Reg. § 1.987-4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU.
(a) In general The net unrecognized section gain or loss of a section QBU is determined by the owner annually as provided in of this section in the owner's functional currency. Only assets and liabilities attributable to the section QBU are taken into account.
(b) Calculation of net unrecognized section 987 gain or loss Net unrecognized section gain or loss of a section QBU for a taxable year equals the sum of:
(1) The section QBU's net accumulated unrecognized section gain or loss for all prior taxable years as determined in of this section; and
(2) The section QBU's unrecognized section gain or loss for the current taxable year as determined in of this section and .
(c) Net accumulated unrecognized section 987 gain or loss for all prior taxable years
(1) In general A section QBU's net accumulated unrecognized section gain or loss for all prior taxable years is the aggregate of the amounts determined under of this section for all prior taxable years to which this section applies, reduced by amounts recognized under , amounts treated as deferred section gain or loss, and amounts treated as suspended section loss for all prior taxable years to which this section applies. Accordingly, net accumulated unrecognized section gain or loss is not reduced under this when deferred section gain or loss is recognized (or suspended) under or when suspended section loss is recognized under or .
(2) Additional adjustments for certain taxable years beginning on or before December 31, 2024 For any section QBU in existence before the transition date, see and for additional adjustments to the section QBU's net accumulated unrecognized section gain or loss.
(d) Calculation of unrecognized section 987 gain or loss for a taxable year The unrecognized section gain or loss of a section QBU for a taxable year is generally determined under through of this section. However, for taxable years in which a current rate election or an annual recognition election is in effect, the unrecognized section gain or loss of a section QBU for a taxable year is determined by applying only through and of this section. See for additional adjustments that must be made to the unrecognized section gain or loss of a section QBU for a taxable year in connection with a section hedging transaction.
(1) Step 1: Determine the change in the owner functional currency net value of the section 987 QBU for the taxable year
(i) In general The change in the owner functional currency net value of the section QBU for the taxable year equals—
(A) The owner functional currency net value of the section QBU, determined in the functional currency of the owner under of this section, on the last day of the taxable year; less
(B) The owner functional currency net value of the section QBU, determined in the functional currency of the owner under of this section, on the last day of the preceding taxable year.
(ii) Year section 987 QBU is terminated If a section QBU is terminated within the meaning of during an owner's taxable year, the termination date is treated as the last day of the taxable year for purposes of this section.
(iii) First taxable year of a section 987 QBU If the owner's taxable year is the first taxable year of a section QBU, the owner functional currency net value of the section QBU described in of this section is zero.
(iv) First year in which an election is in effect or ceases to be in effect Except as otherwise provided, the owner functional currency net value of the section QBU described in of this section is determined based on the elections that were (or were not) in effect on the last day of the preceding taxable year.
(2) Step 2: Increase the amount determined in step 1 by the amount of assets transferred from the section 987 QBU to the owner
(i) In general The amount determined in of this section is increased by the total amount of assets transferred from the section QBU to the owner during the taxable year translated into the functional currency of the owner as provided in of this section.
(ii) Assets transferred from the section 987 QBU to the owner during the taxable year The total amount of assets transferred from the section QBU to the owner for the taxable year translated into the functional currency of the owner equals the sum of:
(A) The amount of the functional currency of the section QBU and the aggregate adjusted basis of all other marked assets, after taking into account , transferred to the owner during the taxable year determined in the functional currency of the section QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and
(B) The aggregate adjusted basis of all historic assets transferred to the owner during the taxable year determined in the functional currency of the section QBU and translated into the functional currency of the owner at the historic rate for each such asset.
(3) Step 3: Decrease the amount determined in steps 1 and 2 by the amount of assets transferred from the owner to the section 987 QBU
(i) In general The aggregate amount determined in and of this section is decreased by the total amount of assets transferred from the owner to the section QBU during the taxable year determined in the functional currency of the owner as provided in of this section.
(ii) Assets transferred from the owner to the section 987 QBU during the taxable year The total amount of assets transferred from the owner to the section QBU for the taxable year equals the sum of:
(A) The amount of functional currency of the owner transferred to the section QBU during the taxable year; and
(B) The aggregate adjusted basis of all other assets, after taking into account , transferred to the section QBU during the taxable year determined in the functional currency of the owner immediately before the transfer.
