Rule2024-28372
Taxable Income or Loss 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
December 11, 2024
Effective
December 10, 2024
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains final regulations relating to the determination of taxable income or loss and foreign currency gain or loss with respect to a qualified business unit. These final 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 89, Number 238 (Wednesday, December 11, 2024)]
[Rules and Regulations]
[Pages 100138-100226]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-28372]
[[Page 100137]]
Vol. 89
Wednesday,
No. 238
December 11, 2024
Part IV
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Taxable Income or Loss and Currency Gain or Loss With Respect to a
Qualified Business Unit; Final Rule
Federal Register / Vol. 89 , No. 238 / Wednesday, December 11, 2024 /
Rules and Regulations
[[Page 100138]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 10016]
RIN 1545-BO07
Taxable Income or Loss and Currency Gain or Loss With Respect to
a Qualified Business Unit
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final rule.
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SUMMARY: This document contains final regulations relating to the
determination of taxable income or loss and foreign currency gain or
loss with respect to a qualified business unit. These final 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: Effective date: The final regulations are effective December 10,
2024.
Applicability dates: For dates of applicability, see Sec. 1.987-
15.
FOR FURTHER INFORMATION CONTACT: Concerning the final regulations
generally, Adam G. Province at (865) 329-4546; concerning the character
and source of section 987 gain or loss, Larry Pounders at (202) 317-
5465; concerning consolidated groups, Jeremy Aron-Dine at (202) 317-
6847 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Authority
This document contains additions and amendments to 26 CFR part 1
(Income Tax Regulations) addressing the application of section 987 of
the Internal Revenue Code (Code) and related provisions (the ``final
regulations''). The additions and amendments are issued under sections
987, 989, and 1502, pursuant to the express delegations of authority
provided under those sections. The express delegations relied upon are
referenced in the Background section of this preamble and in the
Summary of Comments and Explanation of Revisions describing the
individual sections of the final regulations. The final regulations are
also issued under the express delegation of authority under section
7805 of the Code.
Background
This document contains final regulations under section 987 of the
Code and related provisions under sections 861, 985 through 989, and
1502 of the 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.
Sections 987 and 989 provide several explicit grants of regulatory
authority. Section 987(3) directs the Secretary to prescribe the proper
adjustments needed to determine the taxable income of the owner of a
section 987 QBU. Those adjustments include (but are not limited to)
rules for sourcing section 987 gain or loss recognized under section
987(3)(B). Similarly, section 987(2) provides that the income of a QBU
is translated at the ``appropriate'' exchange rate. Section 989(b)(4)
provides that the appropriate exchange rate generally is the average
rate for the taxable year, ``except as provided in regulations.''
Section 989(c) directs the Secretary to ``prescribe such
regulations as may be necessary or appropriate to carry out the
purposes of this subpart.'' \1\ The grant of authority in section
989(c) includes regulations limiting the recognition of foreign
currency loss on certain remittances from QBUs, providing for the
appropriate treatment of related party transactions (including
transactions between QBUs of the same taxpayer), and setting forth
procedures for determining the average exchange rate for any period.
Section 989(c)(2), (5), and (6).
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\1\ The reference to ``this subpart'' refers to subpart J of
part III of subchapter N of chapter 1 of the Code, which includes
section 987.
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On December 8, 2016, the Department of the Treasury (``Treasury
Department'') and the Internal Revenue Service (``IRS'') published
Treasury Decision 9794, which contained final regulations under
sections 861, 985, 987, 988, and 989 (the ``2016 final regulations''),
in the Federal Register (81 FR 88806). The same day, the Treasury
Department and the IRS published Treasury Decision 9795, which
contained temporary regulations under sections 987 and 988 (the ``2016
temporary regulations''), in the Federal Register (81 FR 88854) and
published a notice of proposed rulemaking (REG-128276-12, 81 FR 88882)
(the ``2016 proposed regulations'') in the Federal Register by cross-
reference to the temporary regulations. On May 13, 2019, the Treasury
Department and the IRS published Treasury Decision 9857, which
contained final regulations under section 987 (the ``2019 final
regulations''), in the Federal Register (84 FR 20790).
On November 14, 2023, the Treasury Department and the IRS published
proposed regulations (REG-132422-17) under sections 861, 985, 987, 988,
989, and 1502 of the Code (the ``2023 proposed regulations'') in the
Federal Register (88 FR 78134). The same day, the Treasury Department
and the IRS also published a notice in the Federal Register (88 FR
77921) that reopened the comment period for the 2016 proposed
regulations.
All written comments received in response to the 2016 proposed
regulations and the 2023 proposed regulations are available at <a href="https://www.regulations.gov">https://www.regulations.gov</a> or upon request. A public hearing on the 2023
proposed regulations was not held because there were no requests to
speak.
Concurrently with the publication of the final regulations, the
Treasury Department and the IRS are publishing in the proposed rule
section of this edition of the Federal Register (RIN 1545-BR37) a
notice of proposed rulemaking providing additional proposed regulations
under section 987 (REG-117213-24) (the ``2024 proposed regulations'').
Summary of Comments and Explanation of Revisions
I. Overview
The Treasury Department and the IRS received a number of written
comments in response to the 2016 proposed regulations and the 2023
proposed regulations. The comments, and the revisions made in response
to those comments, are summarized in this Summary of Comments and
Explanation of Revisions.
The final regulations retain the basic approach and structure of
the 2023 proposed regulations, with the revisions described in this
Summary of Comments and Explanation of Revisions.
II. Comments and Changes to Proposed Sec. 1.987-1: Scope, Definitions,
and Special Rules
Proposed Sec. 1.987-1 would provide rules regarding the scope of
the
[[Page 100139]]
regulations under section 987 (``section 987 regulations''), including
which entities are subject to the regulations, rules relating to
elections under section 987, and other rules.
A. Scope
Under proposed Sec. 1.987-1(b)(1), the section 987 regulations
would apply to all taxpayers, subject to a de minimis rule for pass-
through entities with minimal U.S. ownership, but they would not apply
to foreign individuals or foreign corporations that either are not
controlled foreign corporations (``CFCs'') or are CFCs in which no
United States shareholders (``U.S. shareholders'') own (within the
meaning of section 958(a)) stock. In contrast to the 2016 final
regulations, the 2023 proposed regulations would not provide an
exception for banks, insurance companies, leasing companies, finance
coordination centers, regulated investment companies, or real estate
investment trusts (``specified entities''). The preamble to the 2023
proposed regulations explains that the current rate election and annual
recognition election are expected to provide additional flexibility for
specified entities to apply the section 987 regulations. 88 FR 78145.
Taxpayers that make a current rate election would treat all assets and
liabilities attributable to a section 987 QBU as marked items, and thus
would not be required to track historic exchange rates. Taxpayers that
make an annual recognition election would recognize all unrecognized
section 987 gain or loss on an annual basis and would not be required
to calculate the amount of a remittance with respect to a section 987
QBU under Sec. 1.987-5. See parts II and IV of the Explanation of
Provisions in the preamble to the 2023 proposed regulations. 88 FR
78138 through 78139, 78141 through 78143. In addition, including
specified entities in the scope of the section 987 regulations is
necessary to provide these entities with sufficient guidance under
section 987 and to provide a consistent set of rules applicable to all
taxpayers.
1. Specified Entities
Comments recommended that specified entities be excluded from the
application of the section 987 regulations. The comments asserted that
additional rules are needed to facilitate the application of the
section 987 regulations to these entities. For example, according to
the comments, it is unclear whether insurance reserves should be
treated as marked items or historic items. A comment also noted that
bank branches often engage in high volumes of intercompany transactions
that could be difficult to account for under the section 987
regulations.
The Treasury Department and the IRS have determined that the final
regulations can be applied by specified entities in an administrable
manner and that excluding specified entities from the scope of the
section 987 regulations would not provide sufficient guidance to ensure
that these entities are using an appropriate method to apply section
987. Moreover, section 987 and its legislative history give no
indication that Congress intended for banks, insurance companies, and
other specified entities to be treated differently from other taxpayers
for this purpose. Accordingly, specified entities are subject to the
final regulations. However, the final regulations contain modifications
intended to facilitate application of the section 987 regulations to
these entities. See parts II.B (rules relating to insurance companies),
V.B (hedging transactions), and VI (modifications to annual remittance
rules to reduce the burden of tracking disregarded transfers) of this
Summary of Comments and Explanation of Revisions.
2. Partnerships and Certain Other Entities
One comment was received relating to the application of section 987
to partnerships, and the Treasury Department and the IRS continue to
study this issue. The Treasury Department and the IRS have determined
that, without additional guidance, the section 987 regulations in their
entirety could not be applied to partnerships in an administrable way.
Accordingly, the final regulations generally apply only with respect to
corporations and individuals. However, as discussed in part VIII of
this Summary of Comments and Explanation of Revisions, certain parts of
the section 987 regulations (including the rules relating to suspension
of section 987 loss and recognition of suspended section 987 loss) are
applicable to partnerships and S corporations.
The section 987 regulations do not apply to trusts or estates
(though trusts and estates can be subject to section 987) because
additional guidance may be needed to apply section 987 to these
entities. In particular, the Treasury Department and the IRS are
studying whether specific rules are needed to address the apportionment
of section 987 gain or loss between the estate or non-grantor trust and
the beneficiaries or whether existing rules under section 643(a)
(defining distributable net income of an estate or trust) sufficiently
address this issue. In addition, specific rules may be needed to
address a beneficiary's application of section 987 with respect to an
estate or non-grantor trust that uses a different functional currency
(which creates a separate layer of currency exposure). The Treasury
Department and the IRS anticipate providing rules applicable to trusts
and estates in future guidance.
3. Application to CFCs
The final regulations apply to individuals and corporations that
are United States persons (``U.S. persons'') and to CFCs in which U.S.
shareholders own stock (directly or indirectly within the meaning of
section 958(a)). See Sec. 1.987-1(b)(1). As explained in parts II.A.2
and VIII of this Summary of Comments and Explanation of Revisions, the
Treasury Department and the IRS are continuing to study the appropriate
rules for applying section 987 to partnerships.
A comment recommended that the scope of the section 987 regulations
be limited to section 987 QBUs owned directly by U.S. persons or by
partnerships with partners that are U.S. persons. According to the
comment, this would reduce the compliance burden on taxpayers and
prevent the selective recognition of section 987 losses. The comment
further asserted that, based on the legislative history of section
987(3), the statute primarily was intended to address section 987 QBUs
owned by U.S. persons.
The comment suggested that simplified mechanics under section
986(c) could be used to account for currency gain or loss arising
between the time earnings are generated by a section 987 QBU and the
time of distribution, but the comment did not explain how those
mechanics would operate. Section 986(c) requires a U.S. shareholder to
recognize foreign currency gain or loss with respect to distributions
of previously taxed earnings and profits attributable to movements in
exchange rates between the date of the income inclusion giving rise to
the previously taxed earnings and profits and the distribution of the
previously taxed earnings and profits.
The final regulations do not adopt the recommendations made by the
comment. It is necessary to apply section 987(1) and (2) to foreign
entities because many aspects of the income tax rules effectively
require that the determination of a taxpayer's items of income, gain,
deduction, and loss be made in a single currency. In addition, it is
not clear how a rule similar to section 986(c) could be applied to
section 987 QBUs in lieu of section 987(3). Because a CFC's earnings
and
[[Page 100140]]
profits are determined in the CFC's functional currency under section
986(b), currency gain or loss on previously taxed earnings and profits
arises under section 986(c) when a CFC's functional currency
appreciates or depreciates against the U.S. dollar between the time the
inclusion is computed and the time the CFC distributes the previously
taxed earnings and profits. However, section 986(c) would not account
for changes in value of a section 987 QBU's functional currency
(measured against the functional currency of its CFC-owner or the U.S.
shareholder) because earnings and profits are not tracked in the
section 987 QBU's functional currency.
However, the Treasury Department and the IRS are studying whether
there are instances in which it would be possible to simplify the
application of section 987 by modifying the application of section
987(3) (and the related regulations, including Sec. Sec. 1.987-4
through 1.987-6, 1.987-8, and 1.987-11 through 1.987-13) to certain
entities. See part II.B of the Comments and Request for Public Hearing
section in the preamble to the 2024 proposed regulations.
B. Special Rules for Insurance Companies
1. Insurance Reserves
A comment requested clarification as to whether insurance reserves
are treated as marked items. The comment noted that the definition of a
marked item under the proposed regulations is tied to the treatment of
an asset or liability under section 988 and that the application of
section 988 to insurance reserves is not clear. The Treasury Department
and the IRS agree that treating insurance reserves as marked items
would facilitate the application of section 987 to insurance companies
and would be consistent with the treatment of liabilities outside the
insurance context. Accordingly, Sec. 1.987-1(d)(1)(iv) includes
insurance reserves in the definition of marked items.
2. Assets That Support Variable Contracts
a. Background on Variable Contracts
In general, variable contracts are life insurance and annuity
contracts under which the amount of the insurance company's obligation
depends, at least in part, on the value of the assets held in a
separate account that is segregated from the general asset accounts of
the insurance company. Provided certain requirements are met, under
section 817(c), an insurance company that issues variable contracts (as
defined in section 817(d)) must separately account for the various
income, exclusion, deduction, asset, reserve, and other liability items
properly attributable to such variable contracts.
As a general matter, section 807 provides that increases in the
life insurance reserves of a life insurance company are deductible and
decreases in the life insurance reserves are includible in income.
However, section 817(a) provides that for purposes of determining the
net decrease or increase in reserves under section 807(a) or (b),
amounts subtracted from or added to separate account reserves by reason
of the depreciation or appreciation of separate account assets (whether
or not realized) are disregarded. Under section 817(a), deductions for
items described in section 805(a)(1) and (6), which include claims and
benefits accrued and losses incurred during the taxable year on
insurance and annuity contracts, are similarly adjusted for the
depreciation or appreciation of separate account assets. Additionally,
section 817(b) provides that the basis of each separate account asset
is decreased by the amount of depreciation, or increased by the amount
of appreciation, of separate account assets (whether or not realized),
to the extent separate account reserves are adjusted for such
depreciation or appreciation under section 817(a). Generally, the
result is a permanent elimination of any effects on company-level
taxable income that would otherwise result from the change in the value
of the separate account assets.
Sometimes, however, an insurance company may provide guarantees
with respect to variable contracts with separate accounts that could
require reserves to be held in a company's general account. Section
817(d)(3) recognizes this situation and states that ``obligations under
such guarantee which exceed obligations under the contract without
regard to such guarantee shall be accounted for as part of the
company's general account.'' Such guarantees might involve a limit on
losses or guarantees of minimum crediting rates. These amounts are not
liabilities of the separate account.
Similarly, CFCs generally must follow the Code and subchapter L
rules in determining their insurance income, with minor modifications
for determining: (i) whether a contract is a life insurance or annuity
contract, and (ii) the amount of insurance reserves. For example, U.S.
tax requirements in sections 72(s), 101(f), 817(h), and 7702 do not
apply so long as no policyholder, annuitant, insured, or beneficiary
under the contract is a United States person and the contract is
regulated as a life insurance or annuity contract in the issuer's home
country. In addition, section 954(i) modifies the subchapter L
computation of insurance reserves and its application to insurance
contracts issued by CFCs. See also section 953(b)(3).
b. Treatment of Assets That Support Variable Contracts for Purposes of
Section 987
A comment recommended that assets which support variable annuity
and life insurance contracts be treated as marked items. The comment
explained that these assets are required by law to be segregated from
the general asset accounts of the insurance company in a separate
account, and the related contracts reflect the investment return and
market value of the separate account assets.
The comment asserted that both the separate account assets and the
related insurance reserves should be treated as marked items in order
to align the treatment of these assets and liabilities for purposes of
section 987. Similarly, the comment recommended that these assets and
liabilities should be treated as attributable to an eligible QBU if
they are reflected on the books and records of the eligible QBU, even
if they would otherwise be excluded under Sec. 1.987-2(b)(2) (for
example, if the separate account assets consist of stock or partnership
interests).
The final regulations provide that separate account assets are
treated as marked items. See Sec. 1.987-1(d)(1)(v). In addition, the
final regulations carve out separate account assets from the exclusions
in Sec. 1.987-2(b)(2), so that separate account assets reflected on
the books and records of an eligible QBU generally will be attributable
to the eligible QBU. See Sec. 1.987-2(b)(2)(ii). These rules are
expected to facilitate matching treatment of separate account assets
and the related insurance contracts, consistent with the treatment of
these items for statutory and financial accounting purposes and the
nature of the issuer's economic obligations.
The final regulations define a separate account asset as an asset
that is reflected on the books and records of an eligible QBU and is
held in a separate account with respect to a separate account insurance
contract. See Sec. 1.987-1(h). A separate account insurance contract
generally is defined as a contract that would be treated as an
insurance contract for Federal income tax purposes for which the assets
supporting the insurance reserves are required to be held in a separate
account under the local insurance regulatory rules. In addition, the
contract generally
[[Page 100141]]
must qualify as a variable contract under section 817(d). However, if
the contract does not qualify as a variable contract under section
817(d) solely because it fails to meet one or more of the requirements
in section 72(s), 101(f), 817(h), or 7702, the contract will be treated
as a separate account insurance contract if it is regulated as a life
insurance or annuity contract under foreign law, the contract reserves
are computed or estimated on the basis of recognized mortality or
morbidity tables and assumed rates of interest (treating the reflection
of the investment return and the market value of assets in the separate
account as an assumed rate of interest), and no policyholder,
annuitant, insured, or beneficiary under the contract is a United
States person. These requirements are consistent with the requirements
for life insurance or annuity contracts issued by CFCs.
3. Assets of an Insurance Company That Produce Financial Services
Income
A comment recommended that assets of an insurance company that
produce financial services income (within the meaning of section
904(d)(2)(D)(ii)(II) and (III)) should be treated as marked items. The
comment asserted that the assets insurance companies hold to support
insurance obligations are closely matched to those obligations and that
concerns related to the selective recognition of large noneconomic
losses under section 987 are not present for insurance companies.
The final regulations do not treat all assets that produce
financial services income as marked assets. As a result, those assets
are classified as marked or historic under the general rules of Sec.
1.987-1(d) or (e). The definition of a marked item under Sec. 1.987-
1(d)(1) is intended to identify those items of a section 987 QBU that
are directly exposed to changes in the value of a section 987 QBU's
functional currency. This definition is designed to ensure that, in the
absence of a current rate election, section 987 gain or loss recognized
by the owner of a section 987 QBU represents bona fide economic gain or
loss. To the extent that a section 987 QBU of an insurance company
holds assets that are not directly exposed to exchange rate
fluctuations (for example, publicly traded stock), and a current rate
election is not in effect, those assets are properly characterized as
historic items even if they generate financial services income.
