treasury Department and the IRS are concerned that taxpayers
who are subject to a current rate election might seek to avoid the
application of the loss-to-the-extent-of-gain rule by making an annual
recognition election after net unrecognized section 987 loss has
accrued. Similarly, the Treasury Department and the IRS are concerned
that taxpayers that have not made a current rate election, but which
have substantial pools of net unrecognized section 987 loss, might make
an annual recognition election to recognize the loss without the need
for a remittance. Accordingly, the proposed regulations would treat any
net accumulated unrecognized section 987 loss and deferred section 987
loss as suspended section 987 loss in the first year in which an annual
recognition election takes effect if either (1) a current rate election
was in effect in the previous year or (2) the owner had more than $5
million of net section 987 losses. Proposed Sec. 1.987-11(d).
3. Recognition of Suspended Section 987 Loss When an Annual Recognition
Election Is in Effect
The proposed regulations also contain a special rule relating to
the recognition of suspended section 987 loss when a current rate
election and an annual recognition election are both in effect. The
Treasury Department and the IRS are concerned that, absent a
modification to the general loss-to-the-extent-of-gain rule in proposed
Sec. 1.987-11(e)(1), taxpayers that have suspended section 987 loss
would get an unwarranted benefit from making an annual recognition
election. Specifically, absent a modification, these taxpayers would be
able to recognize suspended section 987 loss even if they had net
losses on a cumulative basis for the taxable years to which the annual
recognition election applied.
For example, assume that an owner of a section 987 QBU has
suspended section 987 loss of $400 that arose in prior years (for
example, under a current rate election). The owner's functional
currency is the U.S. dollar, and the section 987 QBU's functional
currency is the euro. In year 1, the owner makes an annual recognition
election. The euro weakens in year 1 and partially recovers in year 2.
As a result of the annual recognition election, the owner recognizes
section 987 loss of $200 in year 1 and recognizes section 987 gain of
$150 in year 2. Under the general loss-to-the-extent-of-gain rule in
Sec. 1.987-11(e)(1), even though the owner recognized net section 987
loss of $50 on a cumulative basis (over years 1 and 2), the owner would
recognize suspended section 987 loss equal to the section 987 gain in
the same recognition grouping that it recognizes in year 2. Assuming
all of the section 987 gain or loss is in the same recognition
grouping, the owner would recognize $350 of total section 987 loss
(equal to $200 of section 987 loss recognized under the annual
recognition election in year 1 and $150 of suspended section 987 loss
recognized under the loss-to-the-extent-of-gain rule in year 2), even
though it recognizes only $150 of section 987 gain.
Accordingly, if a taxpayer makes both an annual recognition
election and a current rate election, the loss-to-the-extent-of-gain
rule would apply by reference to the net cumulative amount of section
987 gain in each recognition grouping that is recognized by the
taxpayer during the relevant testing period (rather than the gross
amount recognized each taxable year). Proposed Sec. 1.987-11(e)(2).
The testing period generally is the period in which section 987 loss is
suspended and both a current rate election and an annual recognition
election are in effect. Proposed Sec. 1.987-11(e)(2)(iii). The
Treasury Department and the IRS request comments on whether any
modifications to the limitation in proposed Sec. 1.987-11(e)(2) would
allow for simplification while preventing inappropriate outcomes.
B. Suspended Section 987 Loss Recognized or Attributed to a Successor
on Termination
The proposed regulations provide a successor rule that applies when
a section 987 QBU with suspended section 987 loss terminates. Under the
successor rule, suspended section 987 loss is not recognized in the
taxable year of termination, but instead becomes attributable to a
successor suspended loss QBU.
For this purpose, an eligible QBU is treated as a successor of a
section 987 QBU if it holds a significant portion of the assets of the
section 987 QBU following its termination, is engaged in the same trade
or business, and is owned by the owner of the section 987 QBU or a
member of the owner's controlled group. Proposed Sec. 1.987-13(b)(1).
For this purpose, any eligible QBU may qualify as a successor, whether
or not it is a section 987 QBU (that is, whether or not it has a
different functional currency than its owner). Thus, for example, if an
owner of a section 987 QBU with suspended section 987 loss contributes
the assets of the section 987 QBU to a subsidiary where they are held
by an eligible QBU of the subsidiary that uses them in the same trade
or business (the ``subsidiary QBU''), the subsidiary QBU is a successor
suspended loss QBU even if it is not a section 987 QBU. Similar
principles apply when a successor terminates. Proposed Sec. 1.987-
13(c)(1).
If a section 987 QBU (or its successor) terminates without a
successor, the original owner of the section 987 QBU recognizes all of
its suspended section 987 loss with respect to the section 987 QBU (or
its successor). Proposed Sec. 1.987-13(b)(2) and (c)(2). Therefore, an
owner generally would recognize suspended section 987 loss when it
transfers the section 987 QBU's assets to an unrelated party or the
section 987 QBU ceases its trade or business (such that there is no
successor suspended loss QBU). These events are similar to the events
that result in a release of the CTA for financial reporting purposes.
Moreover, the Treasury Department and the IRS expect that taxpayers
would be less likely to sell or wind up the trade or business of a
section 987 QBU for the purpose of selectively recognizing section 987
losses and, accordingly, there is less of a need for continued
suspension of section 987 loss after these events occur.
In addition, suspended section 987 loss is recognized if the owner
of the successor ceases to be related to the original owner of the
suspended loss QBU due to a direct or indirect transfer of interests in
the owner of the successor. Proposed Sec. 1.987-13(d). If the owner of
a successor suspended loss QBU ceases to be related to the original
owner of the section 987 QBU for a different reason (for example, due
to a transfer of interests in the original owner of the suspended loss
QBU), the successor suspended loss QBU is no longer treated as a
successor, and suspended section 987 loss can no longer be recognized
in connection with a termination (though it can still be recognized
under the loss-to-the-extent-of-gain rule). Proposed Sec. 1.987-13(e).
[[Page 78141]]
This rule is intended to prevent taxpayers from transferring the stock
of the original owner out of its controlled group for the purpose of
selectively recognizing suspended section 987 loss, while leaving
behind the assets and activities of the section 987 QBU in the hands of
a different controlled group member.
Similarly, suspended section 987 loss is not recognized when the
owner of a section 987 QBU liquidates in a transaction described in
section 331. Proposed Sec. 1.987-13(f). Instead, suspended section 987
loss that is not recognized in the taxable year of the liquidation is
eliminated and will never be recognized. This rule is intended to
prevent taxpayers from entering into section 331 transactions in order
to trigger the recognition of suspended section 987 loss. For example,
a U.S. shareholder could cause an upper-tier CFC that owns a section
987 QBU with suspended section 987 loss to transfer all of its assets
and liabilities to a lower-tier CFC in a section 351 contribution, and
then cause the upper-tier CFC to liquidate in a transaction described
in section 331 in order to recognize the suspended loss. The Treasury
Department and the IRS are aware that similar transactions have been
used to claim large section 987 losses under current law.
In the case of a combination or separation, the suspended section
987 loss of a combined or separated QBU is determined under rules
similar to those applicable to net accumulated unrecognized section 987
gain or loss under proposed Sec. 1.987-4(f). Proposed Sec. 1.987-
11(b)(2) and (3). Therefore, the suspended section 987 loss of a
separating QBU is allocated to the separated QBUs in proportion to the
assets properly reflected on the books and records of each separated
QBU after the separation. Proposed Sec. 1.987-11(b)(3)
C. Special Rule for Inbound Liquidations and Reorganizations
Under the proposed regulations, if a foreign corporation liquidates
or merges into a domestic corporation in a section 381(a) transaction,
the domestic corporation does not succeed to or take into account any
unused suspended section 987 loss of the foreign corporation. Proposed
Sec. 1.987-13(g). This rule is intended to prevent the importation of
suspended section 987 loss that was generated offshore. Due to
differences in how income of a CFC is taxed to its U.S. shareholders,
these losses may relate to income subject to tax at a significantly
reduced effective rate. For example, a suspended section 987 loss that
is allocated and apportioned to the other income grouping under
proposed Sec. 1.987-6 may effectively reduce only earnings that would
typically not be subject to current U.S. tax, and which may be eligible
for a dividends received deduction under section 245A upon
distribution. As a result, depending on the particular facts, such
losses may have little or no impact on the U.S. tax liability of a
CFC's U.S. shareholder when they are recognized and are generally not
equivalent to the section 987 gains or losses typical of a domestic
corporation.
Furthermore, even if the domestic corporation could, in theory,
succeed to the suspended section 987 loss, the loss may have been
assigned to an income group, such as the tested income group, that is
not relevant to a domestic corporation, in which case, it would be
highly unlikely that the suspended section 987 loss could ever be used
(absent a subsequent outbound asset transfer by the domestic
corporation to a foreign successor) under the loss-to-the-extent-of-
gain rule because the domestic corporation would not recognize section
987 gain in the same recognition grouping.
D. Rejection of Financial Accounting Deferral Rule
The Treasury Department and the IRS also considered a rule that
would defer the recognition of all section 987 gain and loss of a
section 987 QBU until a taxable year in which the section 987 QBU's
trade or business ceases to be performed by any member of the
controlled group or substantially all of the assets and activities of
the QBU are transferred outside of the controlled group. This approach
would more closely parallel the rules for determining when the CTA is
released for financial accounting purposes.
However, the loss limitation rule provided in the proposed
regulations is more consistent with the statutory provisions of section
987(3), which contemplates the recognition of section 987 gain or loss
at the time of a remittance, and section 989(c)(2), which authorizes
regulations limiting the recognition of foreign currency loss on
certain remittances. Moreover, the Treasury Department and the IRS are
concerned that a rule that defers the recognition of all section 987
gain or loss may be difficult to administer. For example, as a
practical matter, taxpayers might not properly track section 987 gain
or loss on an annual basis if it is not expected to be recognized in
the foreseeable future and the sale or liquidation of a section 987 QBU
might occur many years after the accrual of section 987 gain or loss
(at which time the necessary records may no longer be available).
IV. Annual Recognition Election
A. Annual Deemed Termination Election Provided in the 2016 Temporary
and Proposed Regulations
As explained in part II.D of the Background section, the 2016
temporary and proposed regulations contained an annual deemed
termination election. Under this election, a section 987 QBU would be
deemed to terminate on the last day of each taxable year, resulting in
the remittance of all the gross assets of the section 987 QBU to its
owner and the recognition of all net unrecognized section 987 gain or
loss on an annual basis. See Sec. Sec. 1.987-8T(d) and 1.987-8(e). The
assets and liabilities of a section 987 QBU subject to the election
would then be deemed to be contributed to the section 987 QBU on the
first day of the following taxable year. See Sec. 1.987-8T(d).
A comment asserted that it was difficult to apply the rules under
the annual deemed termination election. If the election was made, a
section 987 QBU's historic assets and the amount of its historic
liabilities would be translated at the end of each year into the
owner's functional currency using historic rates (due to the deemed
termination and remittance); the historic rate would generally be the
yearly average exchange rate for the year of the deemed termination.
The assets and liabilities would then be retranslated into the section
987 QBU's functional currency at the beginning of the following taxable
year at the yearly average exchange rate for the following taxable year
(due to the deemed contribution). See Sec. Sec. 1.987-2(d)(2) and
1.987-5(f)(3). As a result, the basis of a section 987 QBU's assets and
the amount of its liabilities (determined in the section 987 QBU's
functional currency) generally would change from one year to the next,
which would increase the compliance burden of applying the section 987
regulations.
B. Annual Recognition Election Provided in the Proposed Regulations
The proposed regulations would replace the annual deemed
termination election with an annual recognition election. Like the
annual deemed termination election, an owner that makes the annual
recognition election would recognize the full amount of net
unrecognized section 987 gain or loss each year. However, the proposed
annual recognition election does not result in a deemed termination of
a
[[Page 78142]]
section 987 QBU and a deemed remittance of its assets or a deemed
contribution to the section 987 QBU. Instead, the owner of a section
987 QBU simply recognizes the full amount of its net unrecognized
section 987 gain or loss on an annual basis. Therefore, the annual
recognition election would not alter the functional currency basis of a
section 987 QBU's assets, the amount of its liabilities, or their
historic exchange rates.
C. Special Rules That Apply When a Current Rate Election and an Annual
Recognition Election Are Both in Effect
The annual recognition election is available to owners whether or
not they make a current rate election. If an owner makes both an annual
recognition election and a current rate election for a taxable year,
the loss suspension rule described in part III of this Explanation of
Provisions does not apply to net unrecognized section 987 loss accrued
while the election is in effect. Because the annual recognition
election requires both gains and losses to be recognized without regard
to whether a remittance occurs, selective recognition of losses is not
possible and, accordingly, a loss limitation should not be needed.
However, see part III.A.3 of this Explanation of Provisions regarding
the application of the loss-to-the-extent-of-gain rule when an annual
recognition election is in effect.
D. Translation of Taxable Income Under an Annual Recognition Election
When a Current Rate Election Is Not in Effect
If an owner of a section 987 QBU makes an annual recognition
election, but does not make a current rate election, section 987
taxable income or loss is determined by translating all items at the
yearly average exchange rate. Unlike under the 2016 temporary and
proposed regulations, this rule is mandatory (rather than elective).
Use of the yearly average exchange rate simplifies the determination of
section 987 taxable income or loss without sacrificing accuracy and is
consistent with financial accounting principles. Therefore, an election
to use historic rates for this purpose should not be needed.
E. Consequences of Making an Annual Recognition Election if a Current
Rate Election Is Not in Effect
As described in part IV.D of this Explanation of Provisions, if an
owner of a section 987 QBU makes an annual recognition election, and
does not make a current rate election, the owner would use the yearly
average exchange rate for purposes of determining section 987 taxable
income or loss. However, the owner would use historic rates to
translate historic items for purposes of determining section 987 gain
or loss. Thus, the same historic item would be translated at different
exchange rates for different purposes. Under the mechanics of the FEEP
method, if a historic asset is sold or depreciated during the taxable
year, the difference between the historic rate basis and the current
year average rate basis would be added to the pool of unrecognized
section 987 gain or loss (and recognized pursuant to the annual
recognition election).
The effect of these rules is that--with respect to historic assets
of a section 987 QBU--an owner that does not make a current rate
election would recognize the same total amount of taxable income each
year regardless of whether it makes an annual recognition election. For
example, assume a section 987 QBU has the euro as its functional
currency, and its owner is a calendar year taxpayer with the U.S.
dollar as its functional currency. At the end of year 1, the section
987 QBU owns a non-depreciable historic asset (Asset A) with a basis of
100 euros, and the historic rate for Asset A is [euro]1=$1. The yearly
average exchange rate in year 2 and the spot rate on December 31, year
2 is [euro]1=$2. In year 2, the section 987 QBU sells Asset A for 150
euros and holds the 150 euros on its balance sheet until the end of
year 2.