(4) Step 4: Decrease the amount determined in steps 1 through 3 by the amount of liabilities transferred from the section 987 QBU to the owner
(i) In general The aggregate amount determined in through of this section is decreased by the total amount of liabilities transferred from the section QBU to the owner during the taxable year translated into the functional currency of the owner as provided in of this section.
(ii) Liabilities transferred from the section 987 QBU to the owner during the taxable year The total amount of liabilities transferred from the section QBU to the owner for the taxable year equals the sum of:
(A) The amount of marked liabilities, after taking into account , transferred to the owner during the taxable year determined in the functional currency of the section QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and
(B) The amount of historic liabilities transferred to the owner during the taxable year determined in the functional currency of the section QBU and translated into the functional currency of the owner at the historic rate for each such liability.
(5) Step 5: Increase the amount determined in steps 1 through 4 by the amount of liabilities transferred from the owner to the section 987 QBU The aggregate amount determined in through of this section is increased by the total amount of liabilities, after taking into account , transferred from the owner to the section QBU during the taxable year determined in the functional currency of the owner immediately before the transfer.
(6) Step 6: Decrease or increase the amount determined in steps 1 through 5 by the section 987 taxable income or loss, respectively, of the section 987 QBU for the taxable year The aggregate amount determined in through of this section is decreased or increased by the section taxable income or loss, respectively, computed under for the taxable year.
(7) Step 7: Increase the amount determined in steps 1 through 6 by certain expenses or losses that are not deductible in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year The aggregate amount determined under through of this section is increased by the amount of any expense or loss that reduces the basis of assets or increases the amount of liabilities attributable to the section QBU for the taxable year but is not deductible in computing the section QBU's taxable income or loss for the taxable year (such as business interest expense that is not deductible under section ). Items of expense or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under if they were deductible in computing the section QBU's taxable income or loss for the taxable year. However, any foreign income taxes incurred by the section QBU with respect to which the owner claims a credit are translated at the same rate at which such taxes were translated under section .
(8) Step 8: Decrease the amount determined in steps 1 through 7 by the amount of certain income or gain that is not included in taxable income in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year The aggregate amount determined under through of this section is decreased by the amount of any income or gain that increases the basis of assets or reduces the amount of liabilities attributable to the section QBU for the taxable year but is not included in taxable income in computing the section QBU's taxable income or loss for the taxable year. Items of income or gain described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under if they were included in taxable income in computing the section QBU's taxable income or loss for the taxable year.
(9) Step 9: Increase or decrease the amount determined in steps 1 through 8 by any income or gain, or any deduction or loss, respectively, that does not impact the adjusted balance sheet The aggregate amount determined under through of this section is increased by any items of income or gain taken into account in of this section (step 6) that do not increase the basis of assets or reduce the amount of liabilities attributable to the section QBU for the taxable year, and decreased by any items of deduction or loss taken into account in of this section (step 6) that do not reduce the basis of assets or increase the amount of liabilities attributable to the section QBU for the taxable year. Items of income, gain, deduction, or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that applied under in computing the section QBU's taxable income or loss for the taxable year.
(10) Step 10: Decrease or increase the amount determined in steps 1 through 9 by any increase or decrease, respectively, to the section 987 QBU's net assets that is not previously taken into account under steps 2 through 9
(i) In general Except as provided in of this section, the aggregate amount determined under through of this section is—
(A) Decreased by the residual increase to net assets (as defined in of this section), translated into the owner's functional currency at the yearly average exchange rate for the taxable year; or
(B) Increased by the residual decrease to net assets (as defined in of this section), translated into the owner's functional currency at the yearly average exchange rate for the taxable year.
(ii) Determining the residual increase or decrease to net assets
(A) In general The residual increase to net assets is the positive amount, if any, that would be determined under through of this section in the functional currency of the section QBU if such amounts were determined in the functional currency of the section QBU. The residual decrease to net assets is the negative amount, if any, that would be determined under through of this section in the functional currency of the section QBU if such amounts were determined in the functional currency of the section QBU.
(B) Application of step 1 in the functional currency of the section 987 QBU if a current rate election is in effect In a taxable year in which a current rate election is in effect, for purposes of applying step 1 ( of this section) in the functional currency of the section QBU, the change in the net value of the section QBU is determined by reference to the QBU net value described in of this section.
