Reg. § 1.987-3T Determination of section 987 taxable income or loss of an owner of a section 987 QBU (temporary).
(a) through (b) (2)(i) [Reserved] For further guidance, see through
(2)
(i)
(ii) No translation of basis or amount realized with respect to a specified owner functional currency transaction treated as a historic asset If the acquisition of a historic asset gives rise to a specified owner functional currency transaction described in of this section, the basis of the historic asset, and any amount realized on a disposition of the historic asset, is not translated if the amount is denominated in the owner's functional currency.
(3) [Reserved] For further guidance, see .
(4) Special rule for section 988 transactions
(i) In general Section and the regulations thereunder apply to section transactions of a section QBU. For this purpose, whether a transaction is a section transaction is determined by reference to the functional currency of the section QBU. (But see of this section, providing that specified owner functional currency transactions are not treated as section transactions.) However, except as provided in of this section, section gain or loss is determined in, and by reference to, the functional currency of the owner of the section QBU rather than the functional currency of the section QBU. Accordingly, in determining section gain or loss of a section QBU with respect to a section transaction of the section QBU, the amounts required under section and the regulations thereunder to be translated on the applicable booking date or payment date with respect to the section transaction are translated into the owner's functional currency at the rate required under section and the regulations thereunder.
(ii) Specified owner functional currency transactions not treated as section 988 transactions Transactions of a section QBU described in sections , , and (including the acquisition of nonfunctional currency as described in ), other than transactions described in of this section, that are denominated in (or determined by reference to) the owner's functional currency (specified owner functional currency transactions) are not treated as section transactions. Thus, no currency gain or loss is recognized by a section QBU under section with respect to such transactions.
(iii) Determination of section 988 gain or loss for qualified short-term section 988 transactions
(A) Determination by reference to the section 987 QBU's functional currency for certain transactions subject to a mark-to-market method of accounting Section gain or loss with respect to section transactions described in of this section that are accounted for under a mark-to-market method of accounting for Federal income tax purposes or under the foreign currency mark-to-market method of accounting described in of this section, and any hedges entered into to manage risk with respect to such transactions within the meaning of (related hedges), must be determined in, and by reference to, the functional currency of the section QBU (rather than the functional currency of its owner).
(B) Qualified short-term section 988 transaction A qualified short-term section transaction is a section transaction that occurs in the ordinary course of a section QBU's business and has an original term of one year or less on the date the transaction is entered into by the section QBU. The holding of currency that is nonfunctional currency (within the meaning of section ) to the section QBU in the ordinary course of a section QBU's trade or business also is treated as a qualified short-term section transaction. Any transaction that is denominated in, or determined by reference to, a hyperinflationary currency, including the holding of hyperinflationary currency, is not considered a qualified short-term section transaction. See , -2(d)(5), and 1.988-2(e)(7) for rules relating to transactions denominated in, or determined by reference to, a hyperinflationary currency.
(C) Election to use a foreign currency mark-to-market method of accounting A taxpayer may elect under this to apply the foreign currency mark-to-market method of accounting described in this paragraph for all qualified short-term section transactions described in of this section, and any related hedges, that are properly attributable to a section QBU on or after the effective date of the election and that are not otherwise accounted for under a mark-to-market method of accounting under section or section . Under the foreign currency mark-to-market method of accounting, the timing of section gain or loss on section transactions is determined under the principles of section . Thus, only section gain or loss is taken into account under the foreign currency mark-to-market method of accounting. Appropriate adjustments must be made to prevent the section gain or loss from being taken into account again under section or another provision of the Code or regulations. A section transaction subject to this election is not subject to the “netting rule” of section and , under which exchange gain or loss is limited to overall gain or loss realized in a transaction, in taxable years prior to the taxable year in which section gain or loss would be recognized with respect to such section transaction but for this election.
(iv) Examples Examples 10 through 13 of of this section illustrate the application of this .
(c)
(1) through(c)
(2)
(i) [Reserved] For further guidance, see through .
(ii) Amount realized with respect to historic assets that are section 988 transactions If the acquisition of a historic asset gave rise to a section transaction described in of this section, then in computing the total gain or loss on a disposition of the historic asset (some or all of which total gain or loss may be section gain or loss described in section and of this section), the amount realized (determined, if necessary, under ) is translated into the owner's functional currency using the spot rate on the date such item is properly taken into account, subject to the limitation under regarding the use of a spot rate convention.
(iii) through (iv) [Reserved] For further guidance, see through .