If the owner does not make an annual recognition election, the
owner will have section 987 taxable income of $200 for year 2. This
reflects the excess of the amount realized (150 euros, translated at
the yearly average exchange rate of [euro]1=$2 into $300) over the
basis of Asset A (100 euros, translated at the historic rate of
[euro]1=$1 into $100). The owner will have no unrecognized section 987
gain or loss for the taxable year under Sec. 1.987-4(d). A comparison
of the year 2 and year 1 year-end balance sheets under Sec. 1.987-
4(d)(1) will reflect an increase of $200 (the excess of 150 euros held
at the end of year 2, translated at the year 2 year-end spot rate of
[euro]1=$2 into $300, over the [euro]100 basis of Asset A, which was
held at the end of year 1, translated at the historic rate of
[euro]1=$1 into $100). However, this increase is fully offset by the
negative adjustment for taxable income of $200 under Sec. 1.987-
4(d)(6).
By contrast, if the owner makes an annual recognition election, the
owner will have section 987 taxable income in year 2 of only $100 (50
euros of taxable income, translated at the yearly average exchange rate
of [euro]1=$2). The owner will also have unrecognized section 987 gain
for the taxable year of $100 under Sec. 1.987-4(d), which reflects the
balance sheet increase of $200 (computed under Sec. 1.987-4(d)(1) as
described in the preceding paragraph) reduced by the negative
adjustment for taxable income of $100. Thus, the difference between
Asset A's basis translated at the yearly average exchange rate (which
is $200) and its basis translated at the historic rate (which is $100)
is added to the pool of unrecognized section 987 gain or loss and this
amount is recognized in year 2 due to the annual recognition election.
The example illustrates that, whether or not the annual recognition
election is made, the owner recognizes the same amount of total income
with respect to Asset A (that is, $200). However, the annual
recognition election has the effect of converting a portion of the
owner's income into section 987 gain or loss. Because section 987 gain
or loss is subject to special source and character rules under proposed
Sec. 1.987-6, the annual recognition election can change the source
and character of an owner's taxable income.
F. Impact of an Annual Recognition Election on the Timing of
Recognition With Respect to Marked and Historic Items
Under an annual recognition election, section 987 gain or loss with
respect to marked items would be recognized annually (whereas, in the
absence of an annual recognition election, section 987 gain or loss
would be deferred until the section 987 QBU makes a remittance).
Therefore, with respect to marked items, an annual recognition election
would accelerate the recognition of section 987 gain or loss. If a
current rate election is in effect, all items of the section 987 QBU
will be treated as marked items generating section 987 gain or loss;
this gain or loss would be accelerated if an annual recognition
election is made.
However, if a current rate election is not in effect, the annual
recognition election would not accelerate the recognition of income
with respect to historic assets. As explained in part IV.E of this
Explanation of Provisions, in the absence of a current rate election,
the owner of a section 987 QBU recognizes the same amount of total
income with respect to historic assets whether or not an annual
recognition election is in effect (though the annual recognition
election has the effect of changing the portion of the income that is
section 987 gain or loss and the portion that is section 987 taxable
income or loss). In addition, as explained in part IV.D of this
Explanation of Provisions, an annual recognition election is expected
to simplify the computation of section
[[Page 78143]]
987 taxable income or loss (because all items would be translated at
the yearly average exchange rate). Therefore, for section 987 QBUs that
do not have a significant amount of marked assets or liabilities, the
election is expected to reduce the compliance burden on taxpayers
without materially accelerating the recognition of income.
V. Changes to the Computation of Unrecognized Section 987 Gain or Loss
for a Taxable Year
The proposed regulations contain several changes to the computation
of unrecognized section 987 gain or loss for a taxable year under Sec.
1.987-4(d) (that is, the amount added to the pool of net unrecognized
section 987 gain or loss each year).\5\ These modifications are
intended to ensure that section 987 gain or loss is attributable only
to exchange rate fluctuations. For example, the proposed regulations
would modify the adjustments for tax-exempt income and non-deductible
expenses to cover all items of income, gain, deduction, or loss that
affect the section 987 QBU's balance sheet but are not taken into
account in determining section 987 taxable income or loss for the
taxable year. Proposed Sec. 1.987-4(d)(7) and (8). The proposed
regulations would also require an adjustment for items of income, gain,
deduction, or loss that are taken into account in determining section
987 taxable income or loss but do not affect the section 987 QBU's
balance sheet for the taxable year. Proposed Sec. 1.987-4(d)(9).
---------------------------------------------------------------------------
\5\ Proposed Sec. 1.987-4(g) contains new examples illustrating
the proposed modifications to the computation of unrecognized
section 987 gain or loss under proposed Sec. 1.987-4(d). The
Treasury Department and the IRS intend to make conforming changes to
the existing examples in Sec. 1.987-4 of the final regulations when
the proposed regulations are finalized.
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Thus, the proposed regulations would account for deferred items
that are expected to be taken into account in computing taxable income
in a subsequent year by taking them into account in the year in which
they impact the section 987 QBU's balance sheet and effectively backing
them out in the future year when they impact taxable income but do not
change the balance sheet. For example, if a section 987 QBU incurs an
expense in year 1, but the deduction associated with the expense is
deferred until year 5, proposed Sec. 1.987-4(d)(7) would treat the
expense as a non-deductible expense in year 1, increasing the year 1
unrecognized section 987 gain or loss. In year 5, the deduction would
have no net effect on unrecognized section 987 gain or loss, since the
deduction would result in a positive adjustment under proposed Sec.
1.987-4(d)(6) (because the deduction reduces taxable income, and
taxable income is a negative adjustment to unrecognized section 987
gain or loss), and an offsetting negative adjustment under proposed
Sec. 1.987-4(d)(9) (since the deduction represents a taxable deduction
that does not affect the balance sheet). As a result, the expense would
impact the calculation of section 987 gain or loss in the same manner
as if it had been deductible in year 1.
In addition, the proposed regulations require an adjustment to
unrecognized section 987 gain or loss for any residual increase or
decrease to the adjusted balance sheet of the section 987 QBU
(determined in the functional currency of the section 987 QBU) that is
not accounted for under the other computational steps. Proposed Sec.
1.987-4(d)(10). This residual amount is translated into the owner's
functional currency at the yearly average exchange rate. The residual
increase or decrease is computed by applying the other computational
steps described in proposed Sec. 1.987-4(d) (steps 1 through 9) in the
functional currency of the section 987 QBU. Because these steps must
already be performed in the owner's functional currency, determining
the residual increase or decrease to the adjusted balance sheet under
proposed Sec. 1.987-4(d)(10) is not expected to significantly increase
the burden of determining net unrecognized section 987 gain or loss.
The application of proposed Sec. 1.987-4(d)(10) would ensure that
non-currency-related changes to the balance sheet do not artificially
increase or decrease the pool of net unrecognized section 987 gain or
loss. However, if the computational steps are applied correctly in the
functional currency of a section 987 QBU, there should not be any
residual increase or decrease to the balance sheet under proposed Sec.
1.987-4(d)(10) (unless a current rate election or an annual recognition
election is made). Rather, the year-over-year increase (or decrease) to
the functional currency balance sheet (step 1) should equal the
functional currency amount of net transfers to the section 987 QBU
(steps 2 through 5) and income of the section 987 QBU (steps 6 through
8), after backing out items of income that do not impact the balance
sheet (step 9). By contrast, when these steps are applied in owner
functional currency, they serve to identify the balance sheet change
attributable to currency movements.
For taxpayers that make a current rate election or an annual
recognition election, the proposed regulations provide that steps 6
through 9 of the computation (relating to income, gain, deduction, or
loss) do not need to be applied. For these taxpayers, all items of
income, gain, deduction, or loss would be taken into account as a
residual increase or decrease to the section 987 QBU's balance sheet
and translated at the yearly average exchange rate. The Treasury
Department and the IRS request comments on whether any additional
adjustments are needed for section 988 gain or loss of a section 987
QBU that is subject to a current rate election or an annual recognition
election. See part XV of this Explanation of Provisions (requesting
comments as to whether section 988 gain or loss of a section 987 QBU
should be determined in the owner's functional currency or the section
987 QBU's functional currency).
VI. Source and Character of Section 987 Gain or Loss
The final regulations provide that the source and character of
section 987 gain or loss is determined in the year of a remittance
using the asset method of Sec. Sec. 1.861-9(g) and 1.861-9T(g). See
Sec. 1.987-6(b)(2). For this purpose, only the assets of the section
987 QBU are taken into account. The proposed regulations would
generally retain this character and source rule, subject to certain
modifications, and would further provide that taxpayers must apply only
the tax book value method in characterizing the assets under proposed
Sec. Sec. 1.861-9(g) and 1.861-9T(g).\6\ See proposed Sec. 1.987-
6(b)(2)(i)(A).
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\6\ The proposed regulations would also make a clarifying change
to Sec. 1.861-9T(g)(2)(ii)(A)(1) to clarify that the references to
beginning-of-year and end-of-year functional currency amounts are to
the owner functional currency amounts and to move certain provisions
from Sec. 1.861-9T to proposed Sec. 1.861-9.
---------------------------------------------------------------------------
Proposed Sec. 1.987-6(b)(2)(i) would provide special rules for the
application of the tax book value method for initially characterizing
section 987 gain or loss. Under these proposed regulations, the assets
of the section 987 QBU would be initially assigned to statutory and
residual groupings under the tax book value method. However, to prevent
circularity, the proportions in which the tax book value of the assets
would be initially assigned to the statutory and residual groups are
determined without regard to section 987 gain or loss. Proposed Sec.
1.987-6(b)(2)(i)(B). The initial assignment would occur after the
application of the income attribution rules of Sec. 1.904-4(f)(2)(vi)
or 1.951A-2(c)(7) (or the
[[Page 78144]]
principles of these rules), but before expenses are allocated and
apportioned to gross income and before the application of provisions
that require a net income computation, such as the high-tax exception
to passive category income in Sec. 1.904-4(c), the high-tax exception
to foreign base company income in Sec. 1.954-1(d), and the high-tax
exclusion from tested income in Sec. 1.951A-2(c)(7).
In addition, because, at the time of the initial assignment, a
taxpayer may not yet know whether a GILTI high-tax election will be in
effect in the taxable year in which the section 987 gain or loss is
recognized (since deferred section 987 gain or loss and suspended
section 987 loss may be recognized in future year), the proposed
regulations would initially assign all of the section 987 gain or loss
that would have been assigned to a tested income group if no GILTI
high-tax election was in effect to a tentative tested income group. See
proposed Sec. 1.987-6(b)(2)(i)(D).
The initial assignment would generally be made in the taxable year
in which section 987 gain or loss is treated as recognized, deferred,
or suspended under proposed Sec. 1.987-6(b)(1). Then, in the taxable
year in which the section 987 gain or loss is recognized (which may be
the same taxable year as the year in which the initial assignment was
made or a future taxable year), any section 987 gain or loss that was
initially assigned to a tentative tested income group would be
reassigned to a tested income group or residual group based on whether
the GILTI high-tax election is in effect in that taxable year and, if
so, whether the income is high-tax. The initial characterization under
proposed Sec. 1.987-6(b)(2)(i) would be used for purposes of applying
the loss-to-the-extent-of-gain rule in proposed Sec. 1.987-11(e) and
(f), and also applies as the starting point for net income calculations
required for other provisions such as the high-tax exception to passive
category income under Sec. 1.904-4(c) and the GILTI and subpart F
high-tax exceptions under Sec. Sec. 1.954-1(d) and 1.951A-2(c)(7).
Proposed Sec. 1.987-6(b)(2)(ii).
Proposed Sec. 1.987-6(b)(2)(iii) would also provide that if a
GILTI high-tax election is made under Sec. 1.951A-2(c)(7)(viii), it
applies to all of the section 987 gain or loss in a tentative tested
income group that is recognized by the CFC in the taxable year as if
the section 987 gain and loss were all assigned to its own separate
tested unit of the CFC. In other words, all section 987 gain or loss
recognized by the CFC in that taxable year in the same section 904
category would be treated as a single tentative tested income item for
purposes of applying the GILTI high-tax exclusion.
For example, if section 987 gain and loss in a section 904 category
is initially assigned to a tentative tested income group under proposed
Sec. 1.987-6(b)(i) and a GILTI high-tax election is in effect in the
year in which the section 987 gain or loss is recognized, the section
987 gain or loss in the section 904 category would be treated as its
own tentative tested income item for purposes of determining whether it
is excluded from tested income under Sec. 1.951A-2(c)(7), after which
the section 987 gain or loss will be reassigned to a tested income
group (if the item is not excluded from tested income) or to the
residual category (if the item is excluded from tested income). Because
foreign countries generally do not impose tax on section 987 gain,
allocation and apportionment of a foreign income tax to section 987
gain under Sec. 1.861-20 and proposed Sec. 1.987-6(b)(3) will likely
be uncommon. As a result, a tentative tested income item consisting of
section 987 gain may often have a zero percent effective rate of
foreign tax and, therefore, would generally not qualify for the GILTI
high-tax exclusion.
As described above, the proposed regulations would provide that,
for purposes of determining the source and character of section 987
gain and loss, the initial assignment of suspended section 987 loss and
deferred section 987 gain and loss is generally made in the taxable
year it becomes suspended or deferred (generally in the year of a
remittance or the year the section 987 QBU is transferred to a related
party), rather than the taxable year in which it is recognized.
Proposed Sec. 1.987-6(b)(1). The Treasury Department and the IRS
anticipate that making the initial assignment in the year of suspension
or deferral, rather than the year the section 987 gain or loss is
recognized, will generally result in determining the source and
character in a year closer in time to the year in which the section 987
loss originated, and therefore will tend to be more accurate. In
addition, making an initial assignment in the taxable year of deferral
or suspension means that the source and character are determined by
reference to the assets of the section 987 QBU while they are still
owned by the owner, rather than after they have been transferred, which
would be both administratively difficult and more likely to introduce
distortions to the determination.
The Treasury Department and the IRS request comments as to whether
it would be appropriate to determine the source and character of
unrecognized section 987 gain or loss by making the initial assignment
in the taxable year in which the section 987 gain or loss is initially
included in unrecognized section 987 gain or loss under Sec. 1.987-
4(d), rather than in the year of a remittance. Making the initial
assignment on an annual basis would require more extensive tracking of
section 987 gain or loss in separate categories. However, this approach
could avoid distortions that could arise from changes in the bases of a
section 987 QBU's assets or shifts in the character of its income or
assets between the time unrecognized section 987 gain or loss is added
to the pool and the time it is recognized. In addition, this approach
could align more closely with the character of income generated by the
section 987 QBU's assets at the time of the exchange rate fluctuations
that give rise to section 987 gain or loss.
The proposed regulations would not change the rule in the final
regulations that section 987 gain or loss that is assigned to a subpart
F income group is treated as foreign currency gain or loss attributable
to section 988 transactions not directly related to the business needs
of the CFC. See proposed Sec. 1.987-6(b)(2)(i)(C). The Treasury
Department and the IRS request comments as to whether it would be
appropriate to eliminate this rule and characterize section 987 gain or
loss by reference to subpart F income groups (as defined in Sec.
1.960-1(d)(2)(ii)(B)) or whether to retain this rule generally but
apply a different rule to taxpayers that make a current rate election
(under which section 987 gain or loss can arise with respect to assets
that would not generate section 988 gain or loss in the hands of the
owner).