4. Deferred Acquisition Costs
A comment recommended that the unamortized portion of specified
policy acquisition expenses (as defined in section 848) should be
treated as marked items. These specified policy acquisition expenses
are generally a specified portion of general deductions and represent
deferred acquisition costs. The comment noted that specified policy
acquisition expenses are akin to prepaid expenses and the amount and
timing of the related deductions are determined under insurance-
specific tax rules.
The final regulations do not treat the unamortized portion of
specified policy acquisition expenses as marked items. Although certain
prepaid expenses are treated as marked items under Sec. 1.987-
1(d)(1)(ii), that rule applies only to prepaid expenses with an
original term of one year or less. The preamble to the 2016 final
regulations explains that, because these prepaid expenses have a short
duration and often are small in amount, treating them as marked items
promotes administrability without creating significant distortions. 81
FR 88810. By contrast, specified policy acquisition expenses under
section 848 generally are amortized over a period of 15 years and can
be substantial in magnitude. Thus, if specified policy acquisition
expenses were treated as marked items, they could give rise to
significant amounts of non-economic section 987 gain or loss.
C. Elections
The 2023 proposed regulations would provide that a current rate
election or an annual recognition election may not be revoked without
consent for any taxable year beginning within 60 months of the first
day of the taxable year for which it was made. Proposed Sec. 1.987-
1(g)(3)(ii)(B). Once revoked, a new current rate election or annual
recognition election may not be made without consent for any taxable
year beginning within 60 months of the first day of the taxable year
for which it was revoked. Id.
A comment recommended that, during the first five years in which
the section 987 regulations are applicable, taxpayers should be allowed
to make or revoke a current rate election without waiting 60 months or
requesting consent. The comment noted that taxpayers may need more
flexibility to reassess their elections during this initial period
because they do not yet have sufficient information or experience
regarding the impact of making (or not making) a current rate election.
The final regulations retain the 60-month limitation for taxpayers
that make a current rate election or an annual recognition election and
apply a similar limitation for purposes of the section 988 mark-to-
market election (see part IV.C.1 of this Summary of Comments and
Explanation of Revisions). Permitting taxpayers to make or revoke
elections on a more frequent basis could increase the potential for
manipulation and abuse. However, taxpayers that wish to change their
elections without waiting 60 months can do so by requesting the
Commissioner's consent, and the Commissioner may consider the need for
additional flexibility on a case-by-case basis.
D. No Change in Method of Accounting
Proposed Sec. 1.987-1(g)(4) provides that elections under section
987 are not governed by the general rules concerning changes in methods
of accounting. In addition, the final regulations clarify that an
election under section 987 is not treated as a method of accounting for
purposes of section 446 or 481. See Sec. 1.987-1(g)(4). Similarly, the
final regulations provide that application of the transition rules
under Sec. 1.987-10 is not treated as a change in method of
accounting. See Sec. 1.987-10(k)(4). No inference is intended as to
whether a change in section 987 methodology is considered a change in
method of accounting before the final regulations become applicable (or
with respect to partnerships or other entities that are not generally
subject to the section 987 regulations).
III. Comments and Changes to Proposed Sec. 1.987-2: Attribution of
Items of an Eligible QBU, the Definition of a Transfer, and Related
Rules
Proposed Sec. 1.987-2 provides rules for attributing items to
eligible QBUs and rules relating to transfers of assets or liabilities
to or from eligible QBUs.
A. Attribution of Items to an Eligible QBU
Under the proposed regulations, items are attributable to an
eligible QBU to the extent they are reflected on the eligible QBU's
separate set of books and records. Proposed Sec. 1.987-2(b)(1). The
final regulations clarify that an item that is not taken into account
for financial accounting purposes is attributed to an eligible QBU to
the extent it would have been reflected on the eligible QBU's books and
records if it were taken into account for financial accounting purposes
(for example, amortization attributable to an item of intangible
property that is recognized and taken into account for tax purposes due
to a section 338 election, but is not recognized or taken into account
for financial reporting purposes). See Sec. 1.987-2(b)(1). Similarly,
in preparing
[[Page 100142]]
an adjusted balance sheet for a section 987 QBU, the owner must make
adjustments to reflect items that were not reflected on the section 987
QBU's books and records for the taxable year but should be so reflected
under United States tax accounting principles. See Sec. 1.987-1(h). No
inference should be drawn from this clarification with respect to other
similar rules that attribute items based on books and records including
under Sec. 1.904-4(f) (foreign branch category income) or Sec.
1.1503(d)-5(c) (income or dual consolidated loss of a separate unit).
B. Disregarded Transactions
Under proposed Sec. 1.987-2(c)(2)(i), an asset is treated as
transferred to a section 987 QBU from its owner if, as a result of a
disregarded transaction, the asset is reflected on the books and
records of (or attributable to) the section 987 QBU. Similarly, an
asset is treated as transferred from a section 987 QBU to its owner if,
as a result of a disregarded transaction, the asset ceases to be
reflected on (or attributable to) the books and records of the section
987 QBU. However, disregarded transactions do not give rise to items of
income, gain, deduction, or loss that are taken into account in
determining section 987 taxable income or loss under Sec. 1.987-3.
Proposed Sec. 1.987-2(c)(2)(iii).
A comment recommended that interbranch loans made by banks and
other regulated financial institutions should not be treated as
transfers for purposes of determining the amount of a remittance under
Sec. 1.987-5(c). The comment asserted that an interbranch loan is not
a permanent transfer because the borrower has an obligation to repay
the lender. Another comment requested that the final regulations
conform the treatment of disregarded transactions for purposes of
section 987 with the reattribution rules provided in Sec. 1.904-
4(f)(2)(vi). Under this approach, disregarded payments would result in
the reattribution of items of gross income between a section 987 QBU
and its owner and between separate 987 QBUs of the same owner, and they
would not be treated as transfers giving rise to the recognition of
section 987 gain or loss. The comment noted that, under proposed Sec.
1.987-2(c)(2), a disregarded payment for services or a sale of
inventory (including a payment from one section 987 QBU to a different
section 987 QBU with the same functional currency) could give rise to a
remittance even though there is no net economic transfer of value.
Further, because disregarded transactions do not give rise to section
987 taxable income or loss under proposed Sec. 1.987-2(c)(2)(iii), the
comment asserted that the amount of section 987 taxable income or loss
may be different from the amount of income that is economically
attributable to the section 987 QBU.
The final regulations retain the disregarded transaction rules of
proposed Sec. 1.987-2(c). See Sec. 1.987-2(c). These rules are needed
to properly account for the effect of a disregarded transaction on the
balance sheet of a section 987 QBU for purposes of determining the
owner's net unrecognized section 987 gain or loss under Sec. 1.987-4,
the amount of a remittance under Sec. 1.987-5(c), and to properly
determine the owner's basis in transferred assets under Sec. 1.987-
5(f).
In the case of a disregarded lending transaction in which a section
987 QBU lends money to its owner, although the owner remains obligated
to repay the borrowed funds, the disregarded loan is not an asset that
can be attributed to the QBU for tax purposes. Accordingly, for tax
purposes, the QBU-lender's balance sheet is diminished by the amount of
the loan in the same way as any other transfer from the QBU to its
owner. To the extent the loan is funded and repaid within the same
taxable year, the two transfers will offset in computing the remittance
amount under Sec. 1.987-5(c). However, when a disregarded loan spans
multiple taxable years, the owner must account for the effect of the
transaction on the net equity of the section 987 QBU (as regarded for
tax purposes).
In addition, the final regulations do not provide for reattribution
of gross income between a section 987 QBU and its owner or between
section 987 QBUs of the same owner for purposes of section 987. When a
section 987 QBU makes a disregarded payment to its owner, the payment
properly triggers the recognition of section 987 gain or loss because
the transferred asset has been withdrawn from the QBU and is no longer
accounted for in the section 987 QBU's functional currency. Even if the
transaction does not reduce the economic value of the section 987 QBU
on a net basis (for example, because the disregarded payment is made in
exchange for services of equal value), it nonetheless results in a net
withdrawal of asset basis from the functional currency environment of
the section 987 QBU and is therefore properly treated as a remittance
for purposes of section 987. Moreover, a rule determining the amount of
a remittance based on the value of property transferred from a section
987 QBU would be difficult to administer and prone to manipulation.
Similarly, because disregarded transactions do not give rise to
taxable income or loss under general tax principles, they are not taken
into account in determining section 987 taxable income or loss. See
Sec. 1.987-2(c)(2)(iii). Instead, the regarded income of an owner that
is properly reflected on the books and records of (or attributable to)
a section 987 QBU under Sec. 1.987-2(b) is determined in the
functional currency of the section 987 QBU and translated into the
owner's functional currency under the rules of Sec. 1.987-3.
Disregarded payments do not serve to reattribute gross income between a
section 987 QBU and its owner for purposes of determining section 987
taxable income or loss. Such a reattribution rule would add complexity
to the section 987 regulations (for example, when income is
reattributed in a taxable year following the taxable year in which the
disregarded payment is made), and it would not serve any necessary
function.
However, the final regulations contain targeted modifications that
are intended to reduce the compliance burden of accounting for certain
transfers between a section 987 QBU and its owner. See part VI of this
Summary of Comments and Explanation of Revisions (describing
modifications to the annual remittance rules to reduce the burden of
tracking and translating disregarded transfers). Additionally, if an
owner elects to group section 987 QBUs with the same functional
currency under Sec. 1.987-1(b)(3)(ii), transactions between the
section 987 QBUs will not be treated as transfers between the section
987 QBUs and their owner for purposes of section 987.
IV. Comments and Changes to Proposed Sec. 1.987-3: Determination of
Section 987 Taxable Income or Loss of an Owner of a Section 987 QBU
Proposed Sec. 1.987-3 would provide rules for determining taxable
income or loss of a section 987 QBU, including section 988 transactions
of a section 987 QBU. Additional rules relating to section 988
transactions would be provided in Sec. 1.987-3 of the 2016 proposed
regulations, for which the comment period was reopened in 2023.
A. Treatment of Section 988 Transactions Under the 2016 Proposed
Regulations
The 2016 proposed regulations provide that the determination of
whether a transaction is a section 988 transaction is made by reference
to the section 987 QBU's functional currency. Thus, a transaction
otherwise within the scope of section 988 that is denominated in a
functional currency other than the section 987 QBU's
[[Page 100143]]
functional currency generally would be treated as a section 988
transaction. See Sec. 1.987-3(b)(4)(i) of the 2016 proposed
regulations. However, section 988 transactions of a section 987 QBU
denominated in, or determined by reference to, the owner's functional
currency (``specified owner functional currency transactions'') would
not be 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 would further provide that section
988 gain or loss of a section 987 QBU generally is determined by
reference to the owner's functional currency. See Sec. 1.987-
3(b)(4)(i) of the 2016 proposed regulations. However, section 988 gain
or loss with respect to certain short-term section 988 transactions
(``qualified short-term section 988 transactions'') accounted for under
a mark-to-market method of accounting would be 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. The 2016 proposed regulations would provide an
election under which taxpayers can apply a mark-to-market method of
accounting with respect to all qualified short-term section 988
transactions. See Sec. 1.987-3(b)(4)(iii)(C) of the 2016 proposed
regulations.
Under the 2016 final regulations (and the 2023 proposed
regulations), a transaction denominated in a currency other than the
section 987 QBU's functional currency is treated as a historic item.
See Sec. 1.987-1(d) and (e). However, the 2016 proposed regulations
provide an exception under which 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 preamble to the 2023 proposed regulations requested comments as
to whether section 988 gain or loss on nonfunctional currency
transactions of a section 987 QBU (including specified owner functional
currency transactions) should be determined in the functional currency
of the section 987 QBU when a current rate election or annual
recognition election is in effect. 88 FR 78154. The preamble expressed
concern that, if such a rule were adopted, specified owner functional
currency transactions would give rise to offsetting positions in the
functional currency of the section 987 QBU; this could create
opportunities for taxpayers to recognize losses while deferring the
offsetting gains. Id. 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 unrecognized section 988 gain and the owner
would have an inverse amount of unrecognized section 987 loss. The
owner could cause the QBU to make a remittance triggering the
recognition of section 987 loss, while deferring the section 988 gain.
B. Comments on the 2023 Proposed Regulations Regarding Section 988
Transactions of Section 987 QBUs
Comments asserted that the section 988 rules of the 2016 proposed
regulations would impose a substantial compliance burden on taxpayers.
The comments noted that for financial accounting purposes, foreign
currency gain or loss on nonfunctional currency transactions of a QBU
is measured by reference to the functional currency of the QBU. In
addition, taxpayers typically hedge their exposure to nonfunctional
currency transactions of a QBU by reference to the QBU's functional
currency. One comment noted that it is common for section 987 QBUs of
insurance companies to hold assets denominated in U.S. dollars for
commercial reasons and that treating these assets as historic items
would increase the compliance burden on insurance companies.
Comments suggested that the rules of the 2016 proposed regulations
be modified to provide that: (i) section 988 gain or loss on
nonfunctional currency transactions of a section 987 QBU is determined
by reference to the functional currency of the section 987 QBU, (ii)
specified owner functional currency transactions are treated as section
988 transactions, and (iii) section 988 transactions of a section 987
QBU are treated as marked items. Alternatively, comments requested that
(if the default rules of the 2016 proposed regulations are retained)
taxpayers should be permitted to elect this modified treatment.
According to the comments, the recommended modifications would
achieve greater consistency with financial accounting standards and
would ease the compliance burden on taxpayers. One comment stated that
such an approach would also be more consistent with the statutory
requirement to determine a section 987 QBU's taxable income or loss in
the QBU's functional currency under sections 985 and 987. Comments
noted that the opportunity for selective recognition of losses is
limited to the extent the taxpayer makes a current rate election
(because section 987 losses will be subject to suspension) or an annual
recognition election (because section 987 gain or loss is recognized
annually without regard to whether a remittance is made). One comment
asserted that, even if neither of these elections is in effect, it is
difficult to selectively recognize material section 987 losses
attributable to section 988 transactions because the remittance
proportion under Sec. 1.987-5 is determined with respect to all the
assets of the section 987 QBU.
Other comments recommended providing an election under which
taxpayers could recognize section 988 gain or loss with respect to all
section 988 transactions of a section 987 QBU on a mark-to-market basis
(effectively expanding the special rule for qualified short-term
section 988 transactions to cover all section 988 transactions of a
QBU). For example, one comment requested mark-to-market timing for
section 988 transactions of a section 987 QBU that is subject to an
annual recognition election. According to this comment, because mark-
to-market timing would apply to both section 988 and section 987 gains
and losses on a current basis, the potential for abuse or selective
loss recognition would be limited. Another comment requested that the
definition of a qualified short-term section 988 transaction under
proposed Sec. 1.987-3(b)(4)(iii)(B) be expanded to include long-term
transactions that have been properly identified as a hedge for U.S. tax
purposes.
Finally, a comment recommended that, if the rules of the 2016
proposed regulations relating to section 988 transactions are retained
in the final regulations, the applicability date of the final
regulations should be deferred until taxable years beginning after
December 31, 2026, so that taxpayers have adequate time to update their
internal accounting systems.
C. Treatment of Section 988 Transactions Under the Final Regulations
1. Section 988 Mark-To-Market Election
The final regulations provide that a taxpayer may elect to
recognize section 988 gain or loss with respect to section 988
transactions of a section 987 QBU under a mark-to-market method of
accounting (a ``section 988 mark-to-market election''). See Sec.
1.987-3(b)(4)(ii). This election is expected to result in consistent
treatment of section 988 transactions for tax and financial reporting
purposes and to reduce the potential for selective recognition of
[[Page 100144]]
losses relating to these transactions, as indicated by the comments.
The section 988 mark-to-market election is subject to the same timing
and consistency requirements as a current rate election or an annual
recognition election. See Sec. 1.987-1(g).
The section 988 mark-to-market election does not apply to a section
988 transaction that is contributed to a section 987 QBU with a built-
in loss if the section 988 transaction was not subject to a mark-to-
market method of accounting in the hands of the transferor. See Sec.
1.987-3(b)(4)(ii)(B). This rule is intended to prevent taxpayers from
accelerating the recognition of section 988 loss by contributing a
section 988 transaction with a built-in loss to a section 987 QBU that
is subject to the section 988 mark-to-market election.
2. Treatment of Section 988 Transactions of a Section 987 QBU Under the
Final Regulations
The final regulations provide new rules for applying section 988
with respect to nonfunctional currency transactions of a section 987
QBU. In response to the comments summarized in part IV.B of this
Summary of Comments and Explanation of Revisions, the Treasury
Department and the IRS have determined that a different framework is
appropriate in order to reduce the compliance burden and complexity of
the section 987 regulations.
Under the final regulations, whether an asset or liability of a
section 987 QBU is a section 988 transaction is determined by reference
to the functional currency of the section 987 QBU (instead of the
owner's functional currency). See Sec. 1.987-3(b)(4)(i). The final
regulations further provide that section 988 gain or loss with respect
to section 988 transactions of a section 987 QBU (including
transactions denominated in the owner's functional currency) is
determined in the functional currency of the section 987 QBU, and
section 988 transactions are treated as marked items. See Sec. Sec.
1.987-1(d)(1)(iii) and 1.987-3(b)(4)(i). The final regulations do not
provide an exception for specified owner functional currency
transactions; thus, such transactions are treated as section 988
transactions of the section 987 QBU.
However, the final regulations provide an anti-abuse rule to
prevent taxpayers from entering into section 988 transactions through
an eligible QBU for the purpose of generating offsetting amounts of
gain and loss that can selectively be recognized or deferred. Under
Sec. 1.987-2(b)(3)(iv), section 988 transactions will not be treated
as attributable to an eligible QBU if they are entered into (or
reflected on the eligible QBU's books and records) with a principal
purpose of generating offsetting amounts of section 988 gain and
section 987 loss or offsetting amounts of section 988 loss and section
987 gain. Section 988 transactions also are subject to the general
anti-avoidance rules of Sec. 1.987-2(b)(3)(i) through (iii).
V. Comments and Changes to Proposed Sec. 1.987-4: Determination of Net
Unrecognized Section 987 Gain or Loss of a Section 987 QBU
Proposed Sec. 1.987-4 provides rules for computing net
unrecognized section 987 gain or loss with respect to a section 987
QBU. In particular, proposed Sec. 1.987-4(d) provides a ten-step
formula for computing unrecognized section 987 gain or loss for the
current taxable year. The first step of this formula is to compute the
change in owner functional currency net value (``OFCNV'') for the
taxable year. Proposed Sec. 1.987-4(d)(1). The other steps make
adjustments for changes to OFCNV that are not attributable to changes
in the exchange rate. Steps 2 through 5 relate to transfers of assets
and liabilities between a section 987 QBU and its owner, and steps 6
through 9 relate to income or loss of the section 987 QBU. Proposed
Sec. 1.987-4(d)(2) through (9). Step 10 is a residual adjustment for
any increase or decrease to the section 987 QBU's balance sheet that is
not otherwise accounted for. Proposed Sec. 1.987-4(d)(10). If a
current rate election is in effect, taxpayers are required to apply
only steps 1 through 5 and step 10.