(v) Translation of income to account for certain foreign income tax claimed as a credit The owner of a section QBU claiming a credit under section for foreign income taxes, other than foreign income taxes deemed paid under section or section , that are properly reflected on the books and records of the section QBU (the creditable tax amount) must determine section taxable income or loss attributable to the section QBU by reducing the amount of section taxable income or loss that otherwise would be determined under this section by an amount equal to the creditable tax amount, translated into U.S. dollars using the yearly average exchange rate for the taxable year in which the creditable tax is accrued, and by increasing the resulting amount by an amount equal to the creditable tax amount, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section . See Example 14 of of this section,, for an illustration of this rule.
(d) Election to translate all items at the yearly average exchange rate Notwithstanding , a taxpayer that has made the annual deemed termination election described in may elect under this to translate all items of income, gain, deduction, and loss with respect to a section QBU determined under in the functional currency of the section QBU into the owner's functional currency, if necessary, at the yearly average exchange rate for the taxable year. Example 9 of of this section illustrates the application of this election.
(e) Example 1 through Example 8 [Reserved] For further guidance, see , Example 1 through Example 8.
Example 9. The facts are the same as in Example 7, except that U.S. Corp properly elects under of this section to translate all items of income, gain, deduction, and loss with respect to Business A at the yearly average exchange rate. Accordingly, Business A's €2,000 gain on the sale of the land is translated at the yearly average exchange rate for 2021 of €1 = $1.05, and the amount of gain reported by U.S. Corp on the sale of the land is $2,100.
Example 10. Business A acquires £100 on August 27, 2021, for €120 and sells the pounds on November 17, 2021, for €125. The dollar-pound spot rate (without the use of a spot rate convention) is £1 = $1 on August 27, 2021, and £1 = $1.10 on November 17, 2021. The disposition of the pounds is a section transaction of Business A under of this section, and the pounds are a historic asset under . Section gain or loss with respect to the disposition of the pounds is determined under of this section and by reference to the dollar functional currency of Business A's owner. The dollar amount realized for the pounds is determined under of this section by translating £100 into $110 using the dollar-pound spot rate on November 17, 2021, without the use of a spot rate convention. The dollar basis in the pounds is determined under by translating £100 into $100 using the historic rate described in , which is the dollar-pound spot rate on August 27, 2021, without the use of a spot rate convention. Thus, U.S. Corp takes into account $10 of section gain with respect to Business A's disposition of £100.
Example 11.
(i) Business A purchases a £100 2-year note for €75 on October 1, 2021, and receives a £100 repayment of principal with respect to the note on December 31, 2021. At the spot rates on October 1, 2021 (as defined in ), without the use of a spot rate convention, Business A's €75 purchase price translates into £80 and $95. At the spot rates on December 31, 2021, without the use of a spot rate convention, the £100 principal amount on the note translates into €90 and $130, and £80 translates into $104.
(ii) The acquisition of the note is a section transaction of Business A under of this section, and the note is a historic asset under . To determine its section taxable income or loss with respect to Business A, U.S. Corp must determine Business A's total gain or loss on the disposition of the note in U.S. Corp's dollar functional currency. Consistent with , U.S. Corp also must determine whether some or all of that gain or loss constitutes section gain or loss described in section .
(iii) To determine Business A's total gain or loss on the disposition of the note, Business A's basis and amount realized on the note must be determined in euros under , if necessary, and translated into dollars under . Business A has a €75 basis in the note that is translated into $95 under at the historic rate described in , which is the spot rate on the date the note was acquired without the use of a spot rate convention. Business A's £100 amount realized on the note is translated into €90 under using the spot rate on December 31, 2021, without the use of a spot rate convention. That €90 amount realized is then translated into $130 under of this section using the spot rate on December 31, 2021, without the use of a spot rate convention. Accordingly, the total gain with respect to the disposition of the note that is included in section taxable income is $35 ($130 less $95).
(iv) U.S. Corp must determine whether some or all of the $35 total gain with respect to the note constitutes section gain. The amount of section gain realized with respect to the note is determined under , which requires a comparison of the functional currency value of the principal amount of the note on the booking date and payment date spot rates, respectively, and defines the principal amount of the note as Business A's purchase price in units of nonfunctional currency, which is £80. Under of this section, section gain or loss with respect to the note is determined by reference to U.S. Corp's dollar functional currency, such that the amounts required under section to be translated on the booking date and payment date are translated into the dollars at the booking date and payment date spot rates. Accordingly, Business A's £80 principal amount with respect to the note is translated at the booking date and payment date spots rates into $95 and $104, respectively. Thus, $9 ($104 less $95) of the $35 total gain taken into account by U.S. Corp as section taxable income with respect to the note is section gain. The remaining $26 of gain, which may be attributable to credit risk or another factor unrelated to currency fluctuations, is sourced and characterized without regard to section .