(C) Application of steps 3 and 5 in the functional currency of the section 987 QBU For purposes of applying steps 3 and 5 ( and of this section) in the functional currency of the section QBU, the amount of assets and liabilities transferred from an owner to a section QBU is determined by translating the basis of the assets and the amount of the liabilities under .
(iii) Modifications for taxable years to which a current rate election or an annual recognition election applies For any taxable year to which a current rate election or an annual recognition election applies, and of this section are applied by replacing “ through of this section” with “ through of this section.”
(e) Determination of the owner functional currency net value of a section 987 QBU
(1) In general Except as provided in of this section, the owner functional currency net value of a section QBU on the last day of a taxable year is equal to the aggregate amount of functional currency and the adjusted basis of each other asset on the section QBU's adjusted balance sheet on that day, less the aggregate amount of each liability on the section QBU's adjusted balance sheet on that day, in each case translated into the owner's functional currency as provided in and of this section.
(i) Marked item A marked item is translated into the owner's functional currency at the spot rate applicable to the last day of the relevant taxable year.
(ii) Historic item A historic item is translated into the owner's functional currency at the historic rate.
(2) Current rate election
(i) In general If a current rate election is in effect, the owner functional currency net value of a section QBU on the last day of a taxable year is equal to the QBU net value described in of this section, translated into the owner's functional currency at the spot rate applicable to that day.
(ii) QBU net value The QBU net value of a section QBU on the last day of a taxable year is determined in the functional currency of the section QBU and is equal to the aggregate amount of functional currency and the adjusted basis of each other asset that is attributable to the section QBU on that day, less the aggregate amount of each liability that is attributable to the section QBU on that day. The QBU net value of a section QBU on the last day of a taxable year may be determined either by preparing an adjusted balance sheet or by following the steps described in of this section (provided that the calculation is made consistently for all years in which a current rate election is in effect). However, in the first taxable year in which a current rate election ceases to be in effect, the owner functional currency net value of the section QBU for the preceding taxable year must be determined by preparing an adjusted balance sheet.
(iii) Alternative calculation of QBU net value The QBU net value of a section QBU on the last day of a taxable year can be computed using the following steps (each applied in the functional currency of the section QBU). See of this section (Example 2) for an example illustrating this rule.
(A) Step 1: Determine the QBU net value on the last day of the preceding taxable year Determine the QBU net value on the last day of the preceding taxable year under this . If the owner's taxable year is the first taxable year of a section QBU, the QBU net value on the last day of the preceding taxable year is zero. In the first taxable year in which a current rate election is in effect (other than the taxable year beginning on the transition date or the first taxable year of a section QBU), the QBU net value on the last day of the preceding taxable year is determined by preparing an adjusted balance sheet. In the taxable year beginning on the transition date (other than the first taxable year of a section QBU), the QBU net value on the last day of the preceding taxable year may be determined either by preparing an adjusted balance sheet or by applying the steps described in this for each taxable year beginning with the first taxable year of the section QBU.
(B) Step 2: Adjust for transfers between the section 987 QBU and its owner The amount determined in of this section is increased by the amount of each transfer described in or of this section and decreased by the amount of each transfer described in or of this section (in each case, after adjustment for gain or loss recognized under ). For this purpose, the amount of assets and liabilities transferred from an owner to a section QBU is determined by translating the basis of the assets and the amount of the liabilities under .
(C) Step 3: Adjust for income or loss of the section 987 QBU The amount determined in of this section is increased by items of income and gain attributable to the section QBU (including tax-exempt income described in of this section) for the taxable year and reduced by items of deduction and loss attributable to the section QBU (including non-deductible expenses described in of this section) for the taxable year. However, no adjustment is made under the preceding sentence for any item of income, gain, deduction, or loss described in of this section.
(f) Combinations and separations
(1) Combinations The net accumulated unrecognized section gain or loss of a combined QBU for a taxable year is equal to the sum of the combining QBUs' net accumulated unrecognized section gain or loss. See of this section (Example 1) for an illustration of this rule.