Under proposed Sec. 1.987-4(e), OFCNV is determined by preparing a
tax basis balance sheet reflecting the section 987 QBU's assets and
liabilities. The basis of each asset and the amount of each liability
is then translated into the owner's functional currency at the
appropriate exchange rate. Under the default rules, marked items are
translated at the year-end spot rate, while historic items are
translated at the applicable historic rate. However, taxpayers that
make a current rate election under Sec. 1.987-1(d)(2) translate all
items on the year-end balance sheet at the year-end spot rate.
A. Mechanics for Calculating Unrecognized Section 987 Gain or Loss for
the Current Taxable Year
1. Earnings and Capital Method
The preamble to the 2023 proposed regulations notes that, under a
current rate election, the total amount of section 987 gain or loss
recognized by an owner with respect to a section 987 QBU would be
similar to the amount computed under the earnings and capital method,
which was described in proposed regulations published in the Federal
Register in 1991 (56 FR 48457, September 25, 1991) (the ``1991 proposed
regulations''). 88 FR 78138 through 78139. Under the earnings and
capital method, the owner of a section 987 QBU computes section 987
gain or loss by maintaining an equity pool in the QBU's functional
currency and a basis pool in the owner's functional currency. The
equity and basis pools are increased by income of the section 987 QBU
and contributions from the owner, and they are decreased by losses of
the section 987 QBU and distributions from the section 987 QBU to the
owner. The preamble to the 1991 proposed regulations explains that the
equity pool generally represents the amount of branch equity (adjusted
basis of assets net of liabilities), and the basis pool represents the
owner's basis in branch equity. 56 FR 48458.
Comments requested that the final regulations include an election
to apply the earnings and capital method of the 1991 proposed
regulations in lieu of the current rate election. These comments
indicated that, even if a current rate election is in effect, proposed
Sec. 1.987-4 imposes a heightened compliance burden (as compared to
the earnings and capital method) because it requires taxpayers to
prepare tax basis balance sheets for each of their section 987 QBUs on
an annual basis. In addition, the comments asserted that taxpayers are
already familiar with the earnings and capital method and would be less
likely to make errors in applying that method because taxpayers track
book-to-tax adjustments in computing taxable income but do not make
book-to-tax adjustments to their balance sheets. One comment
recommended allowing taxpayers to use the earnings and capital method
only if a current rate election and an annual recognition election are
both in effect.
The final regulations do not permit taxpayers to use the earnings
and capital method. As explained in the preamble to the 2023 proposed
regulations, such an election would allow different taxpayers to apply
section 987 using fundamentally different methodologies, which would
increase the overall complexity of the section 987 regulations and make
them more difficult to administer. 88 FR 78138. For example, it would
be difficult for taxpayers to transition from one method to another in
an administrable way. Moreover, under the earnings and capital method,
the amount of section
[[Page 100145]]
987 gain or loss recognized is determined based on the percentage of a
section 987 QBU's net equity remitted (rather than the percentage of
gross assets remitted, as required under Sec. 1.987-5), which can
inappropriately accelerate the recognition of section 987 gain or loss.
If a section 987 QBU has negative net equity, section 987 gain or loss
cannot be recognized under the earnings and capital method until the
section 987 QBU terminates, which is inconsistent with the statutory
requirement to recognize currency gain or loss on transfers of property
from the section 987 QBU.
However, the final regulations modify the existing framework of
Sec. 1.987-4 to allow taxpayers that make a current rate election to
use certain elements of the earnings and capital method in lieu of
preparing a tax basis balance sheet.\2\ These modifications are
expected to minimize the compliance burden of transitioning from the
1991 proposed regulations to the final regulations. Under the final
regulations, if a current rate election is in effect, OFCNV is computed
by determining the aggregate basis of the QBU's assets, net of the
QBU's liabilities, in the functional currency of the section 987 QBU
(``QBU net value'') and translating the QBU net value into the owner's
functional currency at the year-end spot rate. See Sec. 1.987-
4(e)(2)(i) and (ii). The final regulations provide that QBU net value
can be computed without a tax basis balance sheet using the formula
provided in Sec. 1.987-4(e)(2)(iii).
---------------------------------------------------------------------------
\2\ Taxpayers would still need to track the gross assets of a
section 987 QBU for other purposes, including the denominator of the
remittance proportion under Sec. 1.987-5.
---------------------------------------------------------------------------
The formula provided in Sec. 1.987-4(e)(2)(iii) is modeled on the
formula used to track the equity pool under the 1991 proposed
regulations, with certain modifications. Under this formula, the QBU
net value on the last day of the taxable year is equal to the QBU net
value at the end of the preceding taxable year, adjusted by transfers
of assets and liabilities between the section 987 QBU and its owner and
by income or loss of the section 987 QBU (each determined in the
section 987 QBU's functional currency). If a taxpayer determines QBU
net value under Sec. 1.987-4(e)(2)(iii), the taxpayer must retain the
information used to determine QBU net value for each taxable year in
lieu of retaining adjusted balance sheets. See Sec. 1.987-9(b)(2).
2. Cumulative Translation Adjustment
Comments requested that taxpayers be permitted to use the
cumulative translation adjustment (``CTA'') determined under U.S.
generally accepted accounting principles (``U.S. GAAP'') to compute
their unrecognized section 987 gain or loss. Alternatively, some
comments recommended that taxpayers should be allowed to use the CTA
for this purpose only with respect to small QBUs and subject to certain
tax adjustments. One comment suggested that section 987 gain or loss
with respect to small QBUs should be recognized when the CTA is
included in income from continuing operations under U.S. GAAP.
The final regulations do not permit taxpayers to use the CTA to
determine their net unrecognized section 987 gain or loss. As explained
in the preamble to the 2023 proposed regulations, section 987(3)
requires currency gain or loss to be recognized at the time of a
remittance, rather than when the CTA is included in income for U.S.
GAAP purposes. 88 FR 78141. Moreover, the Treasury Department and the
IRS have determined that significant differences may arise between the
computation of the CTA for financial accounting purposes and the
determination of unrecognized section 987 gain or loss under Sec.
1.987-4(d). For example, the CTA is unlikely to reflect the correct
amount of currency gain or loss for tax purposes because of book-to-tax
differences in the basis of assets or because certain items are
disregarded for tax purposes but regarded for financial accounting
purposes. If the comment's recommended approach were adopted, complex
rules would be needed to adjust the CTA amount in order to derive the
correct amount to be recognized for tax purposes.
3. Simplified Accounting for Disregarded Transactions
A comment recommended that taxpayers that make a current rate
election should be permitted to determine unrecognized section 987 gain
or loss for the taxable year by applying only two steps: step 1
(determining the change in OFCNV) and step 10 (reducing the amount
determined in step 1 by the change in QBU net value, translated into
the owner's functional currency at the yearly average exchange rate).
The recommended rule would have the effect of accounting for all
transfers between the owner and the section 987 QBU (which would
otherwise be accounted for under steps 2 through 5) as part of step 10;
consequently, the net amount of all transfers would be translated at
the yearly average exchange rate. The comment posited that this
approach would simplify the computations for taxpayers with a high
volume of disregarded intercompany transactions.
The final regulations retain the requirement to apply steps 2
through 5 when a current rate election is in effect. Under these steps,
transfers of marked assets and liabilities between a section 987 QBU
and its owner generally are translated at the spot rate applicable on
the date of transfer. Because the applicable spot rate may differ
significantly from the yearly average exchange rate, it would not be
appropriate to account for all transfers between a section 987 QBU and
its owner by translating them at the yearly average exchange rate under
step 10. The Treasury Department and the IRS continue to study possible
simplifications of Sec. 1.987-4 relating to disregarded transactions
between a section 987 QBU and its owner, including whether, in certain
circumstances, unrecognized section 987 gain or loss for a taxable year
could be computed using only steps 1 and 10. See Sec. 1.987-2(f) of
the 2024 proposed regulations for proposed rules containing an election
under which certain disregarded transactions between a section 987 QBU
and its owner would not be taken into account in computing unrecognized
section 987 gain or loss.
B. Hedging Transactions
1. Comment on Matching Source and Character of Section 988 Gain or Loss
From a Hedging Transaction With the Source and Character of Section 987
Gain or Loss
A comment recommended adoption of a hedging rule under which a
taxpayer that hedges exchange rate risk with respect to its net
investment in a section 987 QBU could match the source and character of
the section 988 gain or loss arising from the hedging transaction with
that of the section 987 gain or loss attributable to the hedged section
987 QBU. Alternatively, the comment suggested that the hedging
transaction could be integrated with the section 987 QBU, such that
section 988 gain or loss with respect to the hedging transaction would
directly offset the section 987 QBU's unrecognized section 987 gain or
loss. The comment asserted that implementing either of these
recommended rules would mitigate the potential for adverse consequences
(or windfalls) under section 987 when the owner's foreign currency
exposure is economically hedged. The comment noted that these rules
would be particularly beneficial for taxpayers that make a current rate
election and an
[[Page 100146]]
annual recognition election (and thus recognize section 987 gain or
loss whether or not there is a remittance).
2. Treatment of Section 987 Hedging Transactions Under the Final
Regulations
The Treasury Department and the IRS agree with the comment that it
would be appropriate to permit symmetrical treatment of currency gain
or loss with respect to a net investment hedge and the hedged section
987 QBU.\3\ Accordingly, Sec. 1.987-14 of the final regulations
provides new rules that apply to certain identified hedging
transactions entered into by the owner of a section 987 QBU (``section
987 hedging transactions'').
---------------------------------------------------------------------------
\3\ The Treasury Department and the IRS previously published
proposed regulations in the Federal Register on December 19, 2017
(82 FR 60135), which contained proposed rules relating to the
treatment of a net investment hedge for purposes of the business
needs exception to the definition of foreign personal holding
company income under section 954(c)(1)(D) and Sec. 1.954-
2(g)(2)(ii). Those proposed regulations would apply only for
purposes of the business needs exception and do not address the
potential for mismatches in other contexts.
---------------------------------------------------------------------------
Under Sec. 1.987-14(d), section 988 gain or loss that would
otherwise be recognized on a section 987 hedging transaction (``hedging
gain or loss'') is instead taken into account in adjusting the owner's
unrecognized section 987 gain or loss for the taxable year (as
determined under Sec. 1.987-4(d)). For example, if the owner has
unrecognized section 987 gain for the taxable year under Sec. 1.987-
4(d), the owner's hedging loss reduces the unrecognized section 987
gain. However, hedging loss cannot reduce unrecognized section 987 gain
for the taxable year below zero, and hedging gain cannot reduce
unrecognized section 987 loss for the taxable year below zero. This
limitation ensures that hedging gain or loss in excess of the currency
exposure generated by the section 987 QBU for the taxable year is not
taken into account under section 987.
3. Requirements To Qualify as a Section 987 Hedging Transaction
A section 987 hedging transaction generally is defined as a
financial instrument (a ``hedge'') entered into by the owner of a
section 987 QBU for the purpose of managing exchange rate risk with
respect to the owner's net investment in the section 987 QBU as part of
the normal course of the owner's trade or business. The hedge may be
entered into with an unrelated counterparty or with a related person.
For example, a CFC that owns a section 987 QBU may enter into a hedge
with its U.S. parent, which has entered into a similar, offsetting,
transaction with a third party.
Several requirements must be met in order for a hedge to qualify as
a section 987 hedging transaction. First, the hedge must be identified
as a section 987 hedging transaction with respect to the hedged QBU on
or before the day the owner enters into the hedge. See Sec. 1.987-
14(b)(2)(i) and (c). A hedge cannot be identified as a section 987
hedging transaction with respect to more than one section 987 QBU.
However, if a grouping election is in effect under Sec. 1.987-
1(b)(3)(ii), all section 987 QBUs that have the same functional
currency will be treated as a single section 987 QBU. The final
regulations also provide a special rule for cases in which a taxpayer
fails to properly identify a hedge due to inadvertent error. See Sec.
1.987-14(c)(2).
Second, a current rate election must be in effect for the taxable
year. See Sec. 1.987-14(b)(2)(ii). In the absence of a current rate
election, gain or loss on a net investment hedge is unlikely to be
comparable in amount to the owner's unrecognized section 987 gain or
loss, and thus the rules of Sec. 1.987-14 would not serve their
intended function.
Third, the owner (and any members of the same controlled group that
are parties to the hedge) must account for section 988 gain or loss
with respect to the hedge under a mark-to-market method of accounting
(for example, under section 1256 or in reliance on proposed Sec.
1.988-7). See Sec. 1.987-14(b)(2)(iii). As a result of this
requirement, foreign currency gain or loss on the hedge will be taken
into account in the taxable year in which the related currency gain or
loss is determined under Sec. 1.987-4(d)).
Fourth, under U.S. GAAP, foreign currency gain or loss on the hedge
must be properly accounted for as a cumulative foreign currency
translation adjustment to shareholders' equity. See Sec. 1.987-
14(b)(2)(iv). This requirement helps to ensure that the hedge is
economically related to the owner's net investment in the section 987
QBU.
Fifth, the hedge must be entered into by the owner of the section
987 QBU, and not by a section 987 QBU of the owner (that is, the hedge
cannot itself be an asset attributable to a section 987 QBU). See Sec.
1.987-14(b)(2)(v).
Finally, an anti-abuse rule provides that a hedge does not qualify
as a section 987 hedging transaction if the hedge or a related
transaction is entered into with a principal purpose of converting
section 987 gain or loss into section 988 gain or loss. See Sec.
1.987-14(b)(3). For example, a taxpayer that owns a section 987 QBU
might enter into a hedging transaction with a related party without
hedging the related party's resulting exchange rate risk (effectively
shifting the exchange rate risk without reducing the group's overall
foreign currency exposure) for the purpose of taking the related
foreign currency gain or loss into account under section 988 (rather
than section 987). Under the anti-abuse rule, the net investment hedge
would not be treated as a section 987 hedging transaction.
4. Consolidated Groups
With regard to consolidated groups (as defined in Sec. 1.1502-
1(h)), Sec. 1.987-14(b)(2)(v) of the final regulations requires that
the same corporation be the owner of the QBU and enter into the section
987 hedging transaction with respect to that QBU (similar requirements
apply when a member of a consolidated group engages in a section 988(d)
hedging transaction under Sec. 1.988-5(a)(5)(v) or (b)(2)(i)(F)). The
Treasury Department and the IRS continue to study whether it would be
possible to treat consolidated group members as a single corporation
for purposes of Sec. 1.987-14 and the section 988(d) hedging
transaction rules without inappropriately shifting income among members
of the group. See also TD 8400, 57 FR 9172, 9176 (soliciting comments
on whether to permit the rules of Sec. 1.988-5 to be applied by
treating consolidated group members as a single corporation).
VI. Comments and Changes to Proposed Sec. 1.987-5: Recognition of
Section 987 Gain or Loss
Proposed Sec. 1.987-5 provides rules for determining the amount of
section 987 gain or loss recognized by the owner of a section 987 QBU.
Under proposed Sec. 1.987-5(a), when a section 987 QBU makes a
remittance, the owner recognizes section 987 gain or loss. In general,
the amount recognized equals the section 987 QBU's net unrecognized
section 987 gain or loss multiplied by the owner's remittance
proportion. The remittance proportion is determined in the owner's
functional currency; it is equal to the amount of the remittance for
the taxable year, divided by the aggregate basis of the section 987
QBU's gross assets reflected on its year-end balance sheet (without
reduction for the remittance). Proposed Sec. 1.987-5(b). For a taxable
year, the amount of a remittance equals the excess of (i) the aggregate
of all amounts transferred from the section 987 QBU to the owner during
the taxable year; over (ii) the aggregate of all amounts transferred
from the owner to the section 987 QBU
[[Page 100147]]
during the taxable year (each determined in the owner's functional
currency). Proposed Sec. 1.987-5(c).
A comment noted that, for taxpayers with a high volume of
disregarded intercompany transactions, it can be difficult to track the
amount of each transfer between the section 987 QBU and its owner and
to translate the transfer into the owner's functional currency at the
appropriate exchange rate. The comment recommended that the amount of a
remittance should be deemed to be equal to the change in the QBU's net
value (if negative) for the taxable year.
Despite compliance and administrative burdens that may result in
certain cases from tracking disregarded transfers for purposes of
determining the amount of a remittance, it would not be appropriate to
determine the remittance amount based solely on the negative change in
net value of a section 987 QBU. Such an approach would not properly
account for distributions out of a section 987 QBU's current year
earnings. For example, if a section 987 QBU distributed an amount
exactly equal to its current year earnings, there would be no change in
the QBU's net value (and thus, no remittance) under the comment's
recommended approach, even if the QBU made a substantial distribution.
Section 987(3) and its legislative history indicate that Congress
intended for gain or loss to be recognized on any remittance from a
section 987 QBU, without regard to whether the remittance is sourced
from current year earnings, prior year earnings, or capital
contributions.
Nonetheless, the final regulations provide two modifications that
are intended to reduce the burden of tracking disregarded transfers for
purposes of Sec. 1.987-5 while preserving consistency with the text
and purpose of section 987. First, the final regulations provide an
alternative formula for computing the annual remittance that is based
on the comment's recommended approach (and does not require tracking of
individual transfers) but contains an adjustment to account for
remittances out of current-year income. Under this formula, the
remittance amount is equal to the negative change in net value of the
section 987 QBU (determined in the QBU's functional currency), adjusted
for income and loss of the section 987 QBU. See Sec. 1.987-5(c)(2).
Mathematically, this formula will produce an amount that is equal to
the aggregate net transfer from the section 987 QBU to its owner for
the taxable year.
Second, Sec. 1.987-5(b) and (c) provide that the numerator and
denominator of the remittance proportion (that is, the amount of the
remittance and the section 987 QBU's gross assets) are determined in
the section 987 QBU's functional currency, rather than the owner's
functional currency. As a result, it is not necessary to separately
translate each transfer for purposes of determining the annual
remittance.
VII. Comments and Changes to Proposed Sec. 1.987-6: Character and
Source of Section 987 Gain or Loss
A. Determining the Character and Source of Section 987 Gain or Loss
1. In General
Under proposed Sec. 1.987-6, section 987 gain or loss is assigned
to the statutory and residual groupings in two steps: an initial
assignment under proposed Sec. 1.987-6(b)(2)(i), followed by a
reassignment described in proposed Sec. 1.987-6(b)(2)(ii). The initial
assignment is made using the asset method under Sec. Sec. 1.861-9(g)
and 1.861-9T(g). It is made after the application of the income
attribution rules of Sec. 1.904-4(f)(2)(vi) or Sec. 1.951A-2(c)(7),
but before expenses are allocated and apportioned to gross income and
before the application of provisions that require a net income
computation. Section 987 gain or loss may be reassigned if required
after the application of provisions that require a net income
computation. For example, if an item of section 987 gain is initially
assigned to tentative tested income, it will be reassigned to tested
income or residual income depending on whether the taxpayer has made
the GILTI high-tax exclusion election and, if so, whether the item
(described in proposed Sec. 1.987-6(b)(2)(iii)) is subject to a high
rate of tax.