A qualified business unit that produces income or loss that is, or
is treated as, ECI is required to use the dollar as its functional
currency. See Sec. 1.985-1(b)(1)(v). The 2016 proposed regulations
would provide an election under which a qualified business unit with a
dollar functional currency may be treated as a section 987 QBU. See
Sec. 1.987-1(b)(6)(iii) of the 2016 proposed regulations. The Treasury
Department and the IRS also request comments as to whether, and in what
circumstances, section 987 gain or loss should be treated as ECI.
VII. Expansion of Entities Covered
In general, the final regulations do not apply to a bank, insurance
company, leasing company, finance coordination center, regulated
investment company, or real estate investment trust (a ``specified
entity''), unless it engages in
[[Page 78145]]
transactions primarily with related persons within the meaning of
section 267(b) or section 707(b) that are not themselves specified
entities. Additionally, the final regulations do not apply to trusts,
estates, S corporations, and partnerships other than section 987
aggregate partnerships. See Sec. 1.987-1(b)(1)(ii).
The Treasury Department and the IRS are concerned that excluding
these entities from the application of the regulations under section
987 would not provide taxpayers with sufficient guidance to ensure
these entities are using an appropriate method to calculate their
section 987 gain or loss. Furthermore, if these entities are not
subject to the regulations under section 987, they may use different
methods of applying section 987 that vary in material ways. Applying a
consistent set of rules to all taxpayers facilitates the fair and
effective administration of the tax law by treating similarly situated
taxpayers similarly as well as eliminating subjectivity and
uncertainty.
In addition, the Treasury Department and the IRS anticipate that
the new current rate election and annual recognition election described
in parts II and IV of this Explanation of Provisions would provide
sufficient flexibility to permit the entities excluded under the 2016
final regulations to apply the proposed regulations. As discussed in
part VIII of this Explanation of Provisions, the proposed regulations
also provide new rules relating to partnerships (other than section 987
aggregate partnerships) and S corporations. See part VIII of this
Explanation of Provisions. These rules are expected to significantly
reduce the administrative burden and complexity of applying section 987
to partnerships as compared to the aggregate rules. Accordingly,
proposed Sec. 1.987-1(b)(1)(ii) generally removes the exclusion for
entities excluded from the 2016 final regulations, making them subject
to the proposed regulations.
The proposed regulations generally continue to exclude foreign non-
grantor trusts and foreign estates if the aggregate interests of
beneficiaries that are United States persons is less than 10 percent,
and foreign partnerships if the aggregate interests of the partners
that are United States persons is less than 10 percent of the capital
and profits interests. Proposed Sec. 1.987-1(b)(1)(ii). The Treasury
Department and the IRS are concerned that the shareholders, partners,
and beneficiaries of these entities may not be able to obtain the
information needed to apply the regulations to these entities, and it
would be difficult for the IRS to administer the regulations with
respect to these entities. For the same reason, the proposed
regulations generally exclude foreign corporations that are not CFCs
and foreign corporations that are CFCs but which have no U.S.
shareholders (which are not excluded under the final regulations).
Foreign individuals are also generally excluded as they are typically
not subject to U.S. tax.
The Treasury Department and the IRS request comments on whether any
additional rules are needed to facilitate the application of the
proposed regulations to the entities that were excluded from the 2016
final regulations. See also part VIII of this Explanation of
Provisions, requesting comments on the application of the proposed
regulations to partnerships and S corporations.
VIII. Partnerships
A. Background
As explained in part II.C of the Background section, the 2006
proposed regulations and 2016 final regulations applied aggregate
theory to partnerships. As explained in the preamble to the 2006
proposed regulations, the 2006 proposed regulations applied the FEEP
method directly at the partner level under aggregate theory with the
goal of more appropriately preserving the correct amounts of exchange
gain or loss as measured from the perspective of the partner. Measuring
the currency gain or loss by reference to the partner, rather than the
partnership, was considered preferable because the partners would
generally bear the economic risk from the exposure.
Comments to the 2006 proposed regulations requested that the
Treasury Department and the IRS reconsider the aggregate approach and
instead treat a partnership as a separate entity with its own
functional currency. The comments indicated that the aggregate approach
was overly complex and that minority partners would not have the power
to compel a partnership to provide them with the information needed to
make the calculations required under the aggregate approach. One
comment acknowledged the economic rationale for the aggregate approach
but, in light of its complexity, recommended that it apply only in
cases in which a partner's interest in partnership capital or profits
exceeds a certain threshold, such as 10 percent.
In the preamble to the 2016 final regulations, the Treasury
Department and the IRS acknowledged concerns regarding the complexity
of the applying the aggregate approach to partnerships, but determined
that it would be feasible to apply an aggregate approach to
partnerships that are wholly owned by related persons. Furthermore, the
aggregate approach was preserved in order to prevent a group of related
parties from holding eligible QBUs through partnerships instead of
directly, and thereby altering the section 987 treatment of the
eligible QBU without meaningfully altering the group's economic
position.
As a result, the 2016 final regulations retained the aggregate
approach to partnerships, but applied it only to section 987 aggregate
partnerships, as discussed in Part II.C of the Background section. The
2016 final regulations did not address other partnerships.
Under the aggregate approach set forth in the 2016 final
regulations, assets and liabilities reflected on the books and records
of an eligible QBU of a section 987 aggregate partnership are allocated
to each partner, which is considered an indirect owner of the eligible
QBU. If the eligible QBU has a different functional currency than its
indirect owner, then the assets and liabilities of the eligible QBU
that are allocated to the partner are treated as a section 987 QBU of
the indirect owner.
B. Method for Determining Share of Assets and Liabilities
The 2006 proposed regulations provided that a partner's share of
assets and liabilities reflected on the books and records of an
eligible QBU is determined in a manner consistent with how the partners
had agreed to share the economic benefits and burdens corresponding to
partnership assets and liabilities, taking into account the rules and
principles of subchapter K.\7\
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\7\ A partner's basis in the partnership was adjusted to take
into account any section 987 gain or loss that it recognized on any
section 987 QBUs owned indirectly through the partnership.
---------------------------------------------------------------------------
A comment noted that the rules in the 2006 proposed regulations for
allocating assets and liabilities to a partner's indirectly owned
section 987 QBU were ambiguous and that the rules and principles of
subchapter K do not provide sufficient guidance in this regard. The
Treasury Department and the IRS acknowledged the ambiguity in the
preamble to the 2016 final regulations, and the 2016 temporary
regulations provided more specific rules for determining a partner's
share of the assets and liabilities reflected on the books and records
of an eligible QBU owned indirectly through a section 987 aggregate
partnership.
[[Page 78146]]
In particular, the temporary regulations provided that, in any
taxable year, a partner's share of each asset and liability of a
section 987 aggregate partnership was proportional to the partner's
liquidation value percentage with respect to the aggregate partnership.
A partner's liquidation value percentage was defined as the ratio of
the liquidation value of the partner's interest in the partnership to
the aggregate liquidation value of all the partners' interests in the
partnership. The liquidation value of the partner's interest in the
partnership was defined as the amount of cash the partner would receive
with respect to its interest if, immediately following the applicable
determination date, the partnership sold all of its assets for cash
equal to the fair market value of such assets (taking into account
section 7701(g)), satisfied all of its liabilities (other than those
described in Sec. 1.752-7), paid an unrelated third party to assume
all of its Sec. 1.752-7 liabilities in a fully taxable transaction,
and then liquidated.
Comments recommended alternative approaches for determining a
partner's share of the assets and liabilities of a section 987
aggregate partnership. Some comments recommended that Sec. 1.987-7 be
withdrawn and replaced with the approach of the 2006 proposed
regulations under section 987, which provided that a partner's share of
assets and liabilities reflected on the books and records of an
eligible QBU held indirectly through the partnership must be determined
in a manner consistent with how the partners have agreed to share the
economic benefits and burdens corresponding to those partnership assets
and liabilities, taking into account the rules and principles of
subchapter K. A comment indicated that the liquidation value percentage
approach was inconsistent with certain principles of subchapter K,
resulting in distortions in the calculation of section 987 gain or loss
in certain cases.
The Treasury Department and the IRS determined that, in the absence
of a more comprehensive set of rules for determining a partner's share
of assets and liabilities reflected on the books and records of an
eligible QBU held indirectly through the partnership that also
articulates the interaction of those rules with applicable rules in
subchapter K, a more flexible approach was warranted. Moreover, the
Treasury Department and the IRS determined that, in certain instances,
the liquidation value percentage methodology set forth in the 2016
temporary regulations could be interpreted as applying in a way that
inappropriately distorts the computation of section 987 gain or loss.
Specifically, under such an interpretation, certain changes in a
partner's liquidation value percentage could introduce distortions in
the calculation of net unrecognized section 987 gain or loss under
Sec. 1.987-4, giving rise to net unrecognized section 987 gain or loss
that is not attributable to fluctuations in exchange rates. For
example, an appreciation or depreciation in property value could result
in a change in liquidation value percentage that causes a change in
owner functional currency net value for purposes of step 1 of the Sec.
1.987-4(d) calculation of unrecognized section 987 gain or loss for a
taxable year without creating an offsetting adjustment under step 6 or
otherwise that would prevent the change in liquidation value percentage
from distorting the calculation of unrecognized section 987 gain or
loss. As a result, such unrecognized appreciation or depreciation
generally could result in unrecognized section 987 gain or loss for a
taxable year being allocated to each partner that indirectly owned a
section 987 QBU even when there was no change in exchange rates.
Accordingly, the Treasury Department and the IRS withdrew Sec.
1.987-7T in the 2019 final regulations. The preamble to the 2019 final
regulations stated that, until new regulations are proposed and
finalized, taxpayers may use any reasonable method for determining a
partner's share of assets and liabilities reflected on the books and
records of an eligible QBU held indirectly through the partnership. For
this purpose, taxpayers may rely on subchapter K principles (consistent
with the 2006 proposed regulations) or an approach similar to the
liquidation value percentage method set forth in Sec. 1.987-7T.
However, it would not be reasonable to apply the liquidation value
percentage method in Sec. 1.987-7T without corresponding adjustments
to the determination of net unrecognized section 987 gain or loss.
Thus, for example, a taxpayer using the liquidation value percentage
method may be required to adjust its determination of net unrecognized
section 987 gain or loss of a section 987 QBU that is owned indirectly
through a partnership to prevent the determination of unrecognized
section 987 gain or loss that is not attributable to fluctuations in
exchange rates. These adjustments may include, for example, treating
any change in a partner's owner functional currency net value that is
attributable to a change in the partner's liquidation value percentage
as resulting in a transfer to or from an indirectly owned section 987
QBU.
C. The Proposed Regulations Apply Entity Theory to Non-Section 987
Aggregate Partnerships
As previously discussed in part VIII.A of this Explanation of
Provisions, although the final regulations applied the aggregate
approach to section 987 aggregate partnerships, the final regulations
did not provide rules for applying section 987 to other partnerships.
The preamble to the 2016 final regulations stated that section 987
regulations would be developed for these other partnerships in a
separate project and indicated that a different approach might be
taken. To that end, the preamble requested comments on how an entity
approach should work for non-section 987 aggregate partnerships.
Several comments were received asserting that the aggregate
approach to partnerships under the 2016 final regulations was overly
complex. Comments recommended that a partnership be treated as a
separate entity with its own functional currency that can be the owner
of a section 987 QBU. Comments also indicated that entity treatment
would be more consistent with the principles of subchapter K.
The Treasury Department and the IRS agree that treating non-section
987 aggregate partnerships as an entity and therefore potentially an
``owner'' of section 987 QBUs would be more administrable than an
aggregate approach and would reduce the compliance burden on taxpayers
and the IRS. However, the Treasury Department and the IRS continue to
study whether partners might be able to achieve inappropriate outcomes
under entity theory. For example, the Treasury Department and the IRS
are concerned that if partnerships maintained section 987 gain and loss
pools under a ``pure'' entity theory paradigm, partners would
effectively be able to transfer their share of net unrecognized section
987 gain or loss to another partner, thereby avoiding gain recognition
or trafficking in losses. To prevent a partner from transferring its
share of net unrecognized section 987 gain or loss to another partner,
the proposed regulations would generally apply a hybrid approach to
entity theory, under which a partnership's net unrecognized section 987
gain or loss with respect to its section 987 QBUs is allocated to its
partners on an annual basis (the ``hybrid approach to entity theory''),
as described in part VIII.D of this Explanation of Provisions.
The hybrid approach to entity theory may reduce concerns about
inappropriate outcomes that might otherwise arise from the transfer of
[[Page 78147]]
partnership interests under an entity theory approach. However, as
described in part VIII.D and E of this Explanation of Provisions, while
the Treasury Department and the IRS study whether the hybrid approach
to entity theory (or a variation thereof) is suitable for all
partnerships, the proposed regulations maintain the aggregate approach
to section 987 aggregate partnerships in the final regulations, as
modified by the 2019 final regulations, with minimal changes. Special
rules are provided in proposed Sec. 1.987-7C for partnerships that
become (or cease to be) section 987 aggregate partnerships. In
addition, for consistency with other transfers of a section 987 QBU,
the proposed regulations would treat a change in the form of ownership
from direct to indirect as a termination of the section 987 QBU under
proposed Sec. 1.987-8(b)(6), subject to the deferral rules pursuant to
proposed Sec. 1.987-12(g)(1)(i)(A). The Treasury Department and the
IRS anticipate publishing a subsequent notice of proposed rulemaking
that more thoroughly addresses the application of section 987 to
partnerships.
D. The Hybrid Approach to Entity Theory
Under the proposed regulations, a partnership (other than a section
987 aggregate partnership) would be treated as a qualified business
unit having its own functional currency. See Sec. 1.989(a)-
1(b)(2)(i)(C); see also Sec. 1.985-1(a)(1). If a partnership owns an
eligible QBU with a functional currency that is different from the
functional currency of the partnership, the eligible QBU would be
treated as a section 987 QBU and the partnership (and not the partner)
would generally be treated as the owner of the eligible QBU. See
proposed Sec. Sec. 1.987-1(b)(4) through (5) and 1.987-7A(b).
A partnership that owns a section 987 QBU would determine its
unrecognized section 987 gain or loss for a taxable year under proposed
Sec. 1.987-4(d) by reference to the functional currency of the
partnership and the section 987 QBU. Proposed Sec. 1.987-7A(b). Under
the hybrid approach, the partnership would allocate to each partner a
share of the unrecognized section 987 gain or loss for the taxable year
with respect to each section 987 QBU owned by the partnership on an
annual basis. The partnership would determine a partner's share of the
unrecognized section 987 gain or loss for the taxable year for each
section 987 QBU based on the partner's distributive share of profits
and losses attributable to that section 987 QBU for the taxable year.
At the partner level, each partner would translate its share of the
unrecognized section 987 gain or loss into its functional currency at
the yearly average exchange rate and calculate its net unrecognized
section 987 gain or loss with respect to each section 987 QBU of the
partnership based on this share. Proposed Sec. 1.987-7A(c)(1).