(2) Separations The net accumulated unrecognized section gain or loss of a separated QBU for a taxable year is equal to the separating QBU's net accumulated unrecognized section gain or loss multiplied by the separation fraction. For purposes of determining the owner functional currency net value and QBU net value of the separated QBUs on the last day of the taxable year preceding the taxable year of separation under and of this section, the assets and liabilities attributable to the separating QBU on that day are deemed to be attributable to the separated QBUs on that day, and are apportioned between the separated QBUs in a reasonable manner that takes into account the assets and liabilities attributable to the separated QBUs immediately after the separation. See of this section (Example 2) for an illustration of this rule.
(3) Examples The following examples illustrate the rules of and of this section. For purposes of these examples, assume that no section elections are in effect.
(i) Example 1: Combination of two section 987 QBUs that have the same owner
(A) Facts DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a manufacturing business that constitutes a section QBU (Manufacturing QBU) that has the euro as its functional currency. Manufacturing QBU has a net accumulated unrecognized section loss of $100. DC1 also owns Entity B, a DE. Entity B conducts a sales business that constitutes a section QBU (Sales QBU) that has the euro as its functional currency. Sales QBU has a net accumulated unrecognized section gain of $110. During the taxable year, Entity A merges into Entity B under local law pursuant to which Entity A ceases to exist, Entity B survives, and Entity B acquires all the assets and liabilities of Entity A. As a result, the books and records of Manufacturing QBU and Sales QBU are combined into a new single set of books and records. The combined entity has the euro as its functional currency.
(B) Analysis Pursuant to , Manufacturing QBU and Sales QBU are combining QBUs, and their combination does not give rise to a transfer that is taken into account in determining the amount of a remittance (as defined in ). For purposes of computing net unrecognized section gain or loss under this section for the year of the combination, the combination is deemed to have occurred on the last day of the owner's prior taxable year, such that the owner functional currency net value of the combined section QBU at the end of that taxable year described under of this section takes into account items attributable to both Manufacturing QBU and Sales QBU at that time. Additionally, any transactions between Manufacturing QBU and Sales QBU occurring during the year of the merger will not result in transfers to or from a section QBU. Pursuant to of this section, the combined QBU will have a net accumulated unrecognized section gain of $10 (the $100 loss from Manufacturing QBU plus the $110 gain from Sales QBU).
(ii) Example 2: Separation of two section 987 QBUs that have the same owner
(A) Facts DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in the Netherlands that constitutes a section QBU (Dutch QBU) that has the euro as its functional currency. The business of Dutch QBU consists of manufacturing and selling bicycles and scooters and is recorded on a single set of books and records. On the last day of year 1, the adjusted basis of the gross assets of Dutch QBU is €1,000. In year 2, the net accumulated unrecognized section loss of Dutch QBU from all prior taxable years is $200. During year 2, Entity A separates the bicycle and scooter business such that each business begins to have its own books and records and to meet the definition of a section QBU under (hereafter, “bicycle QBU” and “scooter QBU”). There are no transfers between DC1 and Dutch QBU before the separation. After the separation, the aggregate adjusted basis of bicycle QBU's assets is €600 and the aggregate adjusted basis of scooter QBU's assets is €400. Each section QBU continues to have the euro as its functional currency.
(B) Analysis Pursuant to , bicycle QBU and scooter QBU are separated QBUs, and the separation of Dutch QBU, a separating QBU, does not give rise to a transfer taken into account in determining the amount of a remittance. For purposes of computing net unrecognized section gain or loss under this section for year 2, the separation will be deemed to have occurred on the last day of the owner's prior taxable year, year 1. Pursuant to of this section and , bicycle QBU will have a separation fraction of €600/€1,000 and net accumulated unrecognized section loss of $120 (€600/€1,000 × $200), and scooter QBU will have a separation fraction of €400/€1,000 and net accumulated unrecognized section loss of $80 (€400/€1,000 × $200).
(g) Examples The following examples illustrate the provisions of this section. For purposes of the examples, U.S. Corp is a domestic corporation that uses the calendar year as its taxable year and has the dollar as its functional currency. Except as otherwise indicated, no section elections are in effect. The examples are not intended to demonstrate when activities constitute a trade or business within the meaning of and and therefore whether a section QBU is considered to exist.