2. Asset Method
The asset method under Sec. Sec. 1.861-9 and 1.861-9T is intended
to serve as an administrable proxy for a section 987 QBU's historical
earnings, in line with the statutory requirement of section 987(3)(B)
(which provides that section 987 gain or loss is sourced by reference
to the source of the income giving rise to post-1986 accumulated
earnings). As explained in the preamble to the 2016 final regulations,
it would be complex and burdensome to source and characterize section
987 gain or loss with direct reference to post-1986 accumulated
earnings, and the gross assets of a section 987 QBU provide a
reasonable proxy for historical earnings that is relatively easy to
administer. 81 FR 88814.
A comment recommended that CFCs which apportion interest expense
using the modified gross income method be permitted to use the same
method to determine the character and source of section 987 gain or
loss (rather than using the asset method under Sec. Sec. 1.861-9(g)
and 1.861-9T(g)). According to the comment, the asset method may not
accurately reflect the income earned by the CFC for the taxable year,
and section 987 losses often could be allocated to a subpart F income
group in excess of the income recognized in that group for the taxable
year. The comment noted that the use of the modified gross income
method would be more administrable and would more readily allow section
987 losses to be used against gross income recognized in the current
year, since the source and character of the section 987 loss would be
determined by reference to the section 987 QBU's gross income for the
current year.
The final regulations do not permit CFCs to use the modified gross
income method to source and characterize section 987 gain or loss
because the source and character of a section 987 QBU's gross income
may vary significantly from year to year, including by reason of
extraordinary events or as a result of tax planning. Accordingly, the
gross income earned in a single year is not a sufficiently reliable
proxy for historical earnings for purposes of section 987(3)(B).
3. Timing of Source and Character Determination
The 2023 proposed regulations provide that the initial assignment
of section 987 gain or loss would generally be made in the taxable year
in which the section 987 gain or loss is treated as recognized,
deferred, or suspended. Proposed Sec. 1.987-6(b)(1).
Comments requested that the character and source of suspended
section 987 loss and deferred section 987 gain or loss be determined in
the year in which it is recognized, rather than in the year in which it
becomes suspended or deferred. The comments noted that the proposed
rules would require extensive tracking of the source and character of
section 987 gain or loss in multiple categories over multiple years.
Comments also posited that the potential for distortion due to changes
in the basis of a QBU's assets or shifts in the character of its income
would be present whether the section 987 gain or loss is characterized
in the taxable year in which it becomes suspended or deferred or in the
taxable year in which it is recognized.
The final regulations retain the rules of proposed Sec. 1.987-
6(b)(1)(ii) and (iii), under which suspended section 987 loss and
deferred section 987 gain or loss are
[[Page 100148]]
characterized in the year of suspension and deferral, respectively, for
several reasons.
First, making an initial assignment in the taxable year of deferral
or suspension provides parity in the timing of the characterization of
gains and losses (that is, both gains and losses are characterized in
the year of a remittance or termination).
Second, this rule is expected to produce source and character
determinations that more closely align with the historical income of
the section 987 QBU during the period in which the relevant section 987
gain or loss arose. Making an initial assignment in the taxable year of
deferral or suspension means that source and character are determined
by reference to the assets of the section 987 QBU contemporaneously
with the remittance or termination, while the affected assets are still
taken into account for purposes of applying the asset method under
Sec. Sec. 1.861-9 and 1.861-9T. By contrast, waiting until the year of
recognition would require deferred section 987 gain or loss and (in
some cases) suspended section 987 loss to be characterized after the
section 987 QBU has been terminated and its assets have been
transferred to a related party, which could result in substantial
distortions.
Third, the timing rule of Sec. 1.987-6(b)(1)(ii) is needed to
facilitate the separate application of the loss-to-the-extent-of-gain
rule under Sec. 1.987-11(e) to section 987 gain or loss in each
recognition grouping. As explained in part X.B.3 of this Summary of
Comments and Explanation of Revisions, in order to prevent taxpayers
from avoiding the loss limitation through the selective recognition of
section 987 gains that are subject to a low rate of tax (or are not
subject to U.S. tax), Sec. 1.987-11(e) provides that suspended section
987 loss in a recognition grouping is not recognized until section 987
gain in the same recognition grouping is recognized. For this rule to
achieve its policy objective, suspended section 987 loss must be
sourced and characterized before determining whether it can be
recognized under Sec. 1.987-11(e). If suspended section 987 loss were
not characterized until the year of recognition, there would be no
administrable way to identify suspended section 987 loss in the
relevant recognition grouping for purposes of Sec. 1.987-11(e) because
the source and character of the suspended section 987 loss would not
yet have been determined.
Finally, in response to comments regarding compliance burden
generally, the final regulations include a number of new rules intended
to simplify the tracking of suspended section 987 loss or deferred
section 987 gain or loss. For instance, the new de minimis rule
(described in part X.A.1 of this Summary of Comments and Explanation of
Revisions) is expected to reduce the burden of tracking suspended
section 987 loss because section 987 loss will be suspended only if it
exceeds the de minimis threshold (the lesser of $3 million or two
percent of gross income). See Sec. 1.987-11(c)(2). In addition,
taxpayers that make the annual recognition election generally would not
be subject to the deferral and loss suspension rules (and thus would
not need to track deferred section 987 gain or loss or suspended
section 987 loss). The lookback rule (described in part X.B.1 of this
Summary of Comments and Explanation of Revisions) will permit suspended
section 987 loss to be recognized in the year of a remittance to the
extent of gain recognized during the lookback period, which will limit
the amount of suspended section 987 loss carried forward to future
years. Additionally, the new rules relating to the characterization of
section 987 gain or loss for purposes of subpart F (described in part
VII.B of this Summary of Comments and Explanation of Revisions) provide
taxpayers more flexibility in characterizing their section 987 gain and
loss relating to subpart F income groups, including an election that
will limit the number of subpart F income groups for which tracking is
required.
B. Characterization of Section 987 Gain or Loss for Purposes of Subpart
F
1. In General
Under proposed Sec. 1.987-6(b)(2)(i)(C), section 987 gain or loss
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 for purposes of section
954(c)(1)(D).
Some comments recommended that, for subpart F purposes, section 987
gain or loss should instead be assigned to the same subpart F income
groups as the income generated by the section 987 QBU's assets. The
comments noted that the recommended rule would better align the
characterization of section 987 gain or loss with the underlying assets
and income of the section 987 QBU and would permit broader utilization
of section 987 loss because the loss could be netted against income in
the same subpart F income groups. One comment asserted that the
recommended rule would be more consistent with section 987(3)(B), which
requires section 987 gain or loss to be sourced by reference to the
source of the income giving rise to post-1986 accumulated earnings.
Other comments stated that section 987 gain or loss should not be
treated as foreign personal holding company income described in section
954(c)(1)(D) because section 954(c)(1)(D) refers to foreign currency
gains or losses under section 988 and makes no reference to gain or
loss recognized under section 987(3). One comment questioned whether
section 987 gain or loss should be assigned to any subpart F income
group because section 954 does not explicitly identify section 987 gain
as a category of subpart F income.
Another comment requested that, if proposed Sec. 1.987-
6(b)(2)(i)(C) is retained for taxpayers applying the default rules, a
different rule should be provided for taxpayers that make a current
rate election (under which all assets and liabilities of a section 987
QBU give rise to currency gain or loss). A comment also recommended
that, if proposed Sec. 1.987-6(b)(2)(i)(C) is retained, the final
regulations should clarify that, for taxpayers predominantly engaged in
the active conduct of a banking, insurance, financing, or similar
business, section 987 gain or loss that is assigned to a subpart F
income group is treated as financial services income within the meaning
of section 904(d)(2)(C).
Other comments requested that, if section 987 gain or loss is
treated as gain or loss from section 988 transactions not directly
related to the business needs of the CFC, taxpayers should be permitted
to use the elections available under Sec. 1.954-2(g)(3)
(characterizing section 988 gain or loss that arises from a specific
category of subpart F income as gain or loss in that category) and
Sec. 1.954-2(g)(4) (treating all section 988 gain or loss as foreign
personal holding company income). One comment recommended that, for
purposes of the election under Sec. 1.954-2(g)(3), section 987 gain or
loss should be allocated to categories of foreign base company income
on a proportionate basis without requiring direct tracing of section
987 gain or loss to specific transactions or assets.
The final regulations retain the approach in the 2023 proposed
regulations and treat section 987 gain or loss as subpart F income to
the extent that the assets of the section 987 QBU generate subpart F
income under the asset method of Sec. Sec. 1.861-9(g) and 1.861-9T(g).
See Sec. 1.987-6(b)(2)(i)(A). However, the Treasury Department and the
IRS agree with the comments that assigning section 987 gain or loss to
the
[[Page 100149]]
same subpart F income groups as the income generated by the section 987
QBU's assets is most consistent with the principles of section
987(3)(B) and is therefore the most appropriate exercise of authority
under sections 987(3) and 989(c). Accordingly, under the final
regulations, the characterization of section 987 gain or loss is
determined under the general rule of Sec. 1.987-6 using the asset
method of Sec. Sec. 1.861-9(g) and 1.861-9T(g), including by assigning
section 987 gain or loss to subpart F income groups. Thus, for example,
if a QBU's assets generate foreign base company sales income, the
section 987 gain or loss will be characterized as foreign base company
sales income.
The Treasury Department and the IRS do not agree with the
suggestion that section 987 gain or loss cannot give rise to subpart F
income merely because section 954 does not explicitly identify section
987 gain as a separate category of subpart F income. Section 987(3)
requires ``proper adjustments (as prescribed by the Secretary)'' to
taxable income of the owner of a section 987 QBU. Further regulatory
authority is provided in section 989(c). The adjustments required under
section 987(3) include sourcing gain or loss recognized on a remittance
by reference to the QBU's historical earnings under section 987(3)(B).
This sourcing rule serves to characterize the adjustments to income
under section 987(3) in the same way as the QBU's underlying income.
Similarly, when a QBU's income is taken into account in determining the
owner's subpart F income, proper adjustments must necessarily include
adjustments to that type of income. Therefore, section 987 gain or loss
must be characterized as foreign personal holding company income or
other types of income described in section 952(a), in appropriate
circumstances, to effectuate the intent of Congress reflected in the
broader statutory scheme.
2. Election To Treat Certain Section 987 Gain or Loss as Foreign
Currency Gain or Loss Attributable to Section 988 Transactions
In the case of section 987 gain or loss that would otherwise be
characterized as passive foreign personal holding company income, the
final regulations provide an election to treat the section 987 gain or
loss as foreign currency gain or loss of the CFC-owner that is
attributable to section 988 transactions not directly related to the
business needs of the CFC (the ``section 988 characterization
election''). See Sec. 1.987-6(b)(2)(i)(C)(1). This election is
intended to benefit taxpayers because it would generally allow section
987 gains and losses assigned to passive foreign personal holding
company income groups, which would otherwise be treated as separate
items (or as allocable to separate items) of passive foreign personal
holding company income under the rules in Sec. 1.954-1(c)(1)(iii)(B),
to be treated as part of (or allocable to) a single item of income.
This would generally facilitate some netting of the CFC-owner's section
987 gains and losses (because they would be assigned to the same item
of income) and would also generally permit a CFC-owner to net its
foreign currency gains and losses from section 988 transactions with
the section 987 gain or loss from its QBUs (to the extent both comprise
passive foreign personal holding company income). Similarly, the
section 988 characterization election should, in many cases, reduce the
number of recognition groupings under Sec. 1.987-11(f), thereby
simplifying the application of the loss-to-the-extent-of-gain rule and
minimizing the tracking burden with respect to any suspended losses.
Section 987 gain or loss subject to the section 988
characterization election is not eligible for the business needs
exception under Sec. 1.954-2(g)(2) because this election applies only
to section 987 gain or loss that would otherwise be characterized by
reference to assets that give rise to passive foreign personal holding
company income. The business needs exception is available only for
foreign currency gain or loss arising from a transaction or property
that does not give rise to subpart F income (which includes foreign
personal holding company income). See Sec. 1.954-
1(g)(2)(ii)(B)(1)(ii).
Similarly, section 987 gain or loss subject to the section 988
characterization election is not eligible for the election in Sec.
1.954-2(g)(3) (election to characterize foreign currency gain or loss
that arises from a specific category of subpart F income as gain or
loss in that category). The Sec. 1.954-2(g)(3) election applies only
to gain or loss that is related to income categories described in the
foreign base company income groups of Sec. 1.954-1(c)(1)(iii)(A)(1) or
(2) or the other subpart F income categories described in section
952(a); it does not apply to gain or loss related to passive foreign
personal holding company income.\4\ By contrast, the section 988
characterization election applies only to section 987 gain or loss that
would otherwise be characterized by reference to assets that give rise
to passive foreign personal holding company income. Thus, the two
elections are mutually exclusive by their terms.
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\4\ While Sec. 1.954-1(c)(1)(iii)(A)(1) includes categories of
foreign personal holding company income, it expressly excludes
passive foreign personal holding company income, which is described
in Sec. 1.954-1(c)(1)(iii)(B). Therefore, the two elections apply
to mutually exclusive income groups.
---------------------------------------------------------------------------
Finally, section 987 gain or loss subject to the section 988
characterization election is not eligible for the election in Sec.
1.954-2(g)(4) (election to treat all foreign currency gains or losses
as foreign personal holding company income). Extending the Sec. 1.954-
2(g)(4) election to section 987 gain or loss could permit inappropriate
use of section 987 losses and would be inconsistent with the limited
purpose of the section 988 characterization election. Therefore, if an
election is in effect under Sec. 1.954-2(g)(3) or (4), the foreign
currency gain or loss to which the election applies is simply
determined without regard to the section 987 gain or loss treated as
foreign currency gain or loss attributable to a section 988 transaction
by reason of the section 988 characterization election.
C. GILTI High-Tax Exclusion
Under the 2023 proposed regulations, for purposes of applying the
high-tax exclusion in Sec. 1.951A-2(c)(7) (the ``GILTI HTE''), all
section 987 gain and loss in a tentative tested income group that is
recognized by a CFC in a taxable year is treated as a single tentative
tested income item that is treated as recognized by a tested unit
separate from the CFC's other tested units. Proposed Sec. 1.987-
6(b)(2)(iii). As a result, section 987 gain or loss is not taken into
account in applying the GILTI HTE with respect to the CFC's other items
of tentative tested income. Instead, the GILTI HTE is applied
separately to section 987 gain and loss and, as a result, section 987
gain or loss generally will not be eligible for the GILTI HTE unless
the CFC is subject to foreign tax on currency gain recognized with
respect to its interest in the QBU under the applicable foreign tax
rules. See proposed Sec. 1.987-6(b)(3).
Some comments noted that these rules would preclude the application
of the GILTI HTE with respect to section 987 gain of a CFC even if the
CFC's section 987 QBUs are operating in jurisdictions subject to a high
foreign tax rate. Another comment noted that the proposed rules would
treat section 987 gain or loss differently from currency gain or loss
recognized under section 988 (for example, section 988 gain or loss on
a net investment hedge with respect to the section 987 QBU) and would
make it difficult to project a
[[Page 100150]]
taxpayer's effective tax rate due to the unpredictability of exchange
rate fluctuations. This comment recommended that proposed Sec. 1.987-
6(b)(2)(iii) be modified to provide that (i) section 987 gain and loss
is taken into account in determining the effective tax rate under Sec.
1.951A-2(c)(7)(vi) and (ii) section 987 gain or loss associated with
highly taxed tested units is excluded from the computation of tested
income.
The final regulations retain the rule that section 987 gain or loss
is treated as a single tentative tested income item that is separate
from the CFC's other tested units. See Sec. 1.987-6(b)(2)(iii).
Although section 987 gain or loss is characterized by reference to the
historical earnings of the section 987 QBU, which may correspond to one
or more tested units, it is not equivalent to current year income or
loss attributable to a tested unit. Section 987 gain or loss is not
properly attributable to the tested unit that corresponds to the
section 987 QBU or to the CFC tested unit, because in most cases
neither the tested unit's country of residence nor the CFC's country of
residence will take the section 987 gain or loss into account in
determining foreign gross income. Therefore, attributing section 987
gain or loss to either tested unit would tend to be distortive and
generally would not further the goals of the high-tax exclusion.\5\
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\5\ While the legislative history relating to the GILTI high-tax
exclusion indicates that high-taxed income does not present base
erosion concerns, the policy rationale underlying that view does not
extend to excluding low-taxed income from GILTI merely because it
may be earned by an entity that also earns high-taxed income. See S.
Comm. on the Budget, Reconciliation Recommendations Pursuant to H.
Con. Res. 71, S. Print. No. 115-20, at 371 (2017) (``The Committee
believes that certain items of income earned by CFCs should be
excluded from the GILTI [regime], either because they should be
exempt from U.S. tax--as they are generally not the type of income
that is the source of the base erosion concerns--or are already
taxed currently by the United States. Items of income excluded from
GILTI because they are exempt from U.S. tax under the bill include
foreign oil and gas extraction income (which is generally immobile)
and income subject to high levels of foreign tax.'').
---------------------------------------------------------------------------
In addition, treating section 987 gain or loss as a single item of
tentative tested income, as if it were attributable to a separate
tested unit (distinct from the section 987 QBU), is consistent with the
determination that a branch comprises a separate tested unit, even if
it is not a tax resident of the foreign country in which it is located,
if the income of the branch is subject to an exclusion, exemption, or
other similar relief (such as a preferential rate) in the CFC's country
of tax residence. See Sec. 1.951A-2(c)(7)(iv)(A)(3). Section 987 gain
or loss is currency gain or loss of the owner of the QBU, and these
gains and losses are generally not subjected to residency-based
taxation in either the country of the QBU or the country in which the
CFC is a resident. Therefore, the section 987 gains and losses of the
CFC are functionally equivalent to gain or loss of a branch that is not
a tax resident in any country and whose income is not subject to
residency-based taxation in the CFC's country of tax residence.
Accordingly, it is appropriate to test the effective rate of
foreign tax on section 987 gains and losses as a separate item of
tentative tested income. The alternative approach recommended by a
comment (which would incorporate section 987 gain or loss in the tested
units that correspond to the section 987 QBU) would distort the
effective tax rate computation with respect to a CFC's other income
because section 987 gain or loss typically is not subject to foreign
tax. These distortions could be favorable or unfavorable to taxpayers,
depending on the circumstances. Moreover, the comment's recommended
approach would complicate the ordering rules and mechanics needed to
apply the loss-to-the-extent-of-gain rule of Sec. 1.987-11(e) with
respect to section 987 gain or loss assigned to a tested income group,
which would increase the administrative and compliance burden of the
section 987 regulations.