Section 987 gain or loss attributable to a section 987 QBU owned by
a partnership would be recognized and taken into account at the partner
level. Notwithstanding that the section 987 gain or loss pools are
allocated to the partners and maintained at the partner level, the
portion of the net unrecognized section 987 gain or loss that a partner
would recognize (or suspend) each year under proposed Sec. 1.987-5(a)
would be determined by reference to the partnership's remittance
proportion with respect to the section 987 QBU. Proposed Sec. 1.987-
7A(c)(3). In other words, if the section 987 QBU is treated as
remitting 20 percent of its gross assets to its owner, the partnership,
in a taxable year of the partnership, each partner that has net
unrecognized section 987 gain or loss with respect to the section 987
QBU would recognize (or suspend) 20 percent of the net unrecognized
section 987 gain or loss.
The proposed regulations provide a framework for adjusting a
partner's basis in its partnership interest based on the principles of
section 705 when a partner recognizes section 987 gain or loss, defers
section 987 gain or loss, or suspends section 987 loss attributable to
a partnership. See proposed Sec. 1.987-7A(d). Similarly, if a partner
in an upper-tier partnership (UTP) recognizes section 987 gain or loss,
defers section 987 gain or loss, or suspends section 987 loss
attributable to a lower-tier partnership (LTP), then the proposed
regulations would provide that UTP makes a corresponding basis
adjustment to its interest in LTP, with similar rules applying to each
successive partnership through which the section 987 gain or loss is
attributable. The basis adjustment between UTP and LTP or between LTPs
constitutes a basis adjustment solely with respect to the partner that
recognizes section 987 gain or loss, defers section 987 gain or loss,
or suspends section 987 loss attributable to the partnership. The
Treasury Department and the IRS request comments on the coordination of
these proposed regulations applicable to partnerships with rules for
capital accounts determined and maintained in accordance with Sec.
1.704-1(b)(2)(iv). Additionally, the Treasury Department and the IRS
request comments on the appropriate currency in which section 743(b)
basis adjustments with respect to assets of a section 987 QBU of a
partnership should be maintained.
The proposed regulations would also provide rules for applying
proposed Sec. Sec. 1.987-11 through 1.987-13 (regarding deferred
section 987 gain or loss and suspended section 987 loss) to partners
and partnerships. Specifically, the application of the loss-to-the-
extent-of-gain rule to suspended section 987 loss of the partner is
done at the partner level. Proposed Sec. 1.987-7A(c)(4). As a result,
any section 987 gain recognized by a partner is taken into account in
determining the suspended section 987 loss that may be recognized by
the partner under proposed Sec. 1.987-11(e), without regard to whether
the section 987 gain was allocated to the partner from that partnership
(or any other partnership) or was attributable to a section 987 QBU
owned directly by the partner. Other rules under proposed Sec. Sec.
1.987-11 through 1.987-13 would generally apply with respect to a
partnership, but may be applied with respect to a partner that ceases
to be a partner in the partnership.
In general, the section 987 elections would be made by the
partnership. However, if a partner terminates its partnership interest,
any annual recognition election in effect with respect to the partner
would apply with respect to its deferred section 987 gain or loss or
suspended section 987 loss that had been allocated to the partner by
the partnership. The partner would also be permitted to make the
election to recognize pretransition section 987 gain or loss ratably
over the transition period under the transition rules. See proposed
Sec. Sec. 1.987-7A(c)(5)(ii) and 1.987-10(e)(5)(ii).
The Treasury Department and the IRS are studying the appropriate
method for determining the portion of a partner's net unrecognized
section 987 gain or loss, deferred section 987 gain or loss, and
suspended section 987 loss that should be recognized, deferred, or
suspended when a portion of a partner's interest in a partnership is
transferred or redeemed (or the partner's interest in the partnership
is otherwise reduced) and whether any special rules are needed in
respect of a transfer or redemption of a partnership interest to
account for the recognition of section 987 gain or loss at the partner
level. Accordingly, the proposed regulations reserve on the treatment
of transfers and redemptions of a partner's partnership interest. The
Treasury Department and the IRS request comments on the appropriate
method of determining the partner's interest in the partnership and the
reduction to its interest in the
[[Page 78148]]
partnership, as well as how increases to a partner's partnership
interest during the year should be taken into account. In addition, the
Treasury Department and the IRS request comments on the appropriate
treatment of transfers of a partnership interest between related
parties or between member of a consolidated group.
In general, proposed Sec. 1.987-6 would provide rules governing
the character and source of section 987 gain or loss. See part VI of
this Explanation of Provisions. The proposed regulations reserve on
whether any special rules are needed in addition to proposed Sec.
1.987-6 for purposes of determining the character and source of section
987 gain or loss of a partner with respect to a section 987 QBU owned
by a partnership. Proposed Sec. 1.987-7A(e). Comments are requested on
whether special rules are needed.
The proposed regulations would treat S corporations in the same
manner as partnerships. Proposed Sec. 1.987-7A(f). Comments are
requested on whether additional guidance is needed with regard to S
corporations and whether there are instances in which the rules for S
corporations should differ from the rules for partnerships.
The Treasury Department and the IRS also request comments as to
whether, under an entity theory of partnerships, section 987 gain or
loss could be recognized at the partnership level and then allocated to
the partners while preventing the transfer of unrecognized section 987
gain or loss among the partners or between a transferor and transferee
partner. Under the hybrid approach in the proposed regulations, a
partner's recognition of section 987 gain or loss upon a sale or other
disposition of a partnership interest results in the conversion of
capital gain or loss to ordinary gain or loss without any remittance
from the partnership QBU and without any change in the relationship
between the QBU and its owner. Comments are requested on whether
special rules are needed to prevent the conversion of capital gain or
loss to ordinary gain or loss. In addition, comments are requested on
whether the recognition of section 987 gain or loss upon a transfer or
redemption of a partnership interest should be limited to the gain or
loss that would otherwise be recognized on transfer or redemption,
under rules similar to Sec. 1.988-2(b)(8).
E. Expanding the Application of Entity Theory
The Treasury Department and the IRS continue to study the
application of entity theory and aggregate theory to partnerships in
the section 987 context, including whether it would be appropriate to
apply a hybrid approach to entity theory to all partnerships,
regardless of whether the partners are related parties. Such an
approach would generally result in a partnership generating the same
amount of section 987 gain or loss as it would if it were a corporation
or an individual.
In connection with these considerations, the Treasury Department
and the IRS are studying the concerns expressed in the 2006 proposed
regulations and the final regulations that parties could achieve a
substantially different section 987 result by owning a section 987 QBU
through a partnership, rather than owning the section 987 QBU directly,
without meaningfully changing the economic relationship of the parties.
Consider, for example, a domestic corporation that wholly owns two
CFCs, each of which use the euro as their functional currency, and
which each own fifty percent of an entity treated as a foreign
partnership (``P'') that operates a British trade or business for which
books and records are maintained in pounds. P also has a smaller
separate French trade or business that is an eligible QBU that
maintains books and records in euros. If just one CFC owned P, then P
would be treated as an entity disregarded from its owner, and the CFC
would have section 987 gain or loss with respect to its interest in P's
pound operations. However, if an election was made to treat P as a
corporation under Sec. 301.7701-3, P would be treated as a CFC that
uses the pound as its functional currency and section 987 gain or loss
with respect to P's euro operations would be measured against the
pound, rather than against the functional currency of P's partners.
Accordingly, it could be argued that, for section 987 purposes, when a
partnership is held by CFCs, aggregate theory achieves a result that is
more akin to treating P as a disregarded entity and entity theory
achieves a result more akin to treating P as a corporation.
However, if instead of being owned by two CFCs, P were owned by two
domestic corporations that use the dollar as their functional currency,
aggregate theory would achieve a result akin to treating P as a
disregarded entity, while entity theory may provide a means of allowing
the domestic corporations to avoid the application of section 987 to
P's pound trade or business without needing to contribute the trade or
business to a CFC, which might have other tax consequences. See, e.g.,
section 367(a) and (d). Accordingly, the Treasury Department and the
IRS are concerned that if only entity theory is applied to
partnerships, there may be instances in which the business of the
partnership should be subject to section 987 but is not, such as when
two domestic corporations own a partnership doing business in the
pound.
When a partner's functional currency differs from that of the
partnership, creating a separate layer of currency exposure, the
Treasury Department and the IRS are studying whether it might be
possible to achieve a result consistent with aggregate theory without
the administrative burden of allocating a portion of a partnership's
assets and liabilities to each partner and calculating the income and
balance sheets of the partnership in the functional currency of each
partner. One such approach might determine a partner's section 987 gain
or loss with respect to the partnership by reference to the partner's
outside basis in the partnership, rather than its share of the inside
asset basis and liabilities (the ``outside basis approach'').
The outside basis approach would be layered on top of the hybrid
approach to entity theory taken by the proposed regulations. Under this
system, a partnership would first determine its section 987 gain or
loss with respect to any section 987 QBUs of the partnership, and
allocate the pool to the partners, as described in Sec. 1.987-7A of
the proposed regulations. If a partner has the same functional currency
as the partnership, no additional steps are taken.
If a partner has a different functional currency than the
partnership, under one alternative (``alternative 1''), the partner
would calculate its section 987 gain or loss with respect to its
interest in the partnership (including its interest in the functional
currency trade or business of the partnership and its interest in each
of the partnership's section 987 QBUs) using a method similar to the
calculation of unrecognized section 987 gain or loss for an owner
applying the current rate election under proposed Sec. 1.987-4(d)
(that is, steps 1 through 5 and 10), but by reference to the partner's
adjusted basis in its partnership interest (``outside basis'') in the
partnership.
Specifically, the partner's annual section 987 gain or loss
attributable to its share of the partnership as a whole would be equal
to its outside basis determined as of the end of the partnership's
taxable year (after taking into account other adjustments prescribed
under section 705 but before any adjustments for section 987 gain or
loss recognized under the outside basis approach) and translated into
the
[[Page 78149]]
partnership's functional currency reduced by its outside basis
determined as of the beginning of the same partnership taxable year and
translated into the partnership's functional currency (the
``partnership functional currency change in value'') (step 1). The
partnership functional currency change in value would then be adjusted
to subtract the partnership functional currency amounts of
contributions to the partnership from the partner and add the
partnership functional currency amounts of distributions from the
partnership to the partner (steps 2 through 5). The result would then
be adjusted to back out the partnership functional currency amount of
the partner's allocable share of income, gain, deduction, and loss of
the partnership (step 10). The result is the partner's unrecognized
section 987 gain or loss attributable to its partnership interest.
Under alternative 1, the partner's unrecognized section 987 gain or
loss attributable to its partnership interest would be recognized
annually and its basis in the partnership would be increased or
decreased accordingly. Alternative 1 approximates the result a partner
would achieve under aggregate theory if it applied the current rate
election and the annual recognition election.
Annual recognition is necessary under alternative 1 to prevent
differences in the partnership's adjusted bases in its assets (``inside
basis'') attributable to fluctuations in the functional currency of the
partnership itself or any section 987 QBUs owned by the partnership and
the partners' outside bases (an ``inside-outside basis disparity''). By
adjusting outside basis for these currency fluctuations, the partner's
section 987 gain or loss with respect to the partnership will include
section 987 gain or loss on the partnership's owner functional currency
net value of the partnership's section 987 QBUs. As a result, the sum
of the owner's section 987 gain or loss attributable to its partnership
interest under the outside basis approach, plus its allocable share of
the partnership's net unrecognized section 987 gain or loss
attributable to the partnership's section 987 QBUs should generally be
equivalent to the sum of its unrecognized section 987 gain or loss
attributable to section 987 QBUs indirectly owned by the partner
through the partnership under the aggregate approach (assuming there
are no other inside-outside basis disparities).
Alternatively, under another alternative (``alternative 2''), it
may not be necessary to require recognition of the partner's section
987 gain or loss annually. Under this approach, the same method is used
to determine the partner's section 987 gain or loss with respect to its
partnership interest as in alternative 1, except that the partnership
functional currency change in value would be determined, not just by
reference to the partner's outside basis in the partnership, but to the
sum of its outside basis and its net accumulated unrecognized section
987 gain or loss attributable to the partnership and the partnership's
section 987 QBUs (that is, the amount that would have been recognized
if the partner had been recognizing its section 987 gain and loss
attributable to the partnership annually as under alternative 1). Under
alternative 2, the partner's unrecognized section 987 gain or loss
attributable to its partnership interest might be recognized when it
receives a distribution from the partnership or disposes of a portion
of its partnership interest.
Both alternative 1 and alternative 2 approximate the result a
partner would achieve under aggregate theory if it applied the current
rate election to its partnership interest. However, alternative 1, but
not alternative 2, requires annual recognition of the partner's net
unrecognized section 987 gain or loss. Accordingly, no additional loss
limitations may be needed for alternative 1. See part IV.C of this
Explanation of Provisions. However, it may be appropriate for the
partner's net accumulated unrecognized section 987 gain or loss under
alternative 2 to be subject to the loss-to-the-extent-of-gain rule in
Sec. 1.987-11(e) of the proposed regulations.
Under one variation to these alternative approaches, the partner's
net accumulated unrecognized section 987 gain or loss attributable to
its partnership interest would net with the partner's net unrecognized
section 987 gain or loss with respect to the partnership's section 987
QBUs when one amount reflects section 987 gain and the other reflects
section 987 loss.
Comments are requested on whether the outside basis approach or a
similar system would achieve results consistent with aggregate theory
in a more administrable manner. Furthermore, comments are requested on
instances in which this system might inappropriately diverge from
aggregate theory and how such divergences might be addressed. For
example, if inside basis and outside basis are not equivalent (for
example, because a partner acquires a partnership interest in a year in
which a section 754 election is not in effect), how the resulting
mismatch might be minimized or eliminated for purposes of measuring the
partner's currency exposure with respect to the partnership. Comments
are also requested on whether the outside basis approach or a similar
system should apply to partners of (i) all partnerships, (ii) only
those partnerships currently treated as section 987 aggregate
partnerships, or (iii) only those partnerships in which the partner
owns more than 50 percent of the partnership interest (taking into
account constructive ownership).
In addition, comments are also requested on any additional rules
that might be necessary to coordinate the outside basis approach or a
similar system with the section 987 regulations or with subchapter K,
when the functional currency of a partner, the partnership, and the
partnership's section 987 QBU differ.
IX. Attribution of Items to the Section 987 QBU
The final regulations provide rules regarding when assets and
liabilities, as well as items of income, gain, deduction, and loss are
attributable to an eligible QBU, and when a section 987 QBU is treated
as making a contribution or distribution to its owner or another
eligible QBU of the owner. See Sec. 1.987-2. In general, the proposed
regulations retain the rules in the final regulations with minor or
clarifying revisions. However, in a change from the final regulations,
the proposed regulations would treat a change in the form of ownership
of a section 987 QBU as a termination, as discussed above.
In general, the final regulations provide that items are
attributable to an eligible QBU if they are reflected on the separate
set of books and records of the eligible QBU, as defined in Sec.
1.989(a)-1(d). Sec. 1.987-2(b)(1). The proposed regulations would
revise the cross-reference to refer to Sec. 1.989(a)-1(d)(1) or (2),
as Sec. 1.989(a)-1(d)(3) refers back to Sec. 1.987-2(b). Proposed
Sec. 1.987-2(b)(1).