(1) Example 1: Determination of net unrecognized section 987 gain or loss
(i) Facts On July 1, year 1, U.S. Corp establishes Japan Branch, a section QBU that has the yen as its functional currency, and U.S. Corp transfers to Japan Branch ¥100,000 with a basis of $1,000 and raw land with a basis of $500. On the same day, Japan Branch borrows ¥10,000 from a bank. In year 1, Japan Branch earns ¥12,000 for providing services and incurs ¥2,000 of related expenses. Japan Branch thus earns ¥10,000 of net income in year 1. The spot rate on July 1, year 1, is $1 = ¥100; the spot rate on December 31, year 1, is $1 = ¥120; and the average rate for the period of July 1, year 1, to December 31, year 1, is $1 = ¥110. Thus, the ¥12,000 of services revenue when translated under at the yearly average exchange rate equals $109.09 (¥12,000 × ($1/¥110)) = $109.09). The ¥2,000 of expenses translated at the same yearly average exchange rate equals $18.18 (¥2,000 × ($1/¥110) = $18.18). Thus, Japan Branch's net income translated into dollars equals $90.91 ($109.09−$18.18 = $90.91).
(ii) Analysis Under of this section, U.S. Corp must compute the net unrecognized section gain or loss of Japan Branch for year 1. Because this is Japan Branch's first taxable year, the net unrecognized section gain or loss (as defined under of this section) is equal to the branch's unrecognized section gain or loss for year 1 as determined in of this section. The calculations under of this section are made as follows:
(A) Step 1 Under of this section (step 1), U.S. Corp must determine the change in the owner functional currency net value (OFCNV) of Japan Branch for year 1 in dollars. The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year.
(1) The OFCNV of Japan Branch on December 31, year 1 is determined under of this section as the sum of the basis of each asset on Japan Branch's adjusted balance sheet on December 31, year 1, less the sum of each liability on Japan Branch's adjusted balance sheet on that date, translated into dollars as provided in and of this section.
(2) For this purpose, Japan Branch will show the following assets and liabilities on its adjusted balance sheet for December 31, year 1: cash of ¥120,000; raw land with a basis of ¥55,000 ($500 translated under at the historic rate of $1 = ¥110); and liabilities of ¥10,000.
(3) Under and of this section, U.S. Corp will translate these items as follows. The ¥120,000 is a marked asset and the ¥10,000 liability is a marked liability. These items are translated into dollars on December 31, year 1, using the spot rate on December 31, year 1, of $1 = ¥120. The raw land is a historic asset and is translated into dollars under of this section at the historic rate, which under is the yearly average exchange rate of $1 = ¥110 applicable to the year the land was transferred to the QBU.
(4) The OFCNV of Japan Branch on December 31, year 1, in dollars is $1,416.67. The determination of the OFCNV of Japan Branch on December 31, year 1, is shown below in dollars together with the corresponding amounts in yen.
| Amount in ¥ | Translation rate | Amount in $ | |
|---|---|---|---|
| Assets | |||
| Yen | 120,000 | $1 = ¥120 (spot rate-12/31/year 1) | $1,000.00 |
| Land | 55,000 | $1 = ¥110 (historic rate-yearly average rate-year 1) | 500.00 |
| Total assets | 175,000 | 1,500.00 | |
| Liabilities | |||
| Bank loan | 10,000 | $1 = ¥120 (spot rate-12/31/year 1) | 83.33 |
| Total liabilities | 10,000 | 83.33 | |
| Year 1 ending net value | 165,000 | 1,416.67 |
(5) Under of this section, the change in OFCNV of Japan Branch for year 1 is equal to the OFCNV of the branch determined in dollars on December 31, year 1, (which is $1,416.67) less the OFCNV of the branch determined in dollars on the last day of the preceding taxable year. Because this is the first taxable year of Japan Branch, the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year is zero under of this section. Accordingly, the change in OFCNV of Japan Branch for year 1 is $1,416.67.
(B) Step 2 (no adjustment) No adjustment is made under of this section (step 2) because no assets were transferred by Japan Branch to U.S. Corp during the taxable year.
(C) Step 3 On July 1, year 1, U.S. Corp transferred to Japan Branch ¥100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ¥55,000, translated under at the historic rate of $1 = ¥110). The total amount of assets transferred from U.S. Corp to Japan Branch in dollars is $1,500, and the total amount of the transfer in yen is ¥155,000. Therefore, under of this section (step 3), the amount determined in previous steps is reduced by $1,500.00, from $1,416.67 to negative $83.33.