The approach set forth in the proposed regulations is also most
consistent with the policy underlying the determination of an
appropriate ``item'' of income for purposes of applying the high-tax
exception under section 954(b)(4) as is reflected in the legislative
history to that section, which directs the Treasury Department and the
IRS to allow reasonable groupings of items of income that are
substantially taxed at the same rate in a single country. See H.R.
Rept. No. 99-426, at 400-01 (1985) (``Although this rule applies
separately with respect to each `item of income' received by a [CFC],
the committee expects that the Secretary will provide rules permitting
reasonable groupings of items of income that bear substantially equal
effective rates of tax in a given country. For example, all interest
income received by a [CFC] from sources within its country of
incorporation may reasonably be treated as a single item of income for
purposes of this rule, if such interest is subject to uniform taxing
rules in that country.''). The Treasury Department and the IRS have
determined that section 987 gains and losses are likely to be taxed at
a different rate of tax than other income generally subject to tax
either in the country of the tested unit or in the country of residence
of the CFC and therefore should reasonably be grouped and tested as a
separate ``item'' of income for this purpose.
As noted in a comment, for purposes of the GILTI HTE, the final
regulations treat section 987 gain or loss differently from section 988
gain or loss on a net investment hedge. However, the new hedging rule
in Sec. 1.987-14 will enable taxpayers to account for the hedge as an
adjustment to unrecognized section 987 gain or loss, as described in
part V.B of this Summary of Comments and Explanation of Revisions.
VIII. Comments and Changes to Proposed Sec. Sec. 1.987-7A, 1.987-7B,
and 1.987-7C--Partnerships
A. Partnership Rules Under the 2023 Proposed Regulations
The 2023 proposed regulations (and the 2016 final regulations)
generally would apply aggregate theory to partnerships wholly owned by
related persons (``section 987 aggregate partnerships''). See proposed
Sec. 1.987-7B. Under proposed Sec. 1.987-1(b)(5)(ii), each partner in
a section 987 aggregate partnership would be treated as an indirect
owner of the partnership's eligible QBUs (and a section 987 aggregate
partnership is not itself a QBU under section 989(a)). Thus, exchange
gain or loss under section 987 would be measured from the perspective
of the partners (rather than the partnership). The aggregate approach
would serve to prevent a group of related parties from holding an
eligible QBU through a partnership (rather than owning it directly) in
order to change the section 987 treatment of the eligible QBU without
meaningfully altering the group's economic position.
The 2023 proposed regulations would provide a different set of
rules for partnerships that are not wholly owned by related partners.
See proposed Sec. 1.987-7A. For these partnerships, the 2023 proposed
regulations would apply a hybrid approach to entity theory, under which
unrecognized section 987 gain or loss of the partnership's eligible
QBUs for a taxable year is determined at the partnership level and then
allocated to the partners for purposes of computing the pool of net
unrecognized section 987 gain or loss. Any section 987 gain or loss
would be recognized and taken into account at the partner level.
The preamble to the 2023 proposed regulations notes that the
Treasury Department and the IRS considered whether it would be
appropriate to apply a hybrid approach to all
[[Page 100151]]
partnerships, regardless of whether the partners are related. 88 FR
78147 through 78148. The preamble explains that such an approach might
reduce the complexity and compliance burden of the section 987
regulations, but that it could permit taxpayers to manipulate the
application of section 987 by holding a section 987 QBU through a
partnership rather than holding it directly. Id. at 78148.
The 2023 proposed regulations would not provide rules relating to a
partner's application of section 987 with respect to a partnership that
uses a different functional currency (which creates a separate layer of
currency exposure). However, the preamble to the 2023 proposed
regulations discusses alternative methodologies under which the
partners could determine and recognize section 987 gain or loss with
respect to their partnership interests. 88 FR 78148 through 78149.
B. Partnership Rules in the Final Regulations
1. In General
The Treasury Department and the IRS continue to study the
appropriate treatment of partnerships for purposes of section 987 and,
accordingly, the final regulations do not provide detailed rules
concerning the determination of section 987 taxable income or loss and
section 987 gain or loss in the case of a partnership. The final
regulations also reserve on the treatment of a partnership as a QBU
under section 989(a) and Sec. 1.989(a)-1(b)(2)(i). See Sec. 1.989(a)-
1(b)(2)(i)(C).
Only one comment regarding partnerships was received in response to
the 2023 proposed regulations. The portions of the comment that relate
to partnership rules that are not included in the final regulations
have not been adopted because they are outside the scope of these
regulations. The Treasury Department and the IRS expect to address
these issues in future guidance.
Pending future guidance, taxpayers must apply sections 987 and
989(a) with respect to partnerships using a reasonable method
consistent with the statute. For example, if a domestic corporation
owns an interest in a foreign partnership (which would use the euro as
its functional currency if it is treated as a QBU under section
989(a)), and the partnership owns an eligible QBU that uses the Swiss
franc as its functional currency, the domestic corporation may apply
section 987 to the eligible QBU under an aggregate approach.
Alternatively, under an entity approach, the partnership could be
treated as a section 987 QBU of the domestic corporation, and the
eligible QBU could be treated as a section 987 QBU of the partnership.
The domestic corporation could also apply a hybrid approach under the
principles of the 2023 proposed regulations. However, taxpayers will
not be considered to have applied a reasonable method unless they apply
the same method consistently from year to year with respect to a
particular partnership or eligible QBU. Members of a controlled group
that are partners in the same partnership must apply the same method
with respect to a particular partnership or eligible QBU, but unrelated
partners are not subject to a consistency requirement. See Sec. 1.987-
7(b).
2. Application of the Final Regulations to Partnerships
Although section 987 applies to partnerships, only certain parts of
the final regulations apply to partnerships. See Sec. 1.987-7(b) and
(c). In particular, the rules relating to suspended section 987 loss in
Sec. Sec. 1.987-11 and 1.987-13 apply to partnerships, and the
deferral rules of Sec. 1.987-12 continue to apply to partnerships,
with certain modifications. See Sec. 1.987-7(c)(2)(i) and (d). These
rules are needed to prevent the selective recognition of losses. In
addition, the final regulations provide that an annual recognition
election and a section 988 mark-to-market election can be made with
respect to a partnership (whether an aggregate or entity approach is
applied). See Sec. 1.987-7(c)(2)(ii) and (iii). These elections are
expected to reduce the compliance burden of applying section 987 in the
partnership context.
Similarly, the rules for determining the source and character of
section 987 gain or loss under Sec. 1.987-6 apply to partnerships, in
order to facilitate application of the loss-to-the-extent-of-gain rule.
See Sec. 1.987-7(c)(2)(i). A comment suggested that special rules
should apply to determine the source and character of section 987 gain
or loss recognized in connection with the sale or redemption of a
partnership interest under the principles of Sec. 1.864(c)(8)-1. The
final regulations do not adopt this approach because it would be
inconsistent with section 987(3)(B) (under which section 987 gain or
loss is sourced by reference to historical earnings) and could allow
taxpayers to manipulate the source and character of section 987 gain or
loss.
Because the section 987 regulations generally do not apply to
partnerships, the general rules of the section 987 regulations must be
adapted as necessary to apply Sec. 1.987-7 and the other applicable
provisions to partnerships. See Sec. 1.987-7(c)(3). The rules must
also be applied in this manner to an S corporation, which is treated
the same way as a partnership for purposes of the section 987
regulations. See Sec. 1.987-7(f).
3. Loss Suspension Rule
Under the final regulations, the general loss suspension rule in
Sec. 1.987-11(c)(1) does not apply to partnerships. See Sec. 1.987-
7(d)(1)(i). Instead, section 987 loss generally will be suspended in
the taxable year in which it would otherwise be recognized under the
method used by the taxpayer to apply section 987 with respect to the
partnership. See Sec. 1.987-7(d)(1)(ii). The loss suspension rule of
Sec. 1.987-7(d)(1)(ii) applies to an eligible QBU that is directly
owned by a partnership, regardless of whether an aggregate approach, an
entity approach, or a hybrid approach is applied. See Sec. 1.987-
7(d)(1)(ii)(A). However, if a partnership is itself treated as a
section 987 QBU of its partners under an entity approach, the loss
suspension rule applies only if at least 95% of the capital and profits
interests in the partnership are owned by related persons. See Sec.
1.987-7(d)(1)(ii)(B). This limitation is intended to reduce the
complexity and compliance burden of the section 987 regulations for
partnerships owned by unrelated persons.
The final regulations provide several other exceptions to the loss
suspension rule of Sec. 1.987-7(d)(1)(ii). First, section 987 loss
with respect to an eligible QBU owned by a partnership is not suspended
if section 987 is consistently applied using a method under which
section 987 gain or loss does not arise with respect to historic items
(for example, a method that follows the principles of Sec. Sec. 1.987-
3 through 1.987-5, under which historic items are assigned a historic
rate, such that their balance sheet value does not change in response
to changes in the value of the section 987 QBU's functional currency).
See Sec. 1.987-7(d)(2)(i). Second, section 987 loss is not suspended
if an annual recognition election is in effect. See Sec. 1.987-
7(d)(2)(ii). Finally, section 987 loss is not suspended if the de
minimis rule in Sec. 1.987-11(c)(2) applies (that is, if the amount of
section 987 loss subject to suspension does not exceed the lesser of $3
million or two percent of gross income, as described in part X.A.1 of
this Summary of Comments and Explanation of Revisions). See Sec.
1.987-7(d)(2)(iii). These rules generally align with the scope of the
loss suspension rule in Sec. 1.987-11(c)(1).
[[Page 100152]]
4. Adjustments to the Basis of a Partner's Interest in the Partnership
The proposed regulations would provide that a partner's basis in a
partnership is adjusted when the partner recognizes section 987 gain or
loss, defers section 987 gain or loss, or suspends section 987 loss
attributable to the partnership. Proposed Sec. 1.987-7A(e). This rule
is intended to avoid duplication of section 987 gain or loss (for
example, when the partnership interest is sold). The final regulations
retain this rule for taxpayers that apply section 987 using a method
that results in recognition, deferral, or suspension of section 987
gain or loss at the partner level. Under Sec. 1.987-7(e), the
partner's basis in its partnership interest is adjusted under the
principles of section 705 as though the section 987 gain or loss was
part of the partner's distributive share of partnership items. See
Sec. 1.987-7(e).
A commenter requested clarification concerning the interaction of
this basis adjustment rule with section 704(d). Section 704(d)(1)
provides that a partner's distributive share of partnership loss
(including capital loss) shall be allowed only to the extent of the
basis of that partner's interest in the partnership at the end of the
partnership year in which such loss occurred. Section 704(d)(2)
provides for the carryover of the excess of any loss over such basis to
the next taxable year. To the extent that basis is available in the
next taxable year, the partner is able to take the loss into account.
Relatedly, the partner will decrease the adjusted basis in its
partnership interest to the extent that any loss carryover is taken
into account within the taxable year. See section 705(a)(2).
The final regulations clarify that the principles of section 704(d)
are applied as though items of section 987 loss, deferred section 987
loss, or suspended section 987 loss were part of the partner's
distributive share of partnership items. See Sec. 1.987-7(e). The
basis adjustment rule in Sec. 1.987-7(e) is intended to replicate the
basis adjustments that would occur if the relevant section 987 gain or
loss was taken into account as part of the partner's distributive share
of partnership income or loss (including the effects of section
704(d)).
5. Other Special Rules for Partnerships
The final regulations contain several other rules that facilitate
the application of section 987 to partnerships. If a partner in a
partnership is treated as the owner of a section 987 QBU directly owned
by the partnership (for example, under an aggregate approach), Sec.
1.987-7(c)(3)(ii) provides a special rule that is used to determine the
members of the owner's controlled group for purposes of Sec. Sec.
1.987-12 and 1.987-13. Under this rule, any member of the partnership's
controlled group is treated as a member of the partner's controlled
group so long as the partner continues to be a partner in the
partnership. Thus, for example, if the partnership contributes the
section 987 QBU's assets to a wholly owned subsidiary of the
partnership, the subsidiary will be treated as a member of the
partner's controlled group and the contribution may be treated as a
deferral event for purposes of Sec. 1.987-12.
When a partnership is itself treated as a QBU of a partner that is
subject to section 987, and the partnership is not engaged in any trade
or business (for example, a partnership that functions as a holding
company), the rules of Sec. 1.987-13(b) through (d) do not apply.
Those rules are designed to attribute suspended section 987 loss to a
successor suspended loss QBU if the assets of a section 987 QBU
continue to be used in the same trade or business by a member of the
controlled group, and they trigger the recognition of suspended section
987 loss if the section 987 QBU terminates without a successor.
However, when a QBU that has suspended section 987 loss is not engaged
in any trade or business, the rules of Sec. 1.987-13(b) through (d)
would not result in the appropriate recognition of suspended section
987 loss and could be prone to manipulation. Accordingly, the suspended
section 987 loss can be recognized only under the loss-to-the-extent-
of-gain rule of Sec. 1.987-11(e).
The transition rules in Sec. 1.987-10 do not apply to
partnerships. Instead, the applicable rules of the section 987
regulations take effect on the transition date with respect to section
987 gain or loss determined and recognized under the taxpayer's
existing method. In addition, taxpayers may not apply the fresh start
transition method with respect to a partnership. As explained in the
preamble to the 2023 proposed regulations, the fresh start transition
method is no longer available because that method results in the
elimination of pretransition gain or loss, and (if it were available)
it could be opportunistically used by taxpayers to eliminate their
pretransition gain. 88 FR 78150 and 78156.
The final regulations also clarify that the rule in Sec. 1.988-
1(a)(10)(i), which provides that transactions between a taxpayer and
its QBU generally are not section 988 transactions, applies only to
disregarded transactions. Thus, a nonfunctional currency transaction
between a partner and a partnership could be treated as a section 988
transaction even though the partnership is treated as a QBU subject to
section 987.
IX. Comments and Changes to Proposed Sec. 1.987-10: Transition Rules
Proposed Sec. 1.987-10 would provide transition rules for the
first year in which the section 987 regulations are applicable. In
particular, proposed Sec. 1.987-10(e) would provide rules for
determining and recognizing pretransition gain or loss with respect to
each of a taxpayer's QBUs.
A. Computation of Pretransition Gain or Loss
1. Taxpayers That Applied Section 987 Using an Eligible Pretransition
Method
Under the 2023 proposed regulations, the computation of
pretransition gain or loss would differ depending on how the taxpayer
applied section 987 before the transition date. If the taxpayer applied
section 987 to a section 987 QBU using an eligible pretransition method
(as described in part IX.B of this Summary of Comments and Explanation
of Revisions), the owner would use that method to compute pretransition
gain or loss. Proposed Sec. 1.987-10(e)(2). The owner's pretransition
gain or loss would be equal to the amount of section 987 gain or loss
that it would have recognized under the eligible pretransition method
if the QBU terminated on the day before the transition date, with
certain adjustments. Proposed Sec. 1.987-10(e)(2)(i)(A).
Under proposed Sec. 1.987-10(e)(2)(i)(B), the amount of
pretransition gain or loss would be increased or reduced by the owner
functional currency net value adjustment (``OFCNV adjustment''), which
reflects 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,
if a taxpayer applied an earnings only method under which currency gain
or loss on the QBU's capital was not recognized at the time of a
remittance but was separately tracked and accounted for in determining
the basis of distributed assets, the currency gain or loss on capital
would be accounted for as part of the OFCNV adjustment.
Two comments were received relating to the OFCNV adjustment. One
comment requested that taxpayers be permitted to use the CTA prepared
for financial accounting purposes rather than making the OFCNV
adjustment. The comment asserted that taxpayers applying an earnings
only method might
[[Page 100153]]
not have the information necessary to compute the OFCNV adjustment.
The final regulations do not permit taxpayers to use the CTA in
lieu of making the OFCNV adjustment. As explained in part V.A.2 of this
Summary of Comments and Explanation of Revisions, the CTA amount may be
substantially different from the amount of section 987 gain or loss
that is properly taken into account for tax purposes. Moreover, it
should not be unduly burdensome for a taxpayer to compute the OFCNV
adjustment because the relevant information is already needed to apply
the taxpayer's existing pretransition method.
Another comment recommended that, in the case of taxpayers applying
an earnings only method, currency gain or loss with respect to the
QBU's capital should not be taken into account in determining
pretransition gain or loss (which is ultimately recognized as section
987 gain or loss after the transition date). The comment noted that
taxpayers may have adopted the earnings only method to reduce the size
of their section 987 gain or loss pools and that the earnings only
method serves to mitigate the potential for selective recognition of
large section 987 losses. Therefore, the comment requested that the
OFCNV adjustment instead be taken into account as an adjustment to
asset basis.
The Treasury Department and the IRS agree that, for taxpayers
applying an earnings only method, accounting for the OFCNV adjustment
in determining the basis of a section 987 QBU's assets would produce a
reasonable result that is consistent with these taxpayers'
pretransition method. Accordingly, under the final regulations, if a
taxpayer applied an earnings only method before the transition date and
does not make a current rate election for the taxable year beginning on
the transition date, the historic rate assigned to the section 987
QBU's historic assets (other than inventory) is equal to the exchange
rate that would have been used to translate those assets if they had
been distributed to the owner on the day before the transition date
(the ``pretransition translation rate''). See Sec. 1.987-10(d)(3)(ii).
As a result, no OFCNV adjustment is made with respect to those assets,
but currency gain or loss related to those assets will be accounted for
as the assets are sold or depreciated under Sec. 1.987-3. For
taxpayers that make a current rate election (and thus will not take
historic rates into account under Sec. 1.987-3), currency gain or loss
on the QBU's capital must be accounted for in determining pretransition
gain or loss. See Sec. 1.987-10(d)(3)(i) and (e)(2)(i)(B).
A comment raised a question as to whether the delegation of
regulatory authority under section 987(3) is self-executing. The
comment suggested that, if section 987(3) is not self-executing, then
it might not be appropriate to attribute pretransition gain or loss to
taxpayers that have not accounted for section 987 gain or loss before
the transition date. The Treasury Department and the IRS have concluded
that section 987(3) is self-executing because it provides a mandatory
delegation under which the Secretary is directed to determine how
(rather than whether) the owner of a section 987 QBU should make proper
adjustments in computing its taxable income. See, e.g., 15 W 17th St.
LLC v. Commissioner, 147 T.C. 557 (2016) (articulating standard for
determining whether a statute is self-executing in the absence of
regulations); Est. of Neumann v. Commissioner, 106 T.C. 216 (1996)
(holding delegation was self-executing because it related to how,
rather than whether, the statute applied). Therefore, taxpayers
currently are obligated to determine section 987 gain or loss in a
reasonable manner and must account for pretransition gain or loss once
the regulations become applicable.