In addition, the final regulations provide that an eligible QBU is
not treated as owning stock of a corporation unless the owner of the
eligible QBU owns less than 10 percent of the value of the corporation
(after taking into account certain attribution rules). Sec. 1.987-
2(b)(2)(i). In order to generally prevent an eligible QBU from owning
stock of a CFC, the proposed regulations would expand the exclusion to
cover all stock unless the owner owns less 10 percent of both the vote
and value of the corporation, and to revise the relevant attribution
rules. Proposed Sec. 1.987-2(b)(2)(i). The proposed regulations also
provide that any type of basis that does not affect the income and loss
of the
[[Page 78150]]
eligible QBU, such as section 743(b) basis, would not be treated as
included on the books and records of the eligible QBU. Proposed Sec.
1.987-2(b)(5).
Similarly, the final regulations provide rules regarding when a
transaction or the recording of an asset or liability as on (or not on)
the books and records of a section 987 QBU is treated as a disregarded
transaction between the section 987 QBU and its owner or another
eligible QBU of the owner. Sec. 1.987-2(c). The proposed regulations
generally retain the substance of these rules but make minor revisions
for clarity. See proposed Sec. 1.987-2(c).
X. Transition Rules
As explained in part II.C of the Background section, the 2016 final
regulations require all owners of section 987 QBUs to apply the fresh
start transition method. Under this method, unrecognized section 987
gain or loss determined for years before the transition date generally
would not be taken into account under section 987. In addition, for
purposes of applying the FEEP method in the first year in which the
regulations apply, the assets and liabilities of the section 987 QBU
must be translated using historic rates.
Comments stated that the fresh start transition method is difficult
to apply because taxpayers did not track historic rates before the
transition date and the data needed to determine historic rates for
items acquired in prior taxable years is not readily available. In
addition, comments asserted that the fresh start transition method
imposes an undue financial burden by permanently eliminating
unrecognized section 987 losses determined before the transition date.
The Treasury Department and the IRS acknowledge that the fresh
start transition method could increase the compliance burden on
taxpayers for the initial year in which the regulations apply and would
fail to account for section 987 gain or loss that arose before the
transition date (to the extent attributable to assets and liabilities
that are no longer reflected on the books and records of the section
987 QBU on the transition date). Therefore, the proposed regulations
provide a new transition rule that would replace the fresh start
transition method.
The new transition rule would account for unrecognized section 987
gain or loss accrued before the transition date. In addition, the new
transition rule would not require taxpayers to retrospectively
determine historic rates for items acquired before the transition date.
As explained in the Applicability Dates section, the fresh start
transition method can no longer be applied to any taxable year for
which the tax return or information return is filed on or after
November 9, 2023.
A. Translation of a Section 987 QBU's Assets and Liabilities at the
Spot Rate
The transition rules under proposed Sec. 1.987-10 would apply in
the taxable year beginning on the transition date (that is, the first
day of the first taxable year in which the regulations apply). For
purposes of determining unrecognized section 987 gain or loss in the
first taxable year in which the regulations apply, the assets and
liabilities reflected on a section 987 QBU's balance sheet at the end
of the previous year would be translated into the owner's functional
currency at the spot rate on the day before the transition date.
Proposed Sec. 1.987-10(d)(1). Similarly, for taxpayers that do not
make a current rate election, the historic rate for historic assets and
liabilities would generally be the spot rate on the day before the
transition date. Proposed Sec. 1.987-10(d)(2). These rules are
intended to simplify the application of the FEEP method by eliminating
the need to determine actual historic rates in the first taxable year
in which the regulations apply.
B. Pretransition Gain or Loss
Under the proposed regulations, an owner of a section 987 QBU must
determine the amount of section 987 gain or loss that has accrued
before the transition date (``pretransition gain or loss''). Proposed
Sec. 1.987-10(e). By default, in the first taxable year in which the
regulations apply, pretransition gain is treated as net unrecognized
section 987 gain, and pretransition loss is treated as suspended
section 987 loss. Proposed Sec. 1.987-10(e)(5)(i). This proposed rule
is intended to prevent taxpayers from selectively recognizing
pretransition loss (which, like section 987 loss generated under a
current rate election, may be computed using a method that results in
large section 987 pools) while deferring pretransition gain until a
remittance. Alternatively, taxpayers can elect to amortize
pretransition gain or loss over a period of ten years beginning on the
transition date. Proposed Sec. 1.987-10(e)(5)(ii).
In order to prevent owners subject to this election from offshoring
pretransition gain or importing pretransition loss, proposed Sec.
1.987-10(e)(5)(ii)(B) provides that, immediately before an inbound or
outbound transaction described in section 381(a), any unrecognized
pretransition gain is recognized and any unrecognized pretransition
loss is suspended. As a result, the suspended section 987 loss may be
recognized, subject to the loss-to-the-extent-of-gain-rule under Sec.
1.987-11(e). In the case of an inbound section 381(a) transaction of a
foreign owner with pretransition loss, any suspended section 987 loss
that is not recognized before the transaction would not carry over to
the domestic acquiring corporation under proposed Sec. 1.987-13(g).
See part III.C of this Explanation of Provisions.
C. Computation of Pretransition Gain or Loss
Under proposed Sec. 1.987-10(e)(2), a taxpayer that applied
section 987 before the transition date using an ``eligible
pretransition method'' (described in part X.D of this Explanation of
Provisions) would use that method to compute pretransition gain or
loss. Pretransition gain or loss generally is equal to the amount of
section 987 gain or loss that would have been recognized under the
eligible pretransition method if the QBU terminated on the day before
the transition date. Proposed Sec. 1.987-10(e)(2)(i)(A). The amount of
pretransition gain or loss must be adjusted to reflect any change to
the basis of the section 987 QBU's assets (net of liabilities) that
occurs as a result of the transition (for example, where the taxpayer
previously used a method that would determine the owner's basis in
distributed assets using historic rates). Proposed Sec. 1.987-
10(e)(2)(i)(B).
A taxpayer that did not apply an eligible pretransition method
before the transition date would determine pretransition gain or loss
using the method provided in Sec. 1.987-10(e)(3). Under this method,
pretransition gain or loss is equal to the sum of the annual amounts of
unrecognized section 987 gain or loss for each taxable year since the
section 987 QBU's inception, reduced by any section 987 gain or loss
recognized before the transition date. Proposed Sec. 1.987-
10(e)(3)(ii).
The amount of unrecognized section 987 gain or loss for each
taxable year would be computed using a simplified version of the method
provided in Sec. 1.987-4(d). Proposed Sec. 1.987-10(e)(3)(iii). The
only information needed to apply this simplified method is the
information reflected in the section 987 QBU's opening and closing
balance sheets for each year. Because this method does not require the
translation of contributions and distributions at the applicable spot
rate, it would only approximate the actual amount of section 987 gain
or loss accrued before the transition date.
[[Page 78151]]
D. Eligible Pretransition Method
1. In General
An eligible pretransition method includes any reasonable method of
applying section 987 before the transition date that fully accounts for
foreign currency gain or loss attributable to the assets and
liabilities of a section 987 QBU (including foreign currency gain or
loss that is recognized in computing taxable income with respect to the
section 987 QBU or its owner). The method provided in the 1991 proposed
regulations, which determines section 987 gain or loss based on
currency fluctuations with respect to the earnings and capital of a
section 987 QBU (an ``earnings and capital'' method) is considered an
eligible pretransition method, provided that it is applied in a
reasonable manner. Proposed Sec. 1.987-10(e)(4)(i). In addition, any
other reasonable method of applying section 987 is an eligible
pretransition method if it produces the same total amount of income
over the life of the owner (taking into account the aggregate of
section 987 gain or loss, section 987 taxable income or loss, and gain
or loss on the disposition of assets and liabilities transferred by a
section 987 QBU to the owner) as a reasonable earnings and capital
method. Proposed Sec. 1.987-10(e)(4)(ii). However, a method under
which the owner does not recognize section 987 gain or loss at the time
of a remittance because the recognition of all section 987 gain or loss
is deferred until the section 987 QBU terminates is not considered an
eligible pretransition method because it is inconsistent with the
statutory requirements under section 987(3). Proposed Sec. 1.987-
10(e)(4)(iv).
2. Earnings Only Method
An earnings only method can qualify as an eligible pretransition
method under proposed Sec. 1.987-10(e)(4)(ii) if it is applied in a
way that produces the same total amount of income as a reasonable
earnings and capital method. This can be accomplished by maintaining a
separate set of equity and basis pools for the section 987 QBU's
capital account and assigning a proportionate amount of the capital
basis pool to property distributed out of capital. See proposed Sec.
1.987-10(l)(2) (Example 2).
The Treasury Department and the IRS are aware that certain
taxpayers apply an earnings only method in a manner that creates a
permanent difference in their income (as compared to the earnings and
capital method). Under this approach, when a section 987 QBU makes a
distribution (whether out of earnings or capital), the owner determines
its basis in the distributed assets by translating the section 987
QBU's basis into the owner's functional currency at the spot rate
applicable on the distribution date (``spot-rate basis''). See proposed
Sec. 1.987-10(l)(3) (Example 3). As a result, the owner's basis may be
higher or lower than the actual cost of acquiring the assets (in the
owner's functional currency) due to exchange rate fluctuations.
When a section 987 QBU makes a distribution out of earnings, which
triggers the recognition of section 987 gain or loss under an earnings
only method, the use of a spot-rate basis is appropriate. However, when
a section 987 QBU makes a distribution out of capital (on which no
section 987 gain or loss is recognized under an earnings only method),
the use of a spot-rate basis artificially steps up (or steps down) the
basis of the distributed assets in the absence of a recognition event.
As a result, if a spot-rate basis is used for capital distributions
under an earnings only method, the owner would not recognize the same
total amount of income as it would under an earnings and capital
method.
The Treasury Department and the IRS are concerned that the use of a
spot-rate basis for capital distributions under an earnings only method
does not accurately measure an owner's economic income with respect to
a section 987 QBU. However, the Treasury Department and the IRS
acknowledge that the preamble to the 2006 proposed regulations endorsed
the use of an earnings only method without explaining how the basis of
distributed assets should be determined. Taxpayers may have
misunderstood the preamble to suggest that an owner of a section 987
QBU can take a spot-rate basis in all distributed assets under an
earnings only method.
Therefore, the proposed regulations provide that an earnings only
method that does not produce the same total amount of income as a
reasonable earnings and capital method can qualify as an eligible
pretransition method, provided it was first applied on a tax return
filed before November 9, 2023 and is consistently applied to all
section 987 QBUs of the same owner. Proposed Sec. 1.987-10(e)(4)(iii).
A taxpayer that begins applying this method on or after November 9,
2023 or fails to apply this method consistently to all of its section
987 QBUs will not be treated as applying an eligible pretransition
method.
XI. Deferral Events and Outbound Loss Events
A. Final Regulations
Section 1.987-12 of the final regulations contains rules that defer
the recognition of section 987 gain or loss in connection with two
categories of related party transactions: deferral events and outbound
loss events. A deferral event is defined to include certain
transactions in which a section 987 QBU terminates and its assets are
reflected on the books and records of a successor QBU after the
termination. See Sec. 1.987-12(b)(2). A successor QBU is a section 987
QBU that is owned by a member of the same controlled group as the
original owner (except if the original owner is a U.S. person and the
owner of the successor QBU is a foreign person). See Sec. 1.987-
12(b)(4). Section 987 gain or loss that is not recognized in connection
with a deferral event (``deferred section 987 gain or loss'') is
recognized by the original owner of the section 987 QBU when the
successor QBU makes a remittance to its owner. See Sec. 1.987-
12(c)(2).
An outbound loss event is defined to include a termination of a
section 987 QBU that is owned by a U.S. person and has net unrecognized
section 987 loss in connection with a transfer of the section 987 QBU's
assets to a related foreign person. See Sec. 1.987-12(d)(2). If the
transfer is a transaction described in section 351 or section 361, any
section 987 loss that is not recognized in connection with the outbound
loss event (``outbound section 987 loss'') is added to the basis of
stock received by the owner of the section 987 QBU. See Sec. 1.987-
12(d)(4). Otherwise, outbound section 987 loss is recognized when the
owner of the section 987 QBU and the related foreign person cease to be
members of the same controlled group. See Sec. 1.987-12(d)(5).
B. Proposed Regulations
1. Deferral Events
The proposed regulations generally retain the principles of the
final regulations relating to deferral events but modify the rules in
several respects. For example, the final regulations provide a de
minimis rule pursuant to which Sec. 1.987-12 would not apply to a
section 987 QBU if the section 987 gain or loss that would not be
recognized under Sec. 1.987-12 would not exceed $5 million. Sec.
1.987-12(a)(3)(ii). To prevent the de minimis rule from allowing an
owner to recognize more than the threshold by transferring multiple
section 987 QBUs to members of its controlled group, the proposed
[[Page 78152]]
regulations would retain the de minimis rule but apply the threshold to
the total deferred section 987 gain or loss that would otherwise be
recognized by the owner in a single taxable year. Proposed Sec. 1.987-
12(a)(2)(ii). In addition, because the proposed regulations would apply
the suspended section 987 loss rules to outbound loss events, any
amount treated as a suspended section 987 loss is not taken into
account in determining whether the threshold has been met. Id.
The final regulations also provide that, if a deferral event
results in multiple successor QBUs, the remittance proportion is
determined by treating all the successor QBUs as a single successor
QBU. Sec. 1.987-12(c)(2)(ii). The Treasury Department and the IRS are
concerned that aggregating the contributions and distributions of
various successor QBUs in order to treat them as the same successor QBU
both increases the administrative burden of determining the remittance
proportion and is less precise than determining a remittance proportion
for each successor QBU. Therefore, the proposed regulations would
apportion an amount of deferred section 987 gain or loss to each
successor QBU and recognize (or suspend) a portion of deferred section
987 gain or loss annually with respect to each successor QBU based on
the specific successor QBU's remittance proportion and on whether that
successor QBU is subsequently transferred. Proposed Sec. 1.987-
12(b)(2) and (c).
Although the proposed regulations generally retain the deferral
rules of Sec. 1.987-12(b) with respect to those circumstances in which
they apply under the final regulations, the Treasury Department and the
IRS recognize that this can lead to odd results in certain cases,
because similar transactions may sometimes be subject to the deferral
rules and other times be subject to no limitation or the suspended loss
rules.
For example, if a CFC (``CFC1'') with a euro functional currency
owns a section 987 QBU (``QBU1'') with a pound functional currency, and
CFC1 transfers QBU1 to a wholly owned subsidiary CFC (``CFC2''), the
deferral rules would generally apply if CFC2's functional currency is
not the pound. However, if CFC2's functional currency is the pound, the
deferral rules would not apply because QBU1 would cease to be a section
987 QBU upon transfer to CFC2, because it would have the same
functional currency as its owner. As a result, if CFC1 does not have a
current rate election in effect (or has both a current rate election
and an annual recognition election in effect), CFC1 would recognize its
net unrecognized section 987 gain or loss with respect to QBU1 on the
transfer. However, if CFC1 has a current rate election in effect (and
does not have an annual recognition election in effect), CFC1 would
recognize net unrecognized section 987 gain on the transfer, but net
unrecognized section 987 loss would become suspended section 987 loss.