(D) Steps 4 and 5 (no adjustment) No adjustment is made under and of this section (steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.
(E) Step 6 Under of this section (step 6), the amount determined in previous steps is decreased by the section taxable income of Japan Branch of $90.91, from negative $83.33 to negative $174.24.
(F) Steps 7 through 9 (no adjustment) No adjustment is made under through of this section (steps 7 through 9) because all of Japan Branch's items of income or deduction for the taxable year impact the basis of Japan Branch's assets or the amount of its liabilities and are taken into account in computing taxable income.
(G) Step 10 (no adjustment)
(1) Calculation of residual increase or decrease to net assets Under of this section, the residual increase (or decrease) to net assets is the positive (or negative) amount, if any, that would be determined under through of this section (steps 1 through 9) in the functional currency of the section QBU if such amounts were determined in the functional currency of the section QBU. In year 1, the relevant steps that must be applied in the functional currency of Japan Branch (the yen) are , , and of this section (steps 1, 3, and 6). For purposes of applying of this section (step 1) in yen, the change in the net value of Japan Branch is ¥165,000. See of this section. For purposes of applying of this section (step 3) in yen, the amount of assets transferred from U.S. Corp to Japan Branch is ¥155,000. See of this section. For purposes of applying of this section (step 6) in yen, Japan Branch earned ¥10,000 of net income in year 1. The application of these steps results in no residual increase or decrease to the adjusted balance sheet, as shown below:
| Change in net value in yen (step 1) | ¥165,000 |
| Subtract amount determined in yen under step 3 (transfers from owner to section 987 QBU) | (¥155,000) |
| Subtract amount determined in yen under step 6 (section 987 taxable income or loss) | (¥10,000) |
| Residual increase or decrease to the adjusted balance sheet | ¥0 |
(2) No residual increase or decrease to the adjusted balance sheet As explained in of this section, there is no residual increase or decrease to the adjusted balance sheet of Japan Branch in year 1. Therefore, no adjustment is made under of this section (step 10). Accordingly, the unrecognized section loss of Japan Branch for year 1 is $174.24.
(2) Example 2: Determination of net unrecognized section 987 gain or loss if a current rate election is in effect
(i) Facts The facts are the same as in of this section (Example 1), except that U.S. Corp makes a current rate election under for year 1.
(ii) Analysis Because a current rate election is in effect for year 1, the unrecognized section gain or loss for year 1 is determined by applying only through and of this section (steps 1 through 5 and step 10). The calculations under of this section are made as follows:
(A) Step 1 The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year.
(1) For this purpose, Japan Branch will show the same assets and liabilities on its adjusted balance sheet for December 31, year 1 as are described in of this section (Example 1), but the land is treated as a marked asset as a result of the current rate election. The adjusted balance sheet reflects cash of ¥120,000, raw land with a basis of ¥50,000 ($500 translated under at the July 1, year 1 spot rate of $1 = ¥100), and liabilities of ¥10,000.
(2) Under of this section, because a current rate election is in effect, the OFCNV of Japan Branch at the end of year 1 is equal to the QBU net value, translated into U.S. dollars at the applicable spot rate on the last day of the taxable year. The QBU net value of Japan Branch at the end of year 1 is ¥160,000, as shown below. The OFCNV of Japan Branch is $1,333.33, which is equal to the QBU net value of ¥160,000, translated at the applicable spot rate on December 31, year 1 of $1 = ¥120.
| Amount in ¥ | |
|---|---|
| Assets: | |
| Yen | 120,000 |
| Land | 50,000 |
| Total assets | 170,000 |
| Liabilities: | |
| Bank loan | 10,000 |
| Total liabilities | 10,000 |
| Year 1 QBU net value | 160,000 |
(3) Under of this section, the change in OFCNV of Japan Branch for year 1 is equal to the OFCNV of the branch determined in dollars on December 31, year 1, (which is $1,333.33) less the OFCNV of the branch determined in dollars on the last day of the preceding taxable year. Because this is the first taxable year of Japan Branch, the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year is zero under of this section. Accordingly, the change in OFCNV of Japan Branch for year 1 is $1,333.33.
(B) Step 2 (no adjustment) No adjustment is made under of this section (step 2) because no assets were transferred by Japan Branch to U.S. Corp during the taxable year.