2. Taxpayers That Did Not Apply Section 987 Using an Eligible
Pretransition Method
Under proposed Sec. 1.987-10(e)(3), taxpayers that did not apply
an eligible pretransition method would be required to determine
pretransition gain or loss by applying a simplified version of the
computation described in Sec. 1.987-4(d) to determine unrecognized
section 987 gain or loss (``annual unrecognized section 987 gain or
loss'') for each taxable year since the section 987 QBU's inception.
Proposed Sec. 1.987-10(e)(3)(iii). Pretransition gain or loss would be
reduced by any section 987 gain or loss recognized before the
transition date. Proposed Sec. 1.987-10(e)(3)(ii)(B).
Comments asserted that the method provided in proposed Sec. 1.987-
10(e)(3) could be burdensome to apply and difficult to administer. Some
comments recommended that taxpayers should not be required to compute
annual unrecognized section 987 gain or loss for each taxable year
since the QBU's inception. Instead, the comments suggested that the
final regulations provide a reasonable cutoff date before which
pretransition gain or loss would not be computed. Another comment
requested that taxpayers be permitted to determine pretransition gain
or loss using the earnings and capital method described in the 1991
proposed regulations, as this would avoid the need to prepare tax basis
balance sheets. A further comment recommended adoption of a de minimis
rule for taxpayers with minimal pretransition gain or loss.
The Treasury Department and the IRS agree that, when a QBU has been
operating for a long period, computing annual unrecognized section 987
gain or loss for all taxable years since the QBU's inception could be
burdensome. Accordingly, the final regulations provide a cutoff date of
September 7, 2006, which is the date on which proposed section 987
regulations were published in the Federal Register (71 FR 52876) (the
``2006 proposed regulations''). Under the final regulations, taxpayers
that did not apply an eligible pretransition method must compute
pretransition gain or loss only for taxable years beginning on or after
September 7, 2006. The publication date of the 2006 proposed
regulations is an appropriate cutoff date for this purpose because the
2006 proposed regulations contained transition rules that were
conditioned on the application of section 987 using a reasonable
method. See Sec. 1.987-10(a)(2) of the 2006 proposed regulations.
The final regulations also provide a de minimis rule to reduce the
compliance burden on small businesses that own section 987 QBUs.\6\
Under the de minimis rule, a qualifying taxpayer may elect to treat all
QBUs that fall below the de minimis threshold as having no
pretransition gain or loss. To qualify for the de minimis rule, the
owner of a section 987 QBU must have gross receipts that fall below the
threshold for the small business exception in section 163(j)(3) (that
is, the owner must have gross receipts of $25 million or less, indexed
to inflation and averaged over the prior 3-year period). If this test
is met, the de minimis rule applies to any section 987 QBU with gross
assets of less than $10 million (averaged over the same 3-year period
and taking into account the assets of all section 987 QBUs in the same
country that are owned by the same owner or a member of its controlled
group).
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\6\ Although taxpayers that own section 987 QBUs generally are
not small businesses, this rule is intended to limit the compliance
burden for small businesses that may be affected.
---------------------------------------------------------------------------
The final regulations do not permit taxpayers to apply an earnings
and capital method in lieu of computing annual unrecognized section 987
gain or loss under Sec. 1.987-10(e)(3). However, as explained in part
V.A.1 of this Summary
[[Page 100154]]
of Comments and Explanation of Revisions, the rules for computing
unrecognized section 987 gain or loss for a taxable year under Sec.
1.987-4(d) have been modified so that they can be applied without the
need for tax basis balance sheets. As a result, the method provided in
Sec. 1.987-10(e)(3) can similarly be applied without tax basis balance
sheets (that is, by computing QBU net value using the formula provided
in Sec. 1.987-4(e)(2)(iii)).
B. Definition of an Eligible Pretransition Method
Under the 2023 proposed regulations, an eligible pretransition
method would be defined to include a reasonable application of the
earnings and capital method described in the 1991 proposed regulations,
any other reasonable method that produces the same total amount of
income as the earnings and capital method over the life of the owner,
or an earnings only method that does not produce the same total amount
of lifetime income as an earnings and capital method (subject to
certain restrictions, including a consistency requirement). Proposed
Sec. 1.987-10(e)(4)(i) through (iii). The owner must have applied the
eligible pretransition method with respect to each taxable year
beginning before the transition date in which it was the owner of the
section 987 QBU. Proposed Sec. 1.987-10(e)(4). For this purpose, a
method under which the owner of a section 987 QBU defers the
recognition of section 987 gain or loss until the section 987 QBU is
terminated, sold, or liquidated is not a reasonable method. Proposed
Sec. 1.987-10(e)(4)(iv).
Comments requested clarification concerning the definition of an
eligible pretransition method. The comments noted that some taxpayers
have applied the 1991 proposed regulations with modifications; for
example, some taxpayers apply an annual netting convention to determine
the amount of a remittance or treat a group of QBUs with the same
functional currency as a single QBU. Other comments indicated that
taxpayers may not account for frequently recurring intercompany
transactions in computing their section 987 gain or loss.
One comment suggested that taxpayers should be treated as having
applied an eligible pretransition method so long as they made a good
faith effort to apply section 987 using a reasonable method. Another
comment recommended that taxpayers that have consistently relied on
their CTA account as an estimate of unrealized section 987 gain or loss
should be considered to have applied an eligible pretransition method
(and thus should be permitted to use their CTA account to determine the
amount of pretransition gain or loss).
Another comment suggested that a CFC that has consistently applied
a reasonable method since the enactment of the Tax Cuts and Jobs Act
(``TCJA''), Public Law 115-97, 131 Stat. 2054 (2017), should be treated
as having applied an eligible pretransition method, even if the method
was not applied in previous taxable years. In particular, the comment
recommended that an owner that began applying an earnings only method
described in proposed Sec. 1.987-10(e)(4)(iii) after the TCJA was
enacted should be deemed to meet the consistency requirement of
proposed Sec. 1.987-10(e)(4)(iii)(B).
In response to these comments, the final regulations clarify and
expand the definition of an eligible pretransition method under Sec.
1.987-10(e)(4). The definition is intended broadly to include any
method that complies with the statutory requirements of section 987 in
a reasonable manner.\7\
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\7\ In certain instances, a method that does not constitute a
reasonable application of section 987 is treated as an eligible
pretransition method in order to reduce the compliance burden of
transitioning onto the section 987 regulations.
---------------------------------------------------------------------------
1. Errors Made in Applying a Pretransition Method and Certain
Consistent Practices That Are Not Treated as Errors
The final regulations provide that a taxpayer is treated as
applying an eligible pretransition method even if the taxpayer made an
error in the application of its method or did not apply the method in
all taxable years in which it was the owner of the section 987 QBU.
Sec. 1.987-10(e)(4)(iv). However, taxpayers are required to compute
pretransition gain or loss under Sec. 1.987-10(e)(2) as though the
eligible pretransition method had been applied without error for all
prior taxable years. Thus, for example, if a taxpayer made an error in
applying its method for a prior year, the deemed termination amount
under Sec. 1.987-10(e)(2)(i)(A) is equal to the amount of section 987
gain or loss the taxpayer would have recognized on termination if it
had not made the error and its section 987 QBU terminated on the day
before the transition date.
If a taxpayer consistently used a reasonable convention to apply
section 987 before the transition date, the taxpayer must use the same
convention in determining pretransition gain or loss under Sec. 1.987-
10(e)(2). See Sec. 1.987-10(e)(4)(v)(B)(1). Thus, unlike a taxpayer
that made an error in applying its pretransition method, a taxpayer
that used a reasonable convention would not be required to recompute
pretransition gain or loss without regard to the convention. Similarly,
if a taxpayer had a consistent practice under which it did not account
for frequently recurring disregarded transactions in determining the
amount of section 987 gain or loss recognized upon a remittance, this
practice is not treated as an error. See Sec. 1.987-10(e)(4)(v)(B)(2).
However, this rule does not apply unless the taxpayer reasonably
accounted for the disregarded transactions in determining the amount of
unrecognized section 987 gain or loss with respect to the section 987
QBU (for example, in the case of a taxpayer applying the 1991 proposed
regulations, by adjusting the equity and basis pools to reflect the
amount of each transfer).
2. Timing for Application of an Eligible Pretransition Method
The final regulations provide that a method of applying section 987
is not an eligible pretransition method unless it was applied on at
least one tax return filed before November 9, 2023 (when the 2023
proposed regulations were filed with the Federal Register). See Sec.
1.987-10(e)(4). Thus, a taxpayer that first adopted a reasonable method
in the first taxable year after the TCJA was enacted would be treated
as applying an eligible pretransition method, but a method adopted
after November 9, 2023, would not qualify. Similarly, the final
regulations modify the consistency requirement for the earnings only
method under Sec. 1.987-10(e)(4)(iii)(B) to require consistent
application for all taxable years since the first taxable year in which
the owner applied an eligible pretransition method. As a result, an
owner that began applying the earnings only method after the TCJA was
enacted (and did not previously apply a different eligible
pretransition method) would meet this requirement.
3. Reliance on the CTA
Under the final regulations, a method that relies on the CTA
determined for financial accounting purposes would not qualify as an
eligible pretransition method; thus, taxpayers relying on CTA
computations must determine pretransition gain or loss using the method
provided in Sec. 1.987-10(e)(3). As discussed in part V.A.2 of this
Summary of Comments and Explanation of Revisions, because the amount of
the CTA can be substantially different from the amount of section 987
gain or loss properly computed for tax purposes, reliance on the CTA
could result in the recognition of significant amounts of artificial
pretransition gain or loss.
[[Page 100155]]
C. Recognition of Pretransition Gain or Loss
In general, under the proposed regulations, pretransition gain is
treated as net unrecognized section 987 gain, while pretransition loss
is treated as suspended section 987 loss. Proposed Sec. 1.987-
10(e)(5)(i)(A) and (B). This rule is intended to prevent taxpayers from
selectively recognizing pretransition loss while deferring
pretransition gain until the year of a remittance. Alternatively,
taxpayers could 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).
A comment recommended that pretransition loss should not be treated
as suspended section 987 loss in the first taxable year in which the
section 987 regulations apply. Instead, the comment recommended that
pretransition loss should be treated as net unrecognized section 987
loss upon transition, which would later become suspended in the year of
a remittance. The comment noted that this would create parity between
pretransition loss and pretransition gain, which is treated as net
unrecognized section 987 gain in the first taxable year in which the
regulations apply.
Another comment recommended that, instead of determining
pretransition gain or loss separately with respect to each QBU, the
total amount of pretransition gain or loss in each category should be
aggregated and netted among all QBUs of the same owner, with the net
amounts reallocated to each QBU on a pro rata basis. In the case of a
consolidated group or a group of related CFCs, the comment suggested
further netting between all members of the consolidated group or group
of related CFCs, respectively.
With respect to the amortization election under proposed Sec.
1.987-10(e)(5)(ii), a comment suggested that taxpayers should be
allowed to elect a shorter amortization period in which to recognize
pretransition gain or loss (either four or five years), which would
better align with certain taxpayers' internal forecasting and planning
windows. A comment also requested clarification as to how the
amortization election applies with respect to a terminating QBU (that
is, a section 987 QBU that terminated after November 9, 2023, and
before the taxable year in which the section 987 regulations are
generally applicable).
The final regulations provide that, if a current rate election is
in effect in the taxable year beginning on the transition date (and an
annual recognition election is not in effect), pretransition gain or
loss is treated as net unrecognized section 987 gain or loss. Thus,
pretransition losses are treated the same way as pretransition gains.
However, if a current rate election is not in effect (or an annual
recognition election is in effect) in the taxable year beginning on the
transition date, pretransition loss is treated as suspended section 987
loss upon transition. This rule is necessary to prevent pretransition
loss from being recognized without limitation.
The final regulations do not permit aggregation and netting of
pretransition gain or loss within the same category. Absent an
amortization election, the source and character of pretransition gains
and losses generally will not be assigned in the taxable year beginning
on the transition date, so it would not be possible to net gains and
losses separately within each recognition grouping. In addition,
aggregation and netting would make the transition rules more
complicated and would increase the burden of administering these rules.
Finally, taxpayers that make the amortization election can, as a
practical matter, achieve the effect of netting pretransition gains and
losses, because those gains and losses will be recognized over the same
ten-year period.
The final regulations retain the ten-year amortization period under
Sec. 1.987-10(e)(5)(ii) and do not permit taxpayers to elect a shorter
amortization period. The Treasury Department and the IRS have
determined that a uniform amortization period should apply to all
electing taxpayers to prevent the potential for whipsaw that could
result from taxpayers with losses electing shorter amortization periods
than taxpayers with gains. In addition, a ten-year period is
appropriate given the expected magnitude of the pretransition gains and
losses that are subject to amortization. However, taxpayers that do not
make the amortization election will retain some control over when gains
and losses are recognized (by choosing whether or not to make
remittances). The final regulations also expand the acceleration rule
of Sec. 1.987-10(e)(5)(ii)(B) to cover transactions entered into with
a principal purpose of avoiding the recognition of pretransition gain
that is subject to the amortization election. See Sec. 1.987-
10(e)(5)(ii)(B)(1).
In addition, the final regulations clarify the application of the
amortization election in the case of a terminating QBU. Under Sec.
1.987-10(e)(5)(ii)(C), any deferred section 987 gain or suspended
section 987 loss with respect to a terminating QBU that has not been
recognized before the first taxable year in which the section 987
regulations are generally applicable is subject to amortization
beginning in that year. However, the final regulations do not modify
the treatment of section 987 gain or loss that has already been
recognized before the transition date; thus, such section 987 gain or
loss is not subject to amortization.
X. Comments and Changes to Proposed Sec. 1.987-11: Suspended Section
987 Loss Relating to Certain Elections; Loss-to-the-Extent-of-Gain Rule
Proposed Sec. 1.987-11 provides rules that suspend the recognition
of section 987 loss in connection with certain elections and rules
under which suspended section 987 loss is recognized to the extent of
recognized section 987 gain (the ``loss-to-the-extent-of-gain rule'').
A. Loss Suspension Rule
1. In General
Under proposed Sec. 1.987-11(c), in a taxable year in which a
current rate election is in effect (and an annual recognition election
is not in effect), any section 987 loss that would otherwise be
recognized as a result of a remittance or termination would be treated
as suspended section 987 loss.
A comment requested that the loss suspension rule of Sec. 1.987-
11(c) be eliminated because it prevents taxpayers from recognizing
section 987 losses in connection with legitimate commercial
transactions. The comment noted that the recognition of section 987
loss often is not the primary factor in determining whether a taxpayer
causes its branch to make a remittance.
The final regulations retain the loss suspension rule in Sec.
1.987-11(c). Congress specifically authorized loss limitation rules to
address the potential for selective recognition of losses. See section
989(c)(2). These rules are integral to the current rate election;
without a loss limitation the current rate election would create
opportunities for abuse. Although remittances are often made for non-
tax reasons, taxpayers can cause section 987 QBUs to make otherwise
disregarded transfers for the purpose of recognizing large section 987
losses, and taxpayers have the ability to structure transactions in
ways that defer the recognition of section 987 gain.
However, the final regulations limit the scope of the loss
suspension rule to cover transactions that would otherwise result in
the recognition of substantial section 987 losses. Under Sec. 1.987-
11(c)(2), if a current rate election is in effect, section 987 loss is
not suspended unless the amount of section 987 loss
[[Page 100156]]
subject to suspension in the taxable year exceeds the lesser of $3
million or two percent of the controlled group's gross income. This
threshold is applied collectively to the section 987 loss of the owner
and all members of the owner's controlled group. This rule is expected
to reduce the compliance burden of tracking suspended section 987
losses, particularly for taxpayers with small section 987 QBUs.
2. Exception for QBUs With De Minimis Historic Assets
Comments requested an exception from the loss suspension rule for
section 987 QBUs with minimal historic assets (such as financial
institutions and insurance companies). Alternatively, a comment
recommended that the loss suspension rule should apply solely to
section 987 loss associated with historic items.
The final regulations do not provide an exception to the loss
suspension rule for taxpayers with a de minimis amount of historic
assets. Such an exception would be difficult to administer because it
would require long-term tracking to ensure that the de minimis
threshold was met in all prior taxable years over which the pool of net
unrecognized section 987 gain or loss accrued. Further, for taxpayers
with minimal historic assets, the compliance burden of applying the
default rules of the final regulations (that is, the rules that apply
in the absence of a current rate election) is expected to be more
limited. A taxpayer that does not make a current rate election
generally would not be subject to the loss suspension rule.
Similarly, under the final regulations, the loss suspension rule of
Sec. 1.987-11(c) is not limited to section 987 loss associated with
historic items. Under Sec. 1.987-4, the pool of net unrecognized
section 987 gain or loss is determined with respect to a section 987
QBU as a whole. Separate computations of unrecognized section 987 loss
associated with marked and historic items, respectively, would add
significant complexity. Moreover, concerns related to selective
recognition of section 987 loss can arise with respect to both marked
and historic items.
B. Loss-to-the-Extent-of-Gain Rule
Under proposed Sec. 1.987-11(e), an owner of a section 987 QBU
recognizes suspended section 987 loss to the extent that it recognizes
section 987 gain in the same recognition grouping (that is, section 987
gain that has the same source and character as the suspended section
987 loss) in the same taxable year. As explained in the preamble to the
2023 proposed regulations, this rule is intended to prevent taxpayers
from selectively recognizing section 987 losses when a current rate
election is in effect. 88 FR 78139.
1. Lookback Rule
The 2023 proposed regulations do not include a lookback rule under
which suspended section 987 loss can be recognized to the extent of
section 987 gain recognized in previous taxable years. The preamble to
the 2023 proposed regulations expressed concern that taxpayers might
exploit a lookback rule by selectively triggering the recognition of
section 987 gain in a taxable year in which the gain could be offset by
losses or in which a taxpayer had excess foreign tax credits. 88 FR
78139.
Several comments recommended adoption of a lookback rule.
Alternatively, a comment recommended modifying proposed Sec. 1.987-
11(e) to permit taxpayers to carry back section 987 losses to earlier
years. Comments posited that, even if section 987 gain recognized in a
previous year is offset by a loss carryforward or other tax attribute,
the section 987 gain would still have a net impact on U.S. tax because
the attribute would no longer be available to be utilized in subsequent
years. However, the same comment expressed a minority view that a
lookback rule would afford some potential for abuse, and suggested
consideration of an anti-abuse rule targeting remittances that do not
have economic effect. One comment recommended that the lookback period
for section 987 gains should include years ending before the transition
date, while another comment suggested that the lookback period should
include only post-transition years.
The Treasury Department and the IRS agree that a lookback rule
would allow for more evenhanded treatment of section 987 gains and
losses when section 987 gain is recognized in an earlier taxable year
and that a lookback rule could be tailored to prevent abuse.