The Treasury Department and the IRS request comments on whether the
deferral rules of proposed Sec. 1.987-12 should remain a separate
deferral regime or should be modified or combined with the suspended
loss rules of proposed Sec. Sec. 1.987-11 and 1.987-13.
2. Outbound Loss Events
The proposed regulations generally retain the definition of an
outbound loss event contained in the final regulations. However, the
proposed regulations provide that outbound section 987 loss is treated
as suspended section 987 loss, instead of being added to the basis of
stock or recognized solely when the owner of the section 987 QBU and
the related foreign person cease to be related. This rule is intended
to permit the recognition of outbound section 987 loss to the extent
the owner recognizes section 987 gain in the same recognition grouping,
as described in part III of this Explanation of Provisions. In
addition, applying the loss suspension rules to outbound loss events
simplifies the proposed regulations by reducing the number of different
types of deferral regimes that apply to section 987 losses.
XII. Making and Revoking Elections
The final regulations contain a number of elections relating to
section 987. The proposed regulations contain several new elections,
including the current rate election, the annual recognition election,
and elections under the transition rules.
Under the final regulations, elections generally are made
separately for each section 987 QBU. See Sec. 1.987-1(g)(1)(i).
Elections cannot be revoked without the Commissioner's consent. See
Sec. 1.987-1(g)(5). Under the 2016 temporary and proposed regulations,
an annual deemed termination election generally cannot be made (except
in the first taxable year in which the election was relevant) if the
aggregate net loss that would be recognized by all owners to which the
election applied exceeds $5 million. See Sec. 1.987-1T(g)(2)(i)(B).
The annual deemed termination election provided in the 2016 temporary
and proposed regulations is irrevocable.
The proposed regulations would provide a consistency requirement
that applies to both the existing elections under the final regulations
and the new elections under the proposed regulations. Under proposed
Sec. 1.987-1(g), these elections would be required to be made or
revoked consistently for all members of the same consolidated group and
all CFCs, partnerships, non-grantor trusts, and estates in which the
ownership interests or beneficiary interests of the U.S. shareholder
(or members of its consolidated group) exceed 50 percent. The
consistency requirement is intended to make the application of the
proposed rules less complex and more administrable; in most cases,
consistent application of the regulations is also expected to reduce
the compliance burden on taxpayers.
The proposed regulations would permit a current rate election or an
annual recognition election to be made or revoked without the
Commissioner's consent. The Treasury Department and the IRS recognize
that these elections can have important consequences for the
substantive application of section 987 and the associated compliance
burden, and that taxpayers may wish to change these elections in
response to changes in the nature and size of their business
operations.
However, the current rate and annual recognition elections are
proposed to be subject to timing restrictions and a loss suspension
rule. If a current rate election or an annual recognition election is
made, it cannot be revoked for five years without the Commissioner's
consent. Similarly, once revoked, these elections cannot be made again
for five years without consent. Proposed Sec. 1.987-1(g)(3)(ii)(B).
These timing requirements are intended to make the proposed regulations
easier to administer. In addition, because the Commissioner's consent
is not required to make or revoke these elections, the timing
requirements are needed to prevent taxpayers from opportunistically
making or revoking elections in response to exchange rate fluctuations.
Proposed Sec. 1.987-11(d)(2) provides that, in the first year in
which a current rate election is revoked, net accumulated unrecognized
section 987 loss is converted into suspended section 987 loss. This
rule is needed to prevent net unrecognized section 987 loss generated
under a current rate election from being recognized without limitation
after the election is revoked.
Similarly, if an annual recognition election is made, and either
(1) a current rate election was in effect for the previous year or (2)
the aggregate accumulated net unrecognized section 987 loss that would
be recognized by the owner as a result of the recognition
[[Page 78153]]
election exceeds $5 million, net accumulated unrecognized section 987
loss is converted into suspended section 987 loss. See Sec. 1.987-
11(d)(1). As discussed in part III.A of this Explanation of Provisions,
this rule is intended to prevent a taxpayer from using an annual
recognition election to trigger the recognition of net unrecognized
section 987 loss that arose in years before the annual recognition
election was made.
XIII. Removal of the Election To Use Spot Rates in Lieu of Yearly
Average Exchange Rates
As explained in part II.C of the Background section, the historic
rate under Sec. 1.987-1(c)(3) of the 2016 final regulations is equal
to the yearly average exchange rate for the year in which a historic
asset was acquired or a historic liability was entered into. The 2016
final regulations provide an election under Sec. 1.987-1(c)(1)(iii) to
use spot rates in lieu of yearly average exchange rates.
The Treasury Department and the IRS understand that this election
may not be helpful to taxpayers, as it would increase the compliance
burden of applying section 987 due to the need to track historic spot
rates for each day in a taxable year on which the section 987 QBU
acquires an asset or incurs a liability. In addition, the availability
of this election adds to the complexity of the regulations and makes
the rules more difficult for the IRS to administer. Accordingly, the
proposed regulations remove the election under Sec. 1.987-1(c)(1)(iii)
to use spot rates in lieu of yearly average exchange rates.
XIV. Consolidated Groups
A. Intercompany Transactions
A section 987 QBU of a member of a consolidated group is a
component of that member. Therefore, a transaction between that QBU and
a different member of the same group constitutes an intercompany
transaction (as defined in Sec. 1.1502-13(b)(1)(i)) and is subject to
the intercompany transaction regulations in Sec. 1.1502-13.
The Treasury Department and the IRS have become aware that
achieving single entity treatment under Sec. 1.1502-13 may be
difficult for certain intercompany transactions involving section 987
QBUs. Accordingly, to facilitate single entity treatment, the proposed
regulations would treat a transaction between the section 987 QBU of
one member and any other member of the same group (including a section
987 QBU of that other member) as a combination of (i) an intercompany
transaction between the members, and (ii) a transfer between each
section 987 QBU and its owner (see Sec. 1.987-2(c)) as necessary to
take into account the effect of the transaction on the assets and
liabilities of each section 987 QBU.
The purpose of Sec. 1.1502-13 is to provide rules to clearly
reflect the taxable income and tax liability of a consolidated group as
a whole by preventing intercompany transactions from creating,
accelerating, avoiding, or deferring consolidated taxable income (CTI)
or consolidated tax liability. See Sec. 1.1502-13(a)(1). The matching
rule in Sec. 1.1502-13(c) (Matching Rule) is one of the principal
mechanisms for achieving this goal. See Sec. 1.1502-13(a)(6)(i).
The Matching Rule is a principle-based rule that redetermines the
attributes of a selling member's (S) intercompany item and a buying
member's (B) corresponding item to produce the effect of transactions
between divisions of a single corporation (single entity treatment).
See Sec. 1.1502-13(a)(2). The Matching Rule also can affect the timing
of these items so that, whenever possible, the effect of these items on
the group's CTI and consolidated tax liability is the same as if S and
B were divisions of a single corporation. See Sec. 1.1502-13(c)(1)(i).
For example, assume that S sells land at a gain to B, which later
sells that land at a gain to an unrelated person. To achieve the same
result as if S and B were divisions of a single corporation, S does not
take into account its gain or loss on the sale until B sells the land
to the unrelated person, and S's and B's holding periods for the land
are aggregated. See Sec. 1.1502-13(a)(2), (c)(1)(ii), and (c)(2); see
also Example 1 in Sec. 1.1502-13(c)(7)(ii)(A).
The Matching Rule relies on an alignment between S's and B's items
that may be unclear in transactions involving section 987 QBUs. For
example, assume that Lender (that is, S) and Borrower (that is, B) are
members of a consolidated group, and Lender has a section 987 QBU
(Lender QBU) whose functional currency is the euro. Lender QBU lends
[euro]100 to Borrower. If Borrower and Lender were divisions of a
single corporation, the loan would be treated as a transfer from Lender
QBU when funded and a transfer to Lender QBU when repaid (or when
interest is paid). These transfers would be taken into account in
determining the amount of a remittance from Lender QBU (potentially
triggering the recognition of section 987 gain or loss), and the single
corporation might recognize section 988 gain or loss when the loan is
repaid. See Sec. Sec. 1.987-5 and 1.988-1(a)(10)(ii)(A).
However, under current law, the foreign currency gain or loss of
Lender and Borrower in the foregoing example does not perfectly offset
in amount on the group's consolidated return. This is the case because
Borrower has foreign currency gain or loss under section 988 when the
loan is repaid, whereas Lender's foreign currency gain or loss under
section 987 will be taken into account only when Lender QBU makes a
remittance. See Sec. Sec. 1.987-5(a) and 1.988-2(b)(6). Because these
amounts are calculated at different times based on different exchange
rates, and because section 988 applies to individual transactions while
section 987 gain or loss is determined on a pooled basis by reference
to the assets and liabilities of a section 987 QBU, achieving single
entity treatment under Sec. 1.1502-13 may be difficult. In other
words, under current law, it may be difficult to ``match'' Lender's
section 987 gain or loss with Borrower's section 988 gain or loss.
Similar mismatches would occur with regard to transactions between
section 987 QBUs of different consolidated group members.
The proposed regulations would address the matching issue in this
example by treating the loan as if it were made directly between Lender
and Borrower. See proposed Sec. 1.1502-13(j)(9). Thus, when the loan
is made, Lender QBU would be treated as transferring [euro]100 to
Lender, which in turn would be treated as lending [euro]100 to Borrower
in an intercompany transaction. The loan would be treated as a section
988 transaction with respect to both Lender and Borrower. When Borrower
pays interest on the loan and repays the loan principal, Lender would
be treated as transferring the interest or principal amount it receives
from Borrower to Lender QBU. Lender's interest income and Borrower's
interest expense, and their section 988 gain and loss with respect to
principal and interest, would offset each other in amount, producing no
net effect on CTI (thereby achieving single entity treatment). The
group would report any foreign currency gain or loss (under section 987
or 988) on the transfers between Lender and Lender QBU (for example,
when Lender QBU loans the [euro]100 to Borrower, which is first treated
as a remittance of the [euro]100 from Lender QBU to Lender) on the
group's consolidated return.
The proposed regulations also would replace Examples 4 and 15 in
Sec. 1.987-2(c)(10) with new examples in Sec. 1.1502-13(j) to
illustrate the application of the proposed rule. The new examples make
clear that the proposed approach applies to reach single entity
treatment
[[Page 78154]]
for all consolidated groups, regardless of whether the taxpayer had a
principal purpose of avoiding tax through the use of section 987. Cf.
Sec. 1.987-2(b)(3)(i) and (c)(10), Example 15 (providing that the IRS
may reallocate a receivable from a section 987 QBU to its owner if a
principal purpose of avoiding tax through the use of section 987 is
present).
B. Separate Return Limitation Years
When a corporation joins a consolidated group, the regulations
under section 1502 may limit the group's ability to use the
corporation's preexisting tax attributes. For example, Sec. 1.1502-
21(c) generally restricts the group's ability to use a member's net
operating loss (NOL) that arose in a year when the corporation was not
a member of the group. In general, Sec. 1.1502-21(c) allows the group
to use only the portion of the NOL that does not exceed the member's
``cumulative register,'' which reflects the member's items of income,
gain, deduction, and loss that have been included in the group's CTI.
See Sec. 1.1502-21(c)(1)(i).
Under the proposed regulations, a corporation that is the owner of
a section 987 QBU may have suspended or deferred section 987 losses
when it joins a consolidated group. The Treasury Department and the IRS
request comments about how rules similar to the rules of Sec. 1.1502-
21(c) should apply to such losses.
XV. Section 988 Transactions of a Section 987 QBU
The temporary regulations provided special rules relating to
section 988 transactions of a section 987 QBU, including transactions
denominated in the owner's functional currency. Although the temporary
regulations have expired, the corresponding provisions of the 2016
proposed regulations remain outstanding.
In general, under the 2016 proposed regulations, whether a
transaction is a section 988 transaction is determined by reference to
the section 987 QBU's functional currency, but any section 988 gain or
loss is determined in the owner's functional currency. See Sec. 1.987-
3(b)(4)(i) of the 2016 proposed regulations. In addition, certain
section 988 transactions of a section 987 QBU that are denominated in,
or determined by reference to, the owner's functional currency
(``specified owner functional currency transactions'') are not treated
as section 988 transactions of the section 987 QBU. See Sec. 1.987-
3(b)(4)(ii) of the 2016 proposed regulations.
The 2016 proposed regulations further provide that section 988 gain
or loss with respect to certain short-term section 988 transactions of
a section 987 QBU (``qualified short-term section 988 transactions'')
that are accounted for under a mark-to-market method of accounting is
determined in the functional currency of the section 987 QBU, and not
the functional currency of its owner. See Sec. 1.987-3(b)(4)(iii) of
the 2016 proposed regulations.
Under the final regulations, a transaction denominated in a
currency other than the section 987 QBU's functional currency is a
historic item. See Sec. 1.987-1(d) and (e). However, the 2016 proposed
regulations provide that a qualified short-term section 988 transaction
for which section 988 gain or loss is determined by reference to the
functional currency of the section 987 QBU is a marked item. See Sec.
1.987-1(d)(3) of the 2016 proposed regulations.
The Treasury Department and the IRS understand that the rules of
the 2016 proposed regulations relating to nonfunctional currency
transactions of a section 987 QBU would increase the compliance burden
on taxpayers in certain contexts (for example, where the section 987
QBU operates as a treasury center). This compliance burden could
potentially be alleviated by treating all transactions (including
specified owner functional currency transactions) denominated in a
currency other than the functional currency of the section 987 QBU as
marked items, determining whether those transactions are section 988
transactions by reference to the functional currency of the section 987
QBU, and determining the section 988 gain or loss with respect to those
transactions in the functional currency of the section 987 QBU.
However, the Treasury Department and the IRS are concerned that, under
this approach, transactions denominated in the owner's functional
currency would be treated as section 988 transactions of a section 987
QBU. Therefore, these transactions would give rise to offsetting
positions in that currency, enabling taxpayers to recognize losses
while deferring the offsetting gains. For example, if a section 987 QBU
held assets denominated in its owner's functional currency, and the
section 987 QBU's functional currency weakened against that of its
owner, the section 987 QBU would have section 988 gain and the owner
would have an inverse amount of section 987 loss.
The Treasury Department and the IRS request comments as to whether
section 988 gain or loss on nonfunctional currency transactions
(including specified owner functional currency transactions) of a
section 987 QBU should be determined in the functional currency of the
section 987 QBU when a current rate election or annual recognition
election is in effect and, if so, what limitations should be imposed to
prevent abuse. Comments are also requested on whether the definition of
qualified short-term section 988 transactions should be expanded or
modified, and whether other exceptions or special rules should be
provided for section 987 QBUs engaged in certain activities (for
example, treasury centers).