(C) Step 3 On July 1, year 1, U.S. Corp transferred to Japan Branch ¥100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ¥50,000, translated under at the spot rate on July 31, year 1 of $1 = ¥100). The total amount of assets transferred in dollars is $1,500.00, and the amount of assets transferred in yen is ¥150,000. Therefore, under of this section (step 3), the amount determined in previous steps is reduced by $1,500, from $1,333.33 to negative $166.67.
(D) Steps 4 and 5 (no adjustment ). No adjustment is made under and of this section (steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.
(E) Steps 6 through 9 do not apply Under of this section, through of this section (steps 6 through 9) do not apply because a current rate election is in effect.
(F) Step 10
(1) Application of relevant steps in Japan Branch's functional currency Under of this section, because a current rate election is in effect, the residual increase or decrease to net assets is determined by applying through of this section (steps 1 through 5) in the functional currency of the section QBU. The relevant steps that must be applied under of this section in the functional currency of Japan Branch are and of this section (steps 1 and 3). Under of this section, step 1 is applied by reference to Japan Branch's QBU net value. See and of this section for amounts determined in yen. The residual increase to net assets is determined as follows:
| Step 1: Change in net value | ¥160,000 |
| Step 3: Subtract amount of transfers from owner to section 987 QBU | (¥150,000) |
| Residual increase or decrease to the adjusted balance sheet | ¥10,000 |
(2) Residual increase or decrease to net assets As explained in of this section, the residual increase to Japan Branch's net assets in year 1 is ¥10,000. This amount, translated at the yearly average exchange rate of $1 = ¥110, equals $90.91. Therefore, the amount determined in previous steps is reduced by $90.91, from negative $166.67 to negative $257.58. Accordingly, the unrecognized section loss of Japan Branch for year 1 is $257.58.
(iii) Alternative computation of QBU net value Alternatively, for purposes of applying steps 1 and 10 ( and of this section), U.S. Corp can determine QBU net value using the following steps under of this section.
(A) Step 1: Determine QBU net value at the end of the preceding taxable year Because year 1 is the first taxable year in which Japan Branch exists, the QBU net value at the end of the preceding taxable year is zero.
(B) Step 2: Adjust for transfers between the section 987 QBU and its owner During year 1, U.S. Corp transferred assets to Japan Branch with an aggregate basis of ¥150,000, as described in of this section. Therefore, the amount determined in step 1 is increased from zero to ¥150,000.
(C) Step 3: Adjust for income or loss of the section 987 QBU During year 1, Japan Branch earned ¥10,000 of net income. Therefore, the amount determined in step 2 is increased from ¥150,000 to ¥160,000.
(D) QBU net value Japan Branch's QBU net value at the end of the preceding taxable year is zero. This amount is increased by the transfer from U.S. Corp of ¥150,000 and by Japan Branch's taxable income of ¥10,000. Japan Branch did not have any tax-exempt income or non-deductible expenses in year 1. Accordingly, Japan Branch's QBU net value at the end of year 1 is ¥160,000.
(3) Example 3: Determination of net unrecognized section 987 gain or loss when a current rate election is revoked
(i) Facts
(A) Background The facts in year 1 are the same as in of this section (Example 2). In year 9, a current rate election remains in effect, U.S. Corp has net unrecognized section loss of $1,000 with respect to Japan Branch, and Japan Branch does not make a remittance. On December 31, year 9, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ¥120,000; raw land with a basis of ¥50,000; and liabilities of ¥10,000. Effective for year 10, U.S. Corp revokes the current rate election.
(B) Operations in year 10 In year 10, Japan Branch earns ¥12,000 for providing services and incurs ¥2,000 of related expenses. Japan Branch thus earns ¥10,000 of net income in year 10. On December 31, year 10, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ¥130,000; raw land with a basis of ¥50,000; and liabilities of ¥10,000. Assume that the spot rate on December 31, year 9, is $1 = ¥120; the spot rate on December 31, year 10, is $1 = ¥130; and the yearly average exchange rate for year 10 is $1 = ¥125. Thus, the ¥12,000 of services revenue when properly translated under at the yearly average exchange rate equals $96.00 (¥12,000 × ($1/¥125)) = $96.00). The ¥2,000 of expenses translated at the same yearly average exchange rate equals $16.00 (¥2,000 × ($1/¥125) = $16.00). Thus, Japan Branch's net income translated into dollars equals $80. There are no transfers of assets or liabilities between U.S. Corp and Japan Branch in year 10.