Accordingly, the final regulations provide that suspended section 987
loss is recognized to the extent of net section 987 gain recognized in
the current year and the three preceding taxable years. See Sec.
1.987-11(e)(3). Taxable years beginning before the transition date are
not included in the lookback period, given the substantial flexibility
taxpayers have had in determining the timing, amount, and character of
section 987 gain or loss recognized before the applicability date of
the final regulations.
Under an anti-abuse rule, section 987 gain is disregarded for
purposes of the loss-to-the-extent-of-gain rule if it is recognized
with a principal purpose of reducing U.S. Federal income tax liability,
including over multiple taxable years. See Sec. 1.987-11(e)(3)(v). For
example, this rule would apply if an owner recognizes section 987 gain
in a taxable year (``year 1'') in which the section 987 gain is offset
by a tax attribute that would not otherwise be used, the section 987
gain is recognized with a principal purpose of releasing suspended
section 987 loss in a subsequent taxable year (``year 2''), and the net
effect of recognizing both the section 987 gain and the suspended
section 987 loss would reduce the combined U.S. Federal income tax
liability for years 1 and 2. In determining whether such a principal
purpose exists, one relevant factor is the extent to which a remittance
does not result in a sustained economic contraction of the section 987
QBU (over a period of at least 12 months). Thus, for example, if a
section 987 QBU makes a remittance giving rise to the recognition of
section 987 gain, and the owner makes an offsetting contribution to the
section 987 QBU within 12 months of the remittance, the section 987
gain may be disregarded for purposes of the loss-to-the-extent-of-gain
rule.
The lookback period generally is limited to three years, because a
longer lookback period would require additional tracking of section 987
gains recognized in prior taxable years and would increase the
compliance and administrative burden of the section 987 regulations. In
addition, this rule is consistent with other Code provisions that limit
loss carryforward or carryback periods to a fixed number of years. See,
e.g., section 1212(a)(1) (generally permitting capital losses to be
carried forward for five years and carried back for three years).
Moreover, it may be difficult to enforce the anti-abuse rule in Sec.
1.987-11(e)(3)(v) with respect to transactions occurring more than
three years before the taxable year in which suspended section 987 loss
is recognized.
The final regulations provide a different lookback period for
taxpayers that make both an annual recognition election and a current
rate election. For these taxpayers, the lookback period includes all
taxable years in which both elections are continuously in effect. See
Sec. 1.987-11(e)(3)(iv)(B). As a result, for purposes of applying the
loss-to-the-extent-of-gain rule, the total amount of section 987 gain
recognized under the annual recognition election for all
[[Page 100157]]
taxable years in which both elections are continuously in effect is
offset by the total amount of section 987 loss recognized under the
annual recognition election for all taxable years in which both
elections are continuously in effect. As explained in the preamble to
the proposed regulations, the Treasury Department and the IRS are
concerned that, in the absence of such a rule, taxpayers would be able
to recognize net losses on a cumulative basis for the taxable years to
which the annual recognition election applies. 88 FR 78140. In
addition, the tracking burden in this context should be more limited
because losses generally are not suspended in taxable years in which an
annual recognition election is in effect.
In general, following a transaction described in section 381(a),
section 987 gain recognized by the transferor corporation in the three
years preceding the transaction is taken into account for purposes of
the lookback rule. See Sec. 1.987-11(e)(5)(i). However, this rule does
not apply in the case of an inbound reorganization or liquidation. See
Sec. 1.987-11(e)(5)(ii). Thus, section 987 gain recognized by the
foreign transferor corporation (which may have been subject to a lower
effective tax rate) cannot be used to release suspended section 987
loss of the domestic acquiring corporation.
2. Application of the Loss-to-the-Extent-of-Gain Rule at the Owner
Level
Under proposed Sec. 1.987-11(e), the loss-to-extent-of-gain rule
is applied separately to each owner with respect to all of its section
987 QBUs. Comments asserted that the loss-to-the-extent-of-gain rule
could produce harsh results when one CFC recognizes section 987 gain
and a related CFC has suspended section 987 loss. One comment noted
that concerns about selective recognition of section 987 loss should be
mitigated to the extent that a different CFC in the same group
recognizes section 987 gain.
Another comment recommended that, with respect to section 987 gain
or loss that is characterized as tested income, the loss-to-the-extent-
of-gain rule should be applied at the level of the U.S. shareholder
with respect to all section 987 QBUs of CFCs owned by the U.S.
shareholder, consistent with the general framework of section 951A.
Under this approach, the excess of the U.S. shareholder's pro rata
share of section 987 losses of any CFC attributable to a tested income
group over its pro rata share of section 987 gains attributable to the
same tested income group would be suspended (and available for
recognition to the extent of the U.S. shareholder's pro rata share of
section 987 gains recognized in future years). Another comment
recommended that the loss-to-the-extent of gain rule should be applied
to a group of related CFCs by treating the group as a single owner.
Under this approach, one CFC could recognize suspended section 987 loss
to the extent that another CFC recognized section 987 gain.
The final regulations generally apply the loss-to-the-extent of
gain rule separately to each owner, taking into account section 987
gain or loss with respect to all of the owner's section 987 QBUs. The
final regulations do not apply the loss-to-the-extent of gain rule at
the level of the U.S. shareholder. Because section 987 gain or loss is
a CFC-level income item that is taken into account in computing each
CFC's taxable income and earnings and profits, a U.S. shareholder level
loss limitation rule could reach inappropriate results for minority
shareholders and would be difficult to administer. For example, if a
CFC is owned by multiple U.S. shareholders, application of the loss-to-
the-extent-of-gain rule at the U.S. shareholder level would require
multiple separate computations to determine the suspended section 987
loss recognized by a single CFC.
Similarly, the final regulations do not treat a group of related
CFCs as a single owner for purposes of the loss-to-the-extent-of-gain
rule. A CFC grouping rule would make the loss-to-the-extent-of-gain-
rule more complex and more difficult to administer. Moreover, under a
CFC grouping rule, a CFC could recognize suspended section 987 loss as
a result of a different CFC's recognition of section 987 gain in the
same recognition grouping in a taxable year in which the loss cannot be
utilized.
3. Expansion of the Loss-to-the-Extent-of-Gain Rule
A comment recommended expansion of the loss-to-the-extent-of-gain
rule so that suspended section 987 loss could be recognized to the
extent of any income recognized by the owner (including but not limited
to section 987 gain) that has the same source and character as the
suspended section 987 loss. Another comment recommended that suspended
section 987 loss should be recognized to the extent of any section 987
gain recognized by the owner, even if the section 987 gain is in a
different recognition grouping. The comment suggested that the
requirement for section 987 gain to be in the same recognition grouping
as suspended section 987 loss does not serve the policy goals of
section 987, and that concerns relating to mismatches between the
source and character of section 987 gains and losses are adequately
policed by other provisions of the Code.
The final regulations do not expand the scope of the loss-to-the-
extent of gain rule to cover taxable income other than section 987
gain. Taxable income other than section 987 gain does not release
suspended section 987 loss under the loss-to-the-extent-of-gain rule
because this rule is intended to target selective recognition of
section 987 loss and deferral of section 987 gain.
In addition, the final regulations retain the rule that section 987
gain can only release suspended section 987 loss in the same
recognition grouping. This rule ensures that the loss-to-the-extent-of-
gain rule effectively limits selective recognition of losses pursuant
to the authority provided in section 989(c)(2). In particular, it
prevents taxpayers from avoiding the loss limitation by recognizing
gains that are subject to a low rate of tax (or are not subject to U.S.
tax).
As explained in part VII.B of this Summary of Comments and
Explanation of Revisions, the final regulations allow section 987 gain
or loss to be assigned to multiple subpart F income groups. Therefore,
each separate subpart F income group (as defined in Sec. 1.960-
1(d)(2)(ii)(B)) constitutes a separate recognition grouping. See Sec.
1.987-11(f)(2)(ii). However, as explained in part VII.B.2 of this
Summary of Comments and Explanation of Revisions, taxpayers can reduce
the number of subpart F recognition groupings by making the section 988
characterization election provided in Sec. 1.987-6(b)(2)(i)(C).
4. Application to Terminating QBUs
A comment requested clarification concerning the application of the
loss-to-the-extent-of-gain rule in the case of a terminating QBU. The
final regulations clarify that, when a terminating QBU has suspended
section 987 loss in a taxable year before the final regulations are
generally applicable, section 987 gain with respect to a taxpayer's
other section 987 QBUs is assigned to a recognition grouping under the
method applied by the taxpayer before the transition date. The owner
recognizes suspended section 987 loss with respect to a terminating QBU
only to the extent of its net section 987 gain in the same recognition
grouping for the taxable year.
[[Page 100158]]
5. SRLY Rule Relating to Suspended Section 987 Losses
When a corporation that is the owner of a section 987 QBU joins a
consolidated group, the corporation may have suspended section 987
losses that arose in earlier years. As explained in the preamble to the
2023 proposed regulations, the regulations issued under the authority
of section 1502 generally limit a consolidated group's ability to use
tax attributes generated in separate return years (as defined in Sec.
1.1502-1(e)). 88 FR 78154. The Treasury Department and the IRS
requested comments on how rules similar to the rules of Sec. 1.1502-
21(c) (limiting the use of net operating losses) should apply to
suspended and deferred section 987 losses. Id. No comments were
received in response to this request.
To prevent inappropriate trafficking of section 987 losses, Sec.
1.987-11(e)(6)(ii) of the final regulations provides that the separate
return limitation year (SRLY) limitation principles of Sec. 1.1502-
21(c) apply to suspended section 987 losses that arose in separate
return years. The rule in Sec. 1.987-11(e)(6)(ii) is based on the SRLY
rules for capital loss carryovers in Sec. 1.1502-22(c). To simplify
the administration of this rule, when a corporation that is the owner
of a section 987 QBU joins a consolidated group, the SRLY limitation is
not applied separately to each recognition grouping determined under
Sec. 1.987-11(f), but rather to the corporation's section 987 losses
overall.
Because deferred section 987 losses under Sec. 1.987-12 are not
subject to a loss-to-the-extent-of-gain rule, but rather are treated
similarly under the section 987 regulations to other unrecognized
section 987 losses, the SRLY limitation in Sec. 1.987-11(e)(6)(ii)
does not apply to such losses.
XI. Comments and Changes to Proposed Sec. 1.987-13: Suspended Section
987 Loss Upon Terminations
Proposed Sec. 1.987-13 would provide suspended loss rules that
apply in connection with certain transactions in which a section 987
QBU or a successor suspended loss QBU terminates.
A. Successor Rules
Under the 2023 proposed regulations, if an owner has suspended
section 987 loss with respect to a section 987 QBU that terminates, an
eligible QBU that holds the assets of the section 987 QBU after the
termination would be treated as a successor suspended loss QBU if it
meets three requirements. Proposed Sec. 1.987-13(b)(1)(i). First, a
significant portion of the assets of the terminating section 987 QBU
must be reflected on the books and records of the eligible QBU. Second,
the eligible QBU must carry on a trade or business of the section 987
QBU. Finally, the eligible QBU must be owned by the owner of the
section 987 QBU or by a member of its controlled group (the owner of
the successor is referred to as the ``successor suspended loss QBU
owner''). Following a termination, if the terminated section 987 QBU
has a successor, suspended section 987 loss with respect to the section
987 QBU would be attributed to the successor. Similar successor rules
would apply upon termination of a successor suspended loss QBU.
Proposed Sec. 1.987-13(c)(1)(i).
If a section 987 QBU or successor suspended loss QBU terminates
without a successor, the owner would recognize its cumulative suspended
section 987 loss with respect to the QBU. Proposed Sec. 1.987-13(b)(2)
and (c)(2). Similarly, the cumulative suspended section 987 loss with
respect to a successor suspended loss QBU would be recognized if the
original suspended loss QBU owner ceases to be a member of the same
controlled group as the successor suspended loss QBU owner due to the
transfer of an ownership interest in the successor suspended loss QBU
owner. Proposed Sec. 1.987-13(d).
A comment recommended that the definition of a successor suspended
loss QBU should be aligned with the definition of a successor deferral
QBU as provided in proposed Sec. 1.987-12(g)(2), so that the same
definition would apply for both purposes. The final regulations
generally retain the definition of a successor suspended loss QBU
provided in the proposed regulations because this definition is needed
to ensure that suspended section 987 loss can be recognized (in excess
of section 987 gain) only when the trade or business of a section 987
QBU ceases to be operated by a member of the same controlled group. The
successor rule in Sec. 1.987-12(g)(2) (which requires the successor to
itself be a section 987 QBU) would not serve this function, because it
would require suspended section 987 loss to be recognized when a
section 987 QBU is transferred to a related owner that has the same
functional currency as the section 987 QBU.
B. Elimination or Limited Recognition of Suspended Section 987 Loss
Following Certain Transactions
Proposed Sec. 1.987-13(e), (f), and (g) would provide rules that
eliminate or limit the recognition of suspended section 987 loss
following certain transactions. First, under proposed Sec. 1.987-
13(e), if the original suspended loss QBU owner ceases to be a member
of the same controlled group as the successor suspended loss QBU owner
due to the transfer of an ownership interest in the original suspended
loss QBU owner, the original suspended loss QBU owner's suspended
section 987 loss would cease to be attributable to any section 987 QBU
or successor suspended loss QBU. After the transaction, the owner's
suspended section 987 loss can be recognized under Sec. 1.987-11(e) to
the extent that the owner recognizes section 987 gain; however, the
suspended section 987 loss cannot be recognized under proposed Sec.
1.987-13(b)(2), (c)(2), or (d). This rule would prevent taxpayers from
transferring the stock of the original suspended loss QBU owner out of
its controlled group for the purpose of selectively recognizing
suspended section 987 loss, while retaining the assets and activities
of the section 987 QBU in the hands of a different controlled group
member.
Proposed Sec. 1.987-13(f) would provide that, if an original
suspended loss QBU owner ceases to exist as a result of a transaction
in which there is no successor described in section 381(a) (for
example, as a result of a section 331 liquidation), then any suspended
section 987 loss that is not recognized after applying the loss-to-the-
extent-of-gain rule cannot be recognized and is eliminated. This rule
is intended to prevent taxpayers from entering into section 331
liquidations in order to trigger the recognition of suspended section
987 loss.
Similarly, under proposed Sec. 1.987-13(g), if an owner of a
section 987 QBU with suspended section 987 loss, or an original
suspended loss QBU owner, ceases to exist in an inbound section 332
liquidation or in an inbound reorganization described in section
381(a)(2), then any suspended section 987 loss of the owner or original
suspended loss QBU owner that is not recognized after application of
the loss-to-the-extent-of-gain rule under proposed Sec. 1.987-11(e)
would be eliminated. This rule would prevent suspended section 987 loss
that was generated offshore from being imported into the United States.
Several comments requested that the rules of proposed Sec. 1.987-
13(e) through (g) be replaced with anti-abuse rules tied to the purpose
for which a taxpayer enters into the relevant transaction. One comment
noted that if a CFC liquidates into its U.S. shareholder and a current
rate election is not in effect, the transaction results in a
termination of
[[Page 100159]]
the CFC's section 987 QBUs under Sec. 1.987-8, and the CFC recognizes
its net unrecognized section 987 gain or loss immediately before the
liquidation. The comment proposed that suspended section 987 loss
should similarly be recognized in connection with an inbound
liquidation.
Other comments recommended that, following a section 331
liquidation or inbound transaction, suspended section 987 loss should
be amortized over a ten-year period or added to the acquiring
corporation's outside stock basis. One comment suggested that the
suspended section 987 loss should be allocated pro rata among the U.S.
shareholder's other foreign entities that own section 987 QBUs. Another
comment requested that Sec. 1.987-13(f) be modified to provide that
suspended section 987 loss is recognized to the extent of the owner's
overall gain (not limited to section 987 gain) recognized in connection
with the section 331 liquidation. One comment suggested that, in
connection with an inbound transaction, suspended section 987 loss
could be recognized to the extent of the inbounded section 987 gain.
The Treasury Department and the IRS have determined that, in order
to facilitate the current rate election (which can have the effect of
enlarging the pools of unrecognized section 987 gain or loss),
effective loss limitation rules are needed to prevent the selective
recognition of section 987 losses by, for example, entering into a
section 331 liquidation, inbound liquidation or reorganization, or a
transfer of the original suspended loss QBU owner. Further, an anti-
avoidance rule tied to the taxpayer's subjective purpose for entering
into a particular transaction would be difficult to administer and,
consequently, would not be an adequate safeguard against abuse given
the critical function served by the loss limitation rules. A subjective
anti-abuse rule would also provide less certainty for taxpayers and the
IRS. Therefore, the final regulations generally retain the rules of
proposed Sec. 1.987-13(e) through (g).
The final regulations do not permit suspended section 987 loss to
be amortized by the acquiring corporation over a ten-year period
following an inbound transaction or section 331 liquidation because
this would nevertheless facilitate loss importation (in the case of an
inbound transaction), even though the benefit would only be recognized
over time, or would allow for losses to be carried over to the acquirer
in a transaction not described in section 381(a) (in the case of a
section 331 liquidation). Similarly, reallocating losses to foreign
entities other than the acquiring corporation would be inconsistent
with the principles of section 381 and would be unduly complex. Adding
suspended section 987 loss of a CFC to the outside basis of a domestic
acquiring corporation's stock would have the same effect as loss
importation (because the increased basis could reduce the taxable
income of the domestic corporation's shareholders upon a sale of stock)
and would also shift losses in a manner that is contrary to general tax
principles.
The final regulations also do not permit suspended section 987 loss
to be recognized to the extent of gain (other than section 987 gain)
recognized in connection with a section 331 liquidation. As explained
in part X.B.3 of this Summary of Comments and Explanation of Revisions,
the loss-to-the-extent of gain rule generally does not allow suspended
section 987 loss to be recognized in excess of section 987 gain. If a
different rule were adopted for section 331 liquidations, taxpayers
could enter into a section 331 liquidation in order to step up the
basis of their assets, with any gain recognized with respect to those
assets being offset by the recognition of suspended section 987 loss.
However, consistent with the 2023 proposed regulations, the final
regulations permit suspended section 987 loss to be recognized to the
extent of section 987 gain recognized in connection with a transaction
described in Sec. 1.987-13(f) or (g). Because those transactions
generally would be treated as terminations under Sec. 1.987-8, any net
unrecognized section 987 gain of the owner will be recognized
immediately before the transaction and will be taken into account under
the loss-to-the-extent-of-gain rule.
C. Clarification of Sec. 1.987-13
A comment requested clarification as to the mechanics for
recognizing suspended section 987 loss following a transaction
described in Sec. 1.987-13(e), in which an original suspended loss QBU
owner is transferred outside the controlled group. The comment also
suggested clarifying the interaction between the successor rules of
Sec. 1.987-13(b) and (c) and the inbound transaction rule in proposed
Sec. 1.987-13(g).