XVI. Definition of a Qualified Business Unit and an Eligible QBU
Under section 985(b), the functional currency of a qualified
business unit is generally either the dollar or the currency of the
economic environment in which a significant part of its activities are
conducted and in which its books and records are kept. Section 985(b);
Sec. 1.985-1(b) through (c). Under section 989, a ``qualified business
unit'' means a ``separate and clearly identified unit'' of a trade or
business of a taxpayer, provided that the unit maintains separate books
and records. Section 989(a). The regulations describe two types of
qualified business units. The activities of a person may be a qualified
business unit if the activities constitute a trade or business and a
separate set of books and records are maintained with respect to the
activities. Sec. 1.989(a)-1(b)(2)(ii). In addition, the so called
``per se'' qualified business units include any corporation,
partnership (other than a section 987 aggregate partnership), trust, or
estate. Sec. 1.989(a)-1(b)(2)(i).
A single qualified business unit may only have a single functional
currency. Certain qualified business units, such as domestic
corporations, are required to use the dollar as their functional
currency unless otherwise provided by a ruling or administrative
pronouncement. Sec. 1.985-1(b)(1)(iii). No rulings or administrative
pronouncements have been issued under this provision other than private
letter rulings that can be relied on only by the specific taxpayer for
whom they were issued. Accordingly, all domestic corporations are
required to use the dollar as their functional currency unless they
have obtained a private letter ruling specifically allowing that entity
to use a different functional currency.
The Treasury Department and the IRS have become aware of
uncertainty regarding whether a per se qualified business unit, such as
a corporation, that has only a single trade or business for which it
keeps a single set of books and records is one qualified business unit
(the corporation and its single trade
[[Page 78155]]
or business) or two qualified business units (the corporation itself
being one and its single trade or business being the other). If a
domestic corporation with a single trade or business for which it keeps
a single set of books and records were a single qualified business
unit, that would effectively mean that (absent a ruling) the functional
currency of the trade or business would be required to be the dollar,
even if the currency of the economic environment of the trade or
business was the euro and books and records are maintained in euros;
whereas another domestic corporation with an identical trade or
business may be permitted to use the euro as the functional currency of
the trade or business, as long as it had at least one other trade or
business that uses the dollar.
To clarify that a per se qualified business unit, such as a
domestic corporation, is permitted to have a single trade or business
that maintains a single set of books and records, and which uses a
functional currency other than the dollar, the proposed regulations
modify the definition of eligible QBU. The revised definition clarifies
that, if a per se QBU has only a single trade or business for which
only a single set of books and records are maintained, only the trade
or business (and not the entity itself) would be an eligible QBU.
Proposed Sec. 1.987-1(b)(4). The entity itself would be the owner of
the eligible QBU. Proposed Sec. 1.987-1(b)(5). As a result, if the
eligible QBU has a functional currency other than the functional
currency of the owner, the eligible QBU would be a section 987 QBU.
The Treasury Department and the IRS request comments on whether a
similar change should be made to Sec. 1.989(a)-1(b). Comments should
also consider whether additional changes are needed in the regulations
under section 985 regarding functional currency or in other provisions
that reference the definition of a qualified business unit, such as
Sec. 1.904-4(f)(3)(vii).
XVII. Other Changes and Revisions
In addition to the provisions described in parts I through XVI of
this Explanation of Provisions, the proposed regulations include other
wording changes, additions, deletions, and organizational changes to
the final regulations and the 2016 proposed regulations for purposes of
clarifying, conforming, and making minor revisions.
Applicability Dates
I. Applicability Dates of the Proposed Regulations
Once finalized, the regulations (and the parts of the final
regulations that are not replaced or modified by the proposed
regulations) would apply to taxable years beginning after December 31,
2024. Proposed Sec. 1.987-14(a)(1).
A taxpayer may also choose to apply the final version of the
proposed regulations and the parts of the final regulations that are
not replaced or modified by the proposed regulations (the ``new final
regulations''), once published in the Federal Register, for taxable
years ending after the date these regulations are published as final in
the Federal Register. Proposed Sec. 1.987-14(b). To choose to apply
the new final regulations, the taxpayer and each member of its
consolidated group and section 987 electing group must consistently
apply the new final regulations in their entirety to the taxable year
and all subsequent taxable years beginning on or before December 31,
2024. Id.
The Treasury Department and the IRS are concerned that taxpayers
may terminate certain QBUs before the general applicability date of the
proposed regulations to avoid the application of these rules.
Accordingly, the proposed regulations would also provide an earlier
applicability date for terminating QBUs to prevent taxpayers from
avoiding these rules. Specifically, the new final regulations are
proposed to apply to a terminating QBU on the day the section 987 QBU
terminates. Proposed Sec. 1.987-14(a)(2). The proposed regulations
would define a terminating QBU as a section 987 QBU if both (1) the
section 987 QBU terminates on or after November 9, 2023, or as a result
of an entity classification election filed on or after November 9, 2023
and effective before November 9, 2023, and (2) neither the new final
regulations nor the 2016 and 2019 section 987 regulations would apply
to the section 987 QBU when it terminates but for the anti-avoidance
rule in proposed Sec. 1.987-14(a)(2). Proposed Sec. 1.987-1(h).
In addition, if the section 987 regulations apply to a taxable year
of a partnership and would not otherwise apply to the taxable year of a
partner in which or with which the partnership's taxable year ends,
then the section 987 regulations apply to that taxable year of the
partner solely with respect to the partner's interest in the
partnership and its section 987 gain or loss attributable to an
eligible QBU held by the partnership.
II. Applicability Dates of the 2016 and 2019 Section 987 Regulations
The proposed regulations also provide rules regarding the
applicability dates of the final regulations and temporary regulations.
Section 1.987-11(a) of the 2016 final regulations generally provides
that the 2016 final regulations apply to taxable years beginning on or
after one year after the first day of the first taxable year following
December 7, 2016. However, taxpayers could choose to apply them to an
earlier taxable year as provided in Sec. 1.987-11(b). The 2019 final
regulations (other than Sec. 1.987-12) have the same applicability
date as the 2016 final regulations.
As described in part V of the Background section, following the
publication of the 2016 final regulations, the Treasury Department and
the IRS have issued several notices stating that future guidance would
defer the applicability dates of most provisions of the final
regulations and the temporary regulations. Because certain provisions
that were originally deferred have since been revoked or expired, those
provisions are no longer subject to deferral; other provisions were
finalized in 2019 and deferral began at that time. The provisions
deferred by the notices (and the respective periods for deferral) are
as follows (collectively, the ``2016 and 2019 section 987
regulations''):
(i) Sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5;
1.987-1 through 1.987-10; 1.988-1(a)(4), (a)(10)(ii), and (i); 1.988-
4(b)(2); and 1.989(a)-1(b)(2)(i), (b)(4), (d)(3), and (d)(4), as
contained in 26 CFR in part 1 in effect on April 1, 2017.
(ii) Sections 1.987-2T(c)(9), 1.987-4T(c)(2) and (f), and 1.987-7T,
as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they
were revoked on May 13, 2019).
(iii) Sections 1.987-2(c)(9) and 1.987-4(c)(2) and (f), as
contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on
May 13, 2019).
(iv) Sections 1.987-1T (other than Sec. Sec. 1.987-1T(g)(2)(i)(B)
and (g)(3)(i)(H)), 1.987-3T, 1.987-6T, 1.988-1T, and 1.988-2T(i), as
contained in 26 CFR in part 1 in effect on April 1, 2017 (until they
expired on December 6, 2019).
Pursuant to the most recent notice, the 2016 and 2019 section 987
regulations would first apply to taxable years beginning after December
7, 2023. Notice 2022-34, 2022-34 I.R.B. 150. The deferral notices also
allow taxpayers to rely on the provisions of the notices before the
section 987 regulations are amended. See id.
Because the proposed regulations would replace or modify parts of
the
[[Page 78156]]
final regulations, the final regulations are not expected to become
applicable in their current form. However, some taxpayers have chosen
to apply the 2016 and 2019 section 987 regulations in accordance with
Sec. 1.987-11(b) and the deferral notices. The proposed regulations
would provide rules for taxpayers who chose to apply the 2016 and 2019
section 987 regulations before the applicability date of those
regulations.
Proposed Sec. 1.987-14(c)(1) would provide that a taxpayer may
choose to apply the 2016 and 2019 section 987 regulations to a taxable
year beginning after December 7, 2016, and beginning on or before
December 31, 2024, in certain circumstances. Specifically, the taxpayer
and each member of its consolidated group and section 987 electing
group would be required to first apply the 2016 and 2019 section 987
regulations to a taxable year ending before November 9, 2023. Proposed
Sec. 1.987-14(c)(1)(i). In addition, the taxpayer and each member of
its consolidated group and section 987 electing group would be required
to consistently apply the 2016 and 2019 section 987 regulations in
their entirety to all section 987 QBUs directly or indirectly owned by
the taxpayer and each member of its consolidated group and section 987
electing group on the transition date for the taxable year that
includes the transition date and all subsequent taxable years before
the taxable year in which the taxpayer and each member of its
consolidated group and section 987 electing group rely on the proposed
regulations or apply the new final regulations. Proposed Sec. 1.987-
14(c)(1)(ii). For purposes of proposed Sec. 1.987-14(c), the term
section 987 electing group does not include foreign partnerships,
foreign non-grantor trusts, or foreign estates. Proposed Sec. 1.987-
14(c)(3)(ii).
If a taxpayer and each member of its consolidated group and section
987 electing group first apply the 2016 and 2019 section 987
regulations on their returns filed on or after November 9, 2023, they
would be required to apply proposed Sec. 1.987-10 in lieu of Sec.
1.987-10 of the final regulations. Proposed Sec. 1.987-
14(c)(1)(iii)(B). For these taxpayers, proposed Sec. 1.987-
14(c)(1)(iii)(B) would provide that a taxpayer and each member of its
consolidated group and section 987 electing group must transition from
the previous method used to comply with section 987 using the
transition rule in proposed Sec. 1.987-10. In other words, these
taxpayers would not be permitted to apply the fresh start method
described in Sec. 1.987-10 of the final regulations.
The Treasury Department and the IRS are concerned that, if the new
proposed transition rule applied solely with respect to taxable years
ending on or after November 9, 2023, taxpayers would effectively have
the option to choose between two alternative transition methods.
Taxpayers with pretransition loss could apply the transition rule of
proposed Sec. 1.987-10 (which preserves the pretransition loss), while
taxpayers with pretransition gain could choose to apply the 2016 and
2109 section 987 regulations before the applicability date of the
proposed regulations to take advantage of the fresh start transition
method (which could eliminate the pretransition gain). Therefore, the
proposed transition rule would apply to taxpayers who choose to apply
the 2016 and 2019 section 987 regulations on their returns filed on or
after November 9, 2023 with respect to a taxable year ending before
November 9, 2023.
Proposed Sec. 1.987-14(c)(2) describes the applicability of the
2016 and 2019 section 987 regulations to section 987 QBUs that were not
directly or indirectly owned by the taxpayer on the taxpayer's
transition date. Specifically, a taxpayer that is applying the 2016 and
2019 section 987 regulations to other section 987 QBUs may choose to
apply the 2016 and 2019 section 987 regulations to any section 987 QBU
that it did not directly or indirectly own on the transition date,
provided the taxpayer applies those regulations consistently to that
QBU for that taxable year and all subsequent taxable years before the
taxable year in which the taxpayer relies on the proposed regulations
or applies the new final regulations.
III. Applicability Dates of Sec. 1.987-12
Section 1.987-12T was issued as part of the temporary regulations
and generally applied to any deferral event (as defined in Sec. 1.987-
12T(b)(2)) or outbound loss event (as defined in Sec. 1.987-12T(d)(2))
that occurred on or after January 6, 2017. The 2019 final regulations
withdrew Sec. 1.987-12T and finalized the proposed regulations under
Sec. 1.987-12 that cross-referenced Sec. 1.987-12T. See Sec. 1.987-
12. The deferral notices did not defer the applicability dates of Sec.
1.987-12T or Sec. 1.987-12, nor would the proposed regulations.
Accordingly, all taxpayers to whom section 987(3) applies are currently
subject to Sec. 1.987-12.
The proposed regulations would replace Sec. 1.987-12 with certain
deferral provisions generally included in proposed Sec. Sec. 1.987-11
through 1.987-13. Accordingly, the proposed regulations would provide
that taxpayers continue to apply Sec. 1.987-12 until the first taxable
year to which they apply the new final regulations.
IV. Reliance on the Proposed Regulations and 2016 Proposed Regulations
Taxpayers may rely on the proposed regulations (and so much of the
final regulations as would not be modified by the proposed regulations)
for taxable years ending after November 9, 2023, provided the taxpayer
and each member of its consolidated group and section 987 electing
group consistently follow the proposed regulations in their entirety
and in a consistent manner.
In addition, taxpayers may rely on the parts of the 2016 proposed
regulations that remain outstanding for taxable years ending after
November 9, 2023, provided that both (i) the taxpayer and each member
of its consolidated group and section 987 electing group consistently
follow these parts in their entirety and in a consistent manner; and
(ii) in that taxable year, the taxpayer follows the proposed
regulations.
For the avoidance of doubt, any person relying on the proposed
regulations is treated as applying them for purposes of any provision
that refers to the application of the proposed regulations or any part
thereof (for example, for purposes of proposed Sec. 1.987-10(b)).
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.
II. Paperwork Reduction Act
The collections of information in the proposed regulations with
respect to section 987 are in proposed Sec. Sec. 1.987-1(g), 1.987-9,
and 1.987-10(k). The likely respondents are individuals who file a Form
1040 and businesses that file a Form 1065, 1066, or 1120. Additionally,
there is a possibility that a trust or estate that files a Form 1041
could be affected by the requirements of the proposed regulations. The
IRS anticipates that the total number of
[[Page 78157]]
respondents could be 500,\8\ and that less than 1% of the total
respondents would be a trust or estate filer.
---------------------------------------------------------------------------
\8\ The estimated number of respondents is based on the number
of taxpayers who filed a Form 8858 in 2021 that showed that the
filer: (1) owned at least one disregarded entity or branch with a
functional currency different from the functional currency of the
owner, and (2) indicated that the disregarded entity was a section
989 QBU. Although these estimates are likely to increase once these
proposed regulations are effective, the Treasury Department and the
IRS do not have data that would allow for an accurate estimate of
these increases.
---------------------------------------------------------------------------
The collection of information provided by proposed Sec. 1.987-1(g)
is required only when a taxpayer makes or revokes certain elections for
purposes of calculating its section 987 taxable income or loss and
section 987 gain or loss with respect to a section 987 QBU. In the
first year to which the section 987 regulations apply to the taxpayer,
or the taxpayer or a member of its consolidated group or section 987
electing group is the owner of a section 987 QBU, the taxpayer may make
any section 987 election. Thereafter, the taxpayer may make or revoke a
current rate election or annual recognition election only every five
years and may make or revoke other elections only with the consent of
the Commissioner, which may be granted with a private letter ruling.
When a taxpayer makes or revokes an election, the collection of
information is mandatory. The collection of information required by
proposed Sec. 1.987-1(g) will be used by the IRS for tax compliance
purposes.
Proposed Sec. 1.987-9 is intended to specify how a taxpayer
satisfies its recordkeeping obligations under section 6001 with respect
to section 987. The recordkeeping requirements under proposed Sec.