Example 12. The facts are the same as in Example 11, except that Business A is owned by a foreign corporation with a pound functional currency. Under of this section, the acquisition of the £100 2-year note is a specified owner functional currency transaction that is not treated as a section transaction of Business A. Because the note is a historic asset under , Business A's €75 basis in the note translates into £80 at the historic rate described in , which provides that the historic rate is the spot rate for the date the note was acquired without the use of a spot rate convention. (If, instead, Business A had purchased the 5-year note for £80 rather than €75, then pursuant to of this section, Business A's basis in the note would have been determined without translating the £80 purchase price because it is denominated in the owner's functional currency.) Under of this section, the £100 amount realized with respect to the note is not translated because it is denominated in the owner's functional currency. Thus, the owner takes into account £20 (£100 less £80) of section taxable income in 2021 with respect to the note.
Example 13.
(i) Business A receives and accrues $100 of income from the provision of services on January 1, 2021. Business A continues to hold the $100 as a U.S. dollar-denominated demand deposit at a bank on December 31, 2021. U.S. Corp has elected under of this section to use the foreign currency mark-to-market method of accounting for qualified short-term section transactions entered into by Business A. The euro-dollar spot rate without the use of a spot rate convention is €1 = $1 on January 1, 2021, and €1 = $2 on December 31, 2021, and the yearly average exchange rate for 2021 is €1 = $1.50.
(ii) Under , the $100 earned by Business A is translated into €100 at the spot rate on January 1, 2021, as defined in without the use of a spot rate convention. In determining U.S. Corp's taxable income, the €100 of service income is translated into $150 at the yearly average exchange rate for 2021, as provided in .
(iii) The $100 demand deposit constitutes a qualified short-term section transaction under of this section because the demand deposit is treated as nonfunctional currency within the meaning of section . Because Business A uses the foreign currency mark-to-market method of accounting for qualified short-term section transactions, under of this section, section gain or loss for such transactions is determined in, and by reference to, euros, the functional currency of Business A. Accordingly, section gain or loss must be determined on Business A's holding of the $100 demand deposit in, and by reference to, the euro. Under , Business A is treated as having an amount realized of €50 when the $100 is marked to market at the end of 2021 under of this section. Marking the dollars to market gives rise to a section loss of €50 (€50 amount realized, less Business A's €100 basis in the $100). In determining U.S. Corp's taxable income, that €50 loss is translated into a $75 loss at the yearly average exchange rate for 2021, as provided in .
Example 14.
(i) Facts. Business A earns €100 of revenue from the provision of services and incurs €30 of general expenses and €10 of depreciation expense during 2021. Except as otherwise provided, U.S. Corp uses the yearly average exchange rate described in to translate items of income, gain, deduction, and loss of Business A. Business A is subject to income tax in Country X at a 25 percent rate. U.S. Corp claims a credit with respect to Business A's foreign income taxes and elects under section to translate the foreign income taxes at the spot rate on the date the taxes were paid. The yearly average exchange rate for 2021 is €1 = $1.50. The historic rate used to translate the depreciation expense is €1 = $1.00. The spot rate on the date that Business A paid its foreign income taxes was €1 = $1.60.
(ii) Analysis. Because U.S. Corp has elected to translate foreign income taxes at the spot rate on the date such taxes were paid rather than at the yearly average exchange rate, U.S. Corp must make the adjustments described in of this section. Accordingly, U.S. Corp determines its section taxable income by reducing the section taxable income or loss that otherwise would be determined under this section by €15, translated into U.S. dollars at the yearly average exchange rate (€1 = $1.50), and increasing the resulting amount by €15, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section (€1 = $1.60). Following these adjustments, Business A's section taxable income for 2021 is $96.50, computed as follows:
| Amount in € | Translation rate | Amount in $ | |
|---|---|---|---|
| Revenue | €100 | €1 = $1.50 | $150.00 |
| General Expenses | (30) | €1 = $1.50 | (45.00) |
| Depreciation | (10) | €1 = $1.00 | (10.00) |
| Tentative section 987 taxable income | €60 | $95.00 | |
| Adjustments under paragraph (c)(2)(v) of this section: | |||
| Decrease by €15 tax translated at yearly average exchange rate (€1 = $1.50) | ($22.50) | ||
| Increase by €15 tax translated at spot rate on payment date (€1 = $1.60) | 24.00 | ||
| Section 987 taxable income | $96.50 |
(f) Effective/applicability date This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under , then this section applies to taxable years to which through apply as a result of such election.
(g) Expiration date The applicability of this section expires on December 6, 2019.
[T.D. 9795, 81 FR 88870, Dec. 8, 2016]