(ii) Analysis
(A) Determination of OFCNV for year 9 Under of this section, the OFCNV of a section QBU on the last day of the preceding taxable year is determined based on the elections that were (or were not) in effect on the last day of that taxable year. In year 9, a current rate election was in effect. Therefore, in determining the OFCNV of Japan Branch for year 9, all assets and liabilities of Japan Branch (including the land) are treated as marked items. Under of this section, because a current rate election was in effect for year 9, the OFCNV of Japan Branch at the end of year 9 is equal to the QBU net value, translated into U.S. dollars at the applicable spot rate on the last day of the taxable year. The QBU net value of Japan Branch at the end of year 9 is ¥160,000, as shown below. The OFCNV of Japan Branch is $1,333.33, which is equal to the QBU net value of ¥160,000, translated at the applicable spot rate on December 31, year 9 of $1 = ¥120.
| Amount in ¥ | |
|---|---|
| Assets: | |
| Yen | 120,000 |
| Land | 50,000 |
| Total assets | 170,000 |
| Liabilities: | |
| Bank loan | 10,000 |
| Total liabilities | 10,000 |
| Year 9 ending net value | 160,000 |
(B) Determination of OFCNV for year 10 In year 10, a current rate election is not in effect. Therefore, in determining the OFCNV of Japan Branch for year 10, the land owned by Japan Branch is treated as a historic item. Under , the historic rate applicable to historic items that were attributable to Japan Branch on the last day of the last taxable year in which a current rate election was in effect (December 31, year 9) generally is equal to the spot rate applicable to that day. Therefore, the historic rate applicable to the land is the spot rate on December 31, year 9. The OFCNV of Japan Branch for year 10 is $1,339.74, determined under of this section as follows (together with the corresponding amounts in yen):
| Amount in ¥ | Translation rate | Amount in $ | |
|---|---|---|---|
| Assets: | |||
| Yen | ¥130,000 | $1 = ¥130 (spot rate-12/31/year 10) | $1,000.00 |
| Land | 50,000 | $1 = ¥120 (historic rate-spot rate-12/31/year 9) | 416.67 |
| Total assets | 180,000 | 1,416.67 | |
| Liabilities: | |||
| Bank loan | 10,000 | $1 = ¥130 (spot rate-12/31/year 10) | 76.92 |
| Total liabilities | 10,000 | 76.92 | |
| Year 10 ending net value | 170,000 | 1,339.74 |
(C) Determination of unrecognized section 987 gain or loss for year 10 The unrecognized section gain or loss of Japan Branch for year 10 is determined under of this section as follows:
(1) Step 1 The change in the OFCNV of Japan Branch for year 10 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 10, less the OFCNV of Japan Branch determined in dollars on the last day of year 9. Therefore, the change in OFCNV is equal to $6.41 ($1,339.74—$1,333.33).
(2) Steps 2 through 5 (no adjustment) No adjustment is made under through of this section (steps 2 through 5) because no assets or liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year.
(3) Step 6 Under of this section (step 6), the amount determined in previous steps is decreased by the section taxable income of Japan Branch of $80.00, from $6.41 to negative $73.59.
(4) Steps 7 through 10 (no adjustment) No adjustment is made under through of this section (steps 7 through 10) because all of Japan Branch's items of income or deduction for the taxable year impact the basis of Japan Branch's assets or the amount of its liabilities and are taken into account in computing taxable income. In addition, Japan Branch does not have a residual increase or decrease to net assets (because the change in net value of ¥10,000 is equal to the amount of Japan Branch's net income in year 10). Accordingly, the unrecognized section loss of Japan Branch for year 10 is negative $73.59.
(D) Determination of net unrecognized section 987 gain or loss In year 10, Japan Branch has net accumulated section loss of $1,000. Because U.S. Corp revoked the current rate election for year 10, the net accumulated section loss of $1,000 becomes suspended section loss under and Japan Branch's net accumulated section loss is reduced to zero. Therefore, in year 10, Japan Branch's net unrecognized section loss is equal to $73.59, its unrecognized section loss for year 10.
[T.D. 10016, 89 FR 100165, Dec. 11, 2024]