1.987-9 are considered general tax records under Sec. 1.6001-1(e). For
Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (``PRA'') purposes,
general tax records are already approved by OMB under 1545-0074 for
individuals and under 1545-0123 for business entities, and will be
approved under 1545-NEW for trust and estate filers. The IRS intends
that the information collection requirements pursuant to proposed Sec.
1.987-9 will be satisfied by the taxpayer maintaining permanent books
and records that are adequate to verify its section 987 gain or loss
and section 987 taxable income or loss with respect to its section 987
QBU. Specifically, with respect to each section 987 QBU, successor
deferral QBU, and successor suspended loss QBU for a taxable year, as
applicable, proposed Sec. 1.987-9 requires taxpayers to maintain books
and records related to the amount of the items of income, gain,
deduction, or loss attributed to the section 987 QBU in the functional
currency of the section 987 QBU and its owner; the adjusted balance
sheet of the section 987 QBU in the functional currency of the section
987 QBU and its owner; the exchange rates used to translate items of
income, gain, deduction, or loss of the section 987 QBU into the
owner's functional currency and, if a spot rate convention is used, the
manner in which the convention is determined; the exchange rates used
to translate the assets and liabilities of the section 987 QBU into the
owner's functional currency and, if a spot rate convention is used, the
manner in which the convention is determined; the amount of assets and
liabilities transferred by the section 987 QBU to the owner determined
in the functional currency of the owner; the amount of the unrecognized
section 987 gain or loss for the taxable year; the amount of the net
accumulated unrecognized section 987 gain or loss at the close of the
taxable year; the amount of a remittance and the remittance proportion
for the taxable year; the computations required under proposed
Sec. Sec. 1.861-9(g) and 1.861-9T(g) for purposes of sourcing and
characterizing section 987 gain or loss, deferred section 987 gain or
loss, or suspended section 987 loss under proposed Sec. 1.987-6; the
cumulative suspended section 987 loss in each recognition grouping; the
outstanding deferred section 987 gain or loss in each recognition
grouping; and the transition information required to be determined
under proposed Sec. 1.987-10(k). These records are required for the
IRS to validate that section 987 gain or loss and section 987 taxable
income or loss have been properly determined.
The collection of information in proposed Sec. 1.987-10(k) is
mandatory. Specifically, proposed Sec. 1.987-10(k) would require a
taxpayer to file a ``Section 987 Transition Information'' statement
with its return for the taxable year beginning on the transition date
(as defined in proposed Sec. 1.987-10(c)). The statement would contain
information that is necessary for a taxpayer to transition to the
proposed section 987 regulations. Specifically, the statement requires
a taxpayer to provide information that is relevant to determining the
taxpayer's pretransition gain or loss with respect to its section 987
QBUs. The collection of information required by proposed Sec. 1.987-
10(k) will be used by the IRS for tax compliance purposes.
The IRS intends that the information described in proposed Sec.
1.987-1(g) will be collected by attaching a statement to a taxpayer's
return (such as the appropriate Form 1040, Form 1120, Form 1065, or
other appropriate form). With respect to proposed Sec. 1.987-10(k),
the IRS also intends that the collection of information will be
conducted by attaching a ``Section 987 Transition Information''
statement to a return. For purposes of the PRA, the reporting burden
associated with those collections of information with respect to
proposed Sec. Sec. 1.987-1(g) and 1.987-10(k) will be reflected in the
Paperwork Reduction Act Submissions associated with those forms. The
OMB Control Numbers for the forms will be approved under 1545-0074 for
individuals, under 1545-0123 for business entities, and under 1545-NEW
for trust and estate filers.
To the extent that a taxpayer makes or revokes an election by
obtaining a private letter ruling, the reporting burden associated with
those collections of information will be reflected in the Paperwork
Reduction Act Submissions associated with Revenue Procedure 2023-1, IRB
2023-1 (or future revenue procedures governing private letter rulings).
The OMB Control Number for the collection of information for Revenue
Procedure 2023-1 is control number 1545-1522. The proposed regulation
would only require taxpayers to follow the procedures under Revenue
Procedure 2023-1 (or future revenue procedure governing private letter
rulings) and would not change the collection requirements of the
Revenue Procedure.
The attachment to a return used for making elections with respect
to these proposed regulations will be used by those taxpayers making or
revoking an election for the taxable year. The ``Section 987 Transition
Information'' statement attached to a return will be used by all
taxpayers, but generally only with respect to the taxable year in which
the taxpayer transitions to these proposed regulations. In certain
cases, if the taxpayer owns a QBU that terminates after November 9,
2023 and before the taxable year in which the taxpayer transitions to
the proposed regulations, the ``Section 987 Transition Information''
statement must be filed for that taxable year too, but the statement
would only contain information with respect to the terminating QBU. The
Treasury Department and the IRS request comments on all aspects of
information collection burdens related to these proposed regulations.
If the IRS releases a form for the purposes of collecting this
information, drafts of IRS forms will be posted for comment at <a href="https://www.irs.gov/draftforms">https://www.irs.gov/draftforms</a>.
The burden will be accounted for in 1545-0074 for individuals and
in 1545-0123 for businesses. The IRS is requesting a new OMB control
number
[[Page 78158]]
to account for trust and estate filers' burden, as reflected below.
A summary of paperwork burden estimates for the elections as
provided in proposed Sec. 1.987-1(g) is as follows:
Estimated number of respondents: 5.
Estimated burden per response: 1.95 hours.
Estimated frequency of response: 1 for the first year in which a
taxpayer applies these regulations. After the first year, the current
rate election and the annual recognition election can generally be
changed only once every five years and other elections can be changed
with the consent of the Commissioner.
Estimated total burden hours: 9.75 burden hours.
A summary of paperwork burden estimates for the ``section 987
transition information'' statement as provided in proposed Sec. 1.987-
10(k) is as follows:
Estimated number of respondents: 5.
Estimated burden per response: 1.95 hours.
Estimated frequency of response: 1 for the initial transition year.
Estimated total burden hours: 9.75 burden hours.
The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act. Commenters
are strongly encouraged to submit public comments electronically.
Written comments and recommendations for the proposed information
collection should be sent to <a href="http://www.reginfo.gov/public/do/PRAMain">www.reginfo.gov/public/do/PRAMain</a>, with
copies to the Internal Revenue Service. Find this particular
information collection by selecting ``Currently under Review--Open for
Public Comments'' then by using the search function. Submit electronic
submissions for the proposed information collection to the IRS via
email at <a href="/cdn-cgi/l/email-protection#1c6c6e7d327f7371717972686f5c756e6f327b736a"><span class="__cf_email__" data-cfemail="7b0b091a55181416161e150f083b120908551c140d">[email protected]</span></a> (indicate REG-132422-17 on the subject
line). Comments on the collection of information should be received by
February 12, 2024.
Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the duties of the IRS, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information (including underlying assumptions and
methodology);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchases of services to provide information.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
III. Regulatory Flexibility Act
Generally, the proposed regulations affect U.S. corporations that
have foreign operations. The number of small entities potentially
affected by the proposed regulations is unknown; however, it is
unlikely to be a substantial number because taxpayers with foreign
operations are typically larger businesses. In accordance with the
Regulatory Flexibility Act (5 U.S.C. 601 et seq.) the Secretary hereby
certifies that these proposed regulations will not have a significant
economic impact on a substantial number of small entities.
IV. Section 7805(f)
Pursuant to section 7805(f), this proposed regulation will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
V. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a State,
local, or Tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. The proposed regulations do not include any Federal mandate
that may result in expenditures by State, local, or Tribal governments,
or by the private sector in excess of that threshold.
VI. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on State and local
governments, and is not required by statute, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. The proposed regulations do not have
federalism implications and do not impose substantial direct compliance
costs on State and local governments or preempt State law within the
meaning of the Executive order.
Comments and Request for Public Hearing
Before these proposed amendments to the final regulations are
adopted as final regulations, consideration will be given to comments
that are submitted timely to the IRS as prescribed in this preamble
under the ADDRESSES heading. The Treasury Department and the IRS
request comments on all aspects of the proposed regulations. Any
comments submitted will be made available at <a href="https://www.regulations.gov">https://www.regulations.gov</a> or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits written comments. Requests for a public
hearing are also encouraged to be made electronically. If a public
hearing is scheduled, notice of the date and time for the public
hearing will be published in the Federal Register.
Drafting Information
The principal authors of the proposed regulations are Raphael J.
Cohen, D. Peter Merkel, Jack Zhou, and Azeka J. Abramoff of the Office
of Associate Chief Counsel (International); and Jeremy Aron-Dine and
Julie Wang of the Office of Associate Chief Counsel (Corporate).
However, other personnel from the Treasury Department and the IRS
participated in their development.
Statement of Availability of IRS Documents
IRS Revenue Procedures, Revenue Rulings, Notices, and other
guidance cited in this document are published in the Internal Revenue
Bulletin or Cumulative Bulletin and are available from the
Superintendent of Documents, U.S. Government Publishing Office,
Washington, DC 20402, or by visiting the IRS website at <a href="https://www.irs.gov">https://www.irs.gov</a>.
Partial Withdrawal of Proposed Regulations
Under the authority of 26 U.S.C. 7805, proposed Sec. Sec. 1.987-
1(g)(2)(i)(B) and (C) and (g)(3)(i)(G) and (H), 1.987-3(d), 1.987-7,
and 1.987-8, contained in the
[[Page 78159]]
notice of proposed rulemaking that was published in the Federal
Register on December 8, 2016 (81 FR 88882) is withdrawn.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, the Treasury Department and the IRS propose to amend
26 CFR part 1 as follows:
PART 1--INCOME TAXES
0
1. The authority citation for part 1 is amended by:
0
a. Removing the entry for Sec. Sec. 1.861-9 and 1.861-9T and
Sec. Sec. 1.861-8T through 1.861-14T;
0
b. Adding entries for Sec. Sec. 1.861-8T, 1.861-9, 1.861-9T, 1.861-
10T, 1.861-11T, 1.861-12T, 1.861-13T, and 1.861-14T in numerical order;
0
c. Removing the entry for Sec. Sec. 1.985-0 through 1.985-5;
0
d. Adding entries for Sec. Sec. 1.985-0 through 1.985-5 in numerical
order;
0
e. Removing the entry for Sec. Sec. 1.987-1 through 1.987-5;
0
f. Adding entries for Sec. Sec. 1.987-1 through 1.987-6, 1.987-7A,
1.987-7B, 1.987-7C, and 1.987-8 through 1.987-11 in numerical order;
0
g. Revising the entry for Sec. 1.987-12;
0
h. Adding entries for Sec. Sec. 1.987-13 and 1.987-14 in numerical
order;
0
i. Removing the entry for Sec. Sec. 1.988-0 through 1.988-5;
0
j. Adding entries for Sec. Sec. 1.988-0 through 1.988-5 and 1.989(a)-1
in numerical order.
0
k. Revising the entry for Sec. 1.1502-13.
The revisions and additions read as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Section 1.861-8T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
Section 1.861-9 also issued under 26 U.S.C. 861, 863(a), 864(e),
864(e)(7), 865(i), 987, and 989(c), and 7701(f).
Section 1.861-9T also issued under 26 U.S.C. 861, 863(a),
864(e), 864(e)(7), 865(i), and 7701(f).
* * * * *
Section 1.861-10T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
* * * * *
Section 1.861-11T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
* * * * *
Section 1.861-12T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
* * * * *
Section 1.861-13T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
* * * * *
Section 1.861-14T also issued under 26 U.S.C. 863(a), 864(e),
865(i), and 7701(f).
* * * * *
Section 1.985-0 also issued under 26 U.S.C. 985.
Section 1.985-1 also issued under 26 U.S.C. 985.
Section 1.985-2 also issued under 26 U.S.C. 985.
Section 1.985-3 also issued under 26 U.S.C. 985.
Section 1.985-4 also issued under 26 U.S.C. 985.
Section 1.985-5 also issued under 26 U.S.C. 985, 987, and
989(c).
* * * * *
Section 1.987-1 also issued under 26 U.S.C. 987, 989(c), and
1502.
Section 1.987-2 also issued under 26 U.S.C. 987, 989(c), and
1502.
Section 1.987-3 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-4 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-5 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-6 also issued under 26 U.S.C. 904, 987, and
989(c).
Section 1.987-7A also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-7B also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-7C also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-8 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-9 also issued under 26 U.S.C. 987, 989(c), and
6001.
Section 1.987-10 also issued under 26 U.S.C. 987, 989(c), and
6001.
Section 1.987-11 also issued under 26 U.S.C. 987, 989(c), and
1502.
Section 1.987-12 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-13 also issued under 26 U.S.C. 987 and 989(c).
Section 1.987-14 also issued under 26 U.S.C. 987 and 989(c).
Section 1.988-0 also issued under 26 U.S.C. 988.
Section 1.988-1 also issued under 26 U.S.C. 988 and 989(c).
Section 1.988-2 also issued under 26 U.S.C. 988.
Section 1.988-3 also issued under 26 U.S.C. 988.
Section 1.988-4 also issued under 26 U.S.C. 988 and 989(c).
Section 1.988-5 also issued under 26 U.S.C. 988.
* * * * *
Section 1.989(a)-1 also issued under 26 U.S.C. 989 and 989(c).
* * * * *
Section 1.1502-13 also issued under 26 U.S.C. 250(c), 987,
989(c), and 1502.
* * * * *
0
2. Section 1.861-9 is amended by:
0
a. Revising paragraphs (g)(2)(ii)(A) introductory text,
(g)(2)(ii)(A)(1), and (g)(2)(ii)(B).
0
b. Adding paragraph (g)(2)(v).
The revisions and addition read as follows:
Sec. 1.861-9 Allocation and apportionment of interest expense and
rules for asset-based apportionment.
* * * * *
(g) * * *
(2) * * *
(ii) * * *
(A) Tax book value method. In the case of taxpayers using the tax
book value method of apportionment, the following rules apply to
determine the value of the assets of a qualified business unit (as
defined in section 989(a)) of a domestic corporation with a functional
currency other than the dollar.
(1) Section 987 QBU. In the case of a section 987 QBU (as defined
in Sec. 1.987-1(b)(3)), the tax book value is determined by applying
the rules of paragraph (g)(2)(i) of this section and Sec. 1.861-
9T(g)(3) to the beginning-of-year and end-of-year owner functional
currency amount of assets. The beginning-of-year owner functional
currency amount of assets is determined by reference to the owner
functional currency amount of assets computed under Sec. 1.987-
4(d)(1)(i)(B) and (e) on the last day of the preceding taxable year.
The end-of-year owner functional currency amount of assets is
determined by reference to the owner functional currency amount of
assets computed under Sec. 1.987-4(d)(1)(i)(A) and (e) on the last day
of the current taxable year. The beginning-of-year and end-of-year
owner functional currency amount of assets, as so determined within
each grouping, are then averaged as provided in paragraph (g)(2)(i) of
this section.
* * * * *
(B) Fair market value method. In the case of taxpayers using the
fair market
[…truncated; see source link]Indexed from Federal Register on November 14, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.