The final regulations clarify that, following a transaction
described in Sec. 1.987-13(e) (in which the original suspended loss
QBU owner is transferred outside the controlled group), the original
owner recognizes suspended section 987 loss to the extent that it
recognizes section 987 gain in the same recognition grouping. Further,
in the case of a transaction described in Sec. 1.987-13(e) (transfer
of original suspended loss QBU owner), Sec. 1.987-13(f) (section 331
liquidation), or Sec. 1.987-13(g) (inbound transaction), suspended
section 987 loss is not recognized or attributed to a successor
suspended loss QBU under Sec. 1.987-13(b) or (c). The final
regulations also clarify that the rules of Sec. 1.987-13(f) apply to a
transaction (such as a section 331 liquidation) in which the owner of a
section 987 QBU ceases to exist without having a successor (that is,
this rule applies even if the section 987 QBU with respect to which the
suspended section 987 loss arose had not previously been terminated,
such that the owner was not an original suspended loss QBU owner).
XII. Comments and Changes to Proposed Sec. 1.987-14: Applicability
Date
Proposed Sec. 1.987-14 would provide rules relating to the
applicability date of the section 987 regulations.
In general, the 2023 proposed regulations are proposed to apply to
taxable years beginning after December 31, 2024. Proposed Sec. 1.987-
14(a)(1). In the case of a terminating QBU (that is, a section 987 QBU
that terminates after November 9, 2023, but before the section 987
regulations are generally applicable), the 2023 proposed regulations,
as finalized, generally would apply immediately before the termination.
A comment requested that the general applicability date be delayed
until taxable years beginning after December 31, 2025, to allow
additional time for taxpayers to build systems and processes to comply
with the final regulations. Another comment requested a deferred
applicability date no earlier than the taxable year beginning on or
after one year after the first day of the first taxable year following
the date on which the final regulations are published.
One comment requested that the special rule for terminating QBUs be
eliminated. The comment asserted that the existing deferral rules under
Sec. 1.987-12 are sufficient to prevent abuse.
Under Sec. 1.987-15, the final regulations generally apply to
taxable years beginning after December 31, 2024, consistent with the
2023 proposed regulations. See Sec. 1.987-15(a)(1). See also
Sec. Sec. 1.861-9(g)(2)(v), 1.985-5(g), 1.988-1(i), 1.988-4(b)(2)(ii),
1.989(a)-1(b)(4) and (d)(4), and 1.1502-13(l)(10). The 2016 final
regulations originally were applicable to taxable years beginning on or
after one year after the
[[Page 100160]]
first day of the first taxable year following December 7, 2016 (thus,
they would have been applicable in 2018 for calendar year taxpayers).
Although the applicability date of those regulations was subsequently
deferred, taxpayers have been on notice for many years concerning the
general framework of the section 987 regulations. Final regulations are
necessary to provide guidance to taxpayers regarding the proper
determination of section 987 taxable income or loss and section 987
gain or loss and to provide a consistent set of rules applicable to all
taxpayers. Accordingly, further deferral would not serve the interest
of sound tax administration. The applicability date under Sec. 1.987-
15(a)(1) is consistent with the rule under section 7805(b) of the Code
regarding retroactivity of regulations or rulings.
In addition, the final regulations retain the special applicability
date providing that the section 987 regulations apply to terminating
QBUs immediately before the termination. See Sec. 1.987-15(a)(2). This
rule is needed to prevent taxpayers from terminating a section 987 QBU
before the section 987 regulations generally become applicable in order
to avoid the rules of the section 987 regulations, including the loss
suspension rules in Sec. Sec. 1.987-10, 1.987-11, and 1.987-13.
XIII. Comments and Changes to Proposed Sec. 1.1502-13: Intercompany
Transactions
The 2023 proposed regulations would provide a new rule applicable
to certain intercompany transactions (as defined in Sec. 1.1502-
13(b)(1)(i)) involving section 987 QBUs. See proposed Sec. 1.1502-
13(j)(9).
In general, Sec. 1.1502-13 provides 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 or consolidated tax
liability. See Sec. 1.1502-13(a). Under Sec. 1.1502-13, the selling
member (S) and the buying member (B) are treated as separate entities
for some purposes but as divisions of a single corporation for other
purposes. The matching rule in Sec. 1.1502-13(c) is one of the
principal rules in Sec. 1.1502-13 that produces the effect of
transactions between divisions of a single corporation (single entity
treatment). See Sec. 1.1502-13(a)(6)(i).
To address potential mismatches that make it difficult to apply the
rules of Sec. 1.1502-13 to section 987 QBUs, the 2023 proposed
regulations would apply a reattribution rule that treats all
intercompany transactions involving a section 987 QBU as attributable
to a member's home office rather than to any section 987 QBU. As a
result, an intercompany transaction between one member of a
consolidated group and a section 987 QBU of another member of the same
group is treated as a combination of (i) an intercompany transaction
between the consolidated group members (that is, S and B), and (ii)
transfers between the section 987 QBU and its owner as necessary to
account for the effect of the transaction on the assets and liabilities
of the section 987 QBU. This approach would ensure that consolidated
taxable income includes the same amount of section 987 gain or loss as
would be recognized if the members were divisions of a single
corporation.
One comment requested that the proposed rule be removed, on the
grounds that it would change the amount of currency gain or loss
recognized by S and B with respect to intercompany transactions. For
example, assume that S has a section 987 QBU with the euro as its
functional currency, and the QBU makes a euro-denominated loan to B.
The comment noted that, under the proposed rule, B's foreign currency
exposure and S's foreign currency exposure offset for Federal income
tax purposes (that is, if B recognizes any section 988 gain or loss on
the interest payments, S will recognize an offsetting amount of section
988 loss or gain). The comment indicated that, for financial accounting
purposes, B's foreign currency exposure would result in net income (it
would not be offset by S's foreign currency exposure). According to the
comment, B would typically enter into a separate hedging transaction
(for example, a foreign currency forward contract) to hedge this
exposure. However, under the proposed rule, because the section 988
gain or loss of B and S with respect to the loan will offset for tax
purposes, the hedging transaction itself will generate net section 988
gain or loss. Therefore, the comment asserted that the proposed rule
may have the practical effect of giving rise to income or loss for tax
purposes for consolidated groups with respect to hedging transactions.
In other words, under the view expressed in the comment, if the
taxpayer enters into a hedging transaction for U.S. GAAP purposes, B
would have section 988 gain or loss on the loan absent the proposed
rule, and such gain or loss would be offset by loss or gain on the
hedging transaction; in contrast, under the proposed rule, B's section
988 gain or loss on the loan would be offset by S's section 988 loss or
gain, and loss or gain on the hedging transaction would not be offset.
The comment appears to reflect the view that, in the absence of the
reattribution rule in proposed Sec. 1.1502-13(j)(9), the matching rule
of Sec. 1.1502-13(c) does not apply to transactions involving section
987 QBUs, and as a result the tax treatment of S and B is determined
independently. Therefore, the comment appears to assume that the
Federal income tax treatment and the accounting treatment of
transactions involving section 987 QBUs would be identical without the
proposed rule.
The Treasury Department and the IRS disagree with the comment. The
intercompany transaction rules in Sec. 1.1502-13 apply to all
intercompany transactions, including those that involve section 987
QBUs, and taxpayers must apply those rules to achieve single entity
treatment. The reattribution rule of proposed Sec. 1.1502-13(j)(9)
merely reflects the application of the intercompany transaction rules
to section 987 QBUs in a simpler and more administrable manner for
taxpayers and the IRS. Therefore, removing the reattribution rule would
not address the concerns expressed in the comment. Additionally, the
approach discussed in the comment would be fundamentally inconsistent
with the purposes of section 1502 and Sec. 1.1502-13: it would not
clearly reflect the income tax liability of the consolidated group,
because it would allow intercompany transactions to accelerate or defer
currency gains and losses. The proposed reattribution rule is therefore
finalized without change.
Comments also requested clarification regarding Example 8 in
proposed Sec. 1.1502-13(j)(10)(viii). In response, the final
regulations include additional facts in Example 8 as well as two
alternative fact patterns involving (i) a member's disposition of an
intercompany loan before its satisfaction, and (ii) a member ceasing to
be a member of the consolidated group while an intercompany loan
remains outstanding. The final regulations also include formatting
changes to the examples under Sec. 1.1502-13(j) that were proposed in
REG-134420-10 (88 FR 52057).
XIV. Other Comments and Revisions
A comment recommended that the Treasury Department and the IRS
consider the impact of section 987 gain or loss on the corporate
alternative minimum tax (``CAMT'') regime. The comment did not
recommend specific rules to be implemented for this purpose. The final
regulations do not address the application of the CAMT regime.
Accordingly, this comment was
[[Page 100161]]
not adopted because it is outside the scope of the final regulations.
Similarly, comments requested that information relating to section
987 should continue to be reported on Form 8858, Schedule C-1, with
modifications for taxpayers that do not make a current rate election.
The development or modification of forms related to section 987 is
outside the scope of the final regulations. Therefore, this comment was
not adopted.
A comment was received in response to the 2016 proposed regulations
during the initial comment period for those proposed regulations. The
comment requested that the 2016 final regulations and the 2016
temporary regulations be reproposed with a deferred applicability date,
which is consistent with the approach taken by the 2023 proposed
regulations and these final regulations.
In addition to the provisions described in parts I through XIII of
this Summary of Comments and Explanation of Revisions, the final
regulations include other wording changes, additions, deletions, and
organizational changes to the 2023 proposed regulations for purposes of
clarification. For example, the rules in Sec. 1.987-3(c)(3) relating
to the adjustments required under the simplified inventory method have
been clarified, and an example has been added to illustrate those
rules. Similarly, the rules of Sec. 1.985-5 have been modified to
update cross-references to the section 987 regulations and to clarify
the example in Sec. 1.985-5(f).
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 Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (PRA)
requires that a Federal agency obtain the approval of the Office of
Management and Budget (OMB) before collecting information from the
public, whether such collection of information is mandatory, voluntary,
or required to obtain or retain a benefit. 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
OMB.
The collections of information in the final regulations with
respect to section 987 are in Sec. Sec. 1.987-1(g), 1.987-9, 1.987-
10(k), and 1.987-14(c). The likely respondents are individuals who file
a Form 1040 and businesses that file a Form 1065 or Form 1120. The
final regulations do not apply to trusts and estates. See part II.A.2
of the Summary of Comments and Explanation of Revisions.
The collection of information provided by 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 in 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, annual recognition election, or section 988
mark-to-market 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 Sec. 1.987-1(g) will be used by the IRS for
tax compliance purposes.
Section 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 Sec. 1.987-9 are considered
general tax records under Sec. 1.6001-1(e). For PRA purposes, general
tax records are already approved by OMB under 1545-0074 for individuals
and under 1545-0123 for business entities. The IRS intends that the
information collection requirements pursuant to 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, 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 (or the information used to determine QBU net value under
Sec. 1.987-4(e)(2)(iii), as explained in part V.A.1 of the Summary of
Comments and Explanation of Revisions); 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 and the
section 987 QBU; 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 for the taxable year; the amount
of the remittance and the remittance proportion for the taxable year;
the computations required under 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
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; the transition information required to be
determined under Sec. 1.987-10(k); and the identification required
under Sec. 1.987-14(c) with respect to a section 987 hedging
transaction. 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 Treasury Department and the IRS are adding a recordkeeping
requirement under Sec. 1.987-14(c) based on a public comment on the
substantive rules of the 2023 proposed regulations which requested
implementation of a section 987 hedging election. See part V.B.1 of the
Summary of Comments and Explanation of Revisions. Under Sec. 1.987-
14(c), the final regulations require an identification statement to be
kept in the taxpayers' books and records with respect to a section 987
hedging transaction described in Sec. 1.987-14(b)(1).
The collection of information in Sec. 1.987-10(k) is mandatory.
Specifically, 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
[[Page 100162]]
transition date (as defined in Sec. 1.987-10(c)). The statement would
contain information that is necessary for a taxpayer to transition to
the final 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 Sec. 1.987-10(k) will
be used by the IRS for tax compliance purposes.
The Treasury Department and the IRS intend that the information
described in 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 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
Sec. Sec. 1.987-1(g) and 1.987-10(k) will be reflected in the PRA
submissions associated with those forms. The OMB Control Numbers for
the forms will be approved under 1545-0074 for individuals and under
1545-0123 for business entities.
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 PRA
submissions associated with revenue procedures governing private letter
rulings. The OMB Control Number for the collection of information for
those revenue procedures is control number 1545-1522. The final
regulations would only require taxpayers to follow the procedures under
Revenue Procedure 2024-1, IRB 2024-1 (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 final 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 final 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 final
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 burden
will be accounted for in 1545-0074 for individuals and in 1545-0123 for
businesses.
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
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it
is hereby certified that this rulemaking will not have a significant
economic impact on a substantial number of small entities within the
meaning of section 601(6) of the Regulatory Flexibility Act. The final
regulations affect taxpayers with foreign branch operations and
taxpayers that own an interest in a foreign partnership (or a
partnership with a foreign branch).
The number of small entities potentially affected by the final
regulations is unknown; however, it is unlikely to be a substantial
number because taxpayers with wholly owned foreign operations are
typically larger businesses. The Treasury Department and the IRS
estimate that the total number of corporations (other than S
corporations) with a foreign branch subject to section 987 is
approximately 2,000. This estimate is based on the number of
corporations (other than S corporations) that filed a Form 8858 in 2022
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 or
branch was a section 989 QBU. As shown in the following table, only a
small percentage of those filers are small entities.
------------------------------------------------------------------------
Percentage of
Total receipts/positive income (2022) filers
------------------------------------------------------------------------
Under $5 Million........................................ 7
$5 Million to $10 Million............................... 2
$10 Million to $25 Million.............................. 4
Over $25 Million........................................ 87
------------------------------------------------------------------------
The number of affected corporations (other than S corporations)
with total receipts of less than $25 million represents 0.02% of all
corporations (other than S corporations) with total receipts of less
than $25 million.
The Treasury Department and the IRS estimate that the total number
of partnerships and S corporations with a foreign branch subject to
section 987 is approximately 800. Approximately 50 percent of those
filers have gross receipts of less than $25 million, but the data does
not indicate whether these partnerships are part of larger enterprises.
The number of affected partnerships and S corporations with total
receipts of less than $25 million represents 0.004% of all partnerships
and S corporations with total receipts of less than $25 million. Small
entities may also own partnership interests.
The primary rules that apply to partnerships (that is, the deferral
rules in Sec. 1.987-12 and the suspended loss rules in Sec. Sec.
1.987-11 and 1.987-13) apply only in the case of a remittance or
termination that would result in the recognition of a significant
amount of section 987 gain or loss. Small entities typically will not
recognize section 987 gain or loss in excess of the applicable
thresholds.
These final regulations generally modify the rules that would
otherwise apply under the 2016 final regulations by providing taxpayers
with additional elections that reduce the compliance burden of applying
section 987. Small entities generally would not be affected by these
rules unless they choose to make one of the new elections in order to
reduce their compliance burden. In addition, the final regulations
contain several rules intended to limit their impact on small
taxpayers. For example, the final regulations provide a de minimis rule
under which section 987 loss is not suspended unless the amount of the
loss exceeds the lesser of $3 million or two percent of gross income,
as described in part X.A.1 of the Summary of Comments and Explanation
of Revisions. In addition, for purposes of the transition rules, the
final regulations provide an election under which small businesses can
treat small QBUs as having no pretransition gain or loss. See part
IX.A.2 of the Summary of Comments and Explanation of Revisions.
A portion of the economic impact of the final regulations may
derive from the collection of information requirements imposed under
Sec. Sec. 1.987-1(g), 1.987-10(k), and 1.987-14(c). The Treasury
Department and the IRS have determined that the average burden is 1.95
hours per response. The IRS's Research, Applied Analytics, and
Statistics division estimates that the appropriate wage rate for this
set of taxpayers is $99.87 per hour. Thus, the annual burden per
taxpayer from each collection of information requirement is $194.75.
The requirements of Sec. 1.987-1(g) apply only if a taxpayer chooses
to make or revoke an election (and only in the year of the election or
revocation), the requirements of Sec. 1.987-10(k) apply
[[Page 100163]]
only in the first taxable year in which the final regulations apply,
and the requirements of Sec. 1.987-14(c) apply only if a taxpayer
identifies a hedge as a section 987 hedging transaction (which is
unlikely to be relevant for small entities).
Another portion of the economic impact of the final regulations may
derive from the recordkeeping requirements of Sec. 1.987-9, which
identify the records needed to satisfy the taxpayer's obligations under
section 6001. The requirements of Sec. 1.987-9 generally will be less
burdensome for small entities than the requirements of the 2016 final
regulations due to the modifications described in part V.A.1 of the
Summary of Comments and Explanation of Revisions (which permit QBU net
value to be computed without preparing a tax basis balance sheet).
IV. Section 7805(f)
Pursuant to section 7805(f) of the Code, the proposed regulations
preceding these final regulations were submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on their
impact on small business and no comments were received.
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 final 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 final 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.
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>.
Drafting Information
The principal authors of these final regulations are Adam G.
Province and Raphael J. Cohen of the Office of Associate Chief Counsel
(International); and Matthew N. Palucki and Jeremy Aron-Dine of the
Office of Associate Chief Counsel (Corporate). However, other personnel
from the Treasury Department and the IRS participated in their
development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, the Treasury Department and the IRS amend 26 CFR part
1 as follows:
PART 1--INCOME TAXES
0
Paragraph 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 through
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 1.987-11 in numerical
order;
0
g. Revising the entry for Sec. 1.987-12;
0
h. Adding entries for Sec. Sec. 1.987-13 through 1.987-15 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; and
0
k. Revising the entry for Sec. 1.1502-13.
The additions and revisions 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.
* * * * *
Section 1.987-1 also issued under 26 U.S.C. 987, 989, and 1502.
Section 1.987-2 also issued under 26 U.S.C. 987, 989, and 1502.
Section 1.987-3 also issued under 26 U.S.C. 987 and 989.
Section 1.987-4 also issued under 26 U.S.C. 987 and 989.
Section 1.987-5 also issued under 26 U.S.C. 987 and 989.
Section 1.987-6 also issued under 26 U.S.C. 904, 987, and 989.
Section 1.987-7 also issued under 26 U.S.C. 987 and 989.
Section 1.987-8 also issued under 26 U.S.C. 987 and 989.
Section 1.987-9 also issued under 26 U.S.C. 987, 989, and 6001.
Section 1.987-10 also issued under 26 U.S.C. 987, 989, and 6001.
Section 1.987-11 also issued under 26 U.S.C. 987, 989, and 1502.
Section 1.987-12 also issued under 26 U.S.C. 987 and 989.
Section 1.987-13 als
[…truncated; see source link]Indexed from Federal Register on December 11, 2024.
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