Reg. § 1.987-6 Character and source of section 987 gain or loss.
(a) Ordinary income or loss Section gain or loss is ordinary income or loss for Federal income tax purposes.
(b) Character and source of section 987 gain or loss With respect to each section QBU, the character and source of section gain or loss is determined under this for all purposes of the Internal Revenue Code, including sections , , and .
(1) Timing of character and source determination The character and source of section gain or loss is determined based on the initial assignment pursuant to of this section and may be reassigned in the year in which the section gain or loss is recognized pursuant to of this section. The initial assignment is made in the earliest of the taxable years described in through of this section.
(i) The taxable year in which net unrecognized section gain or loss is recognized.
(ii) The taxable year in which net unrecognized section loss or pretransition loss becomes suspended section loss.
(iii) The taxable year in which net unrecognized section gain or loss becomes deferred section gain or loss.
(iv) In the case of pretransition gain or loss that is recognized ratably over the transition period pursuant to the election under , the taxable year that includes the transition date.
(2) Method for determining the character and source of section 987 gain or loss
(i) Initial assignment
(A) In general In the taxable year of the initial assignment, determined under of this section, the owner assigns gross section gain or loss to the statutory and residual groupings in the same proportions as the proportions in which the tax book value of the assets of the section QBU are assigned to the groupings under the asset method in and -9T(g), as modified by this . For purposes of applying the asset method, the owner takes into account only the assets that are attributable to the section QBU under . See and (grouping of section gain and loss and applying the loss-to-the-extent-of-gain rule on basis of the initial assignment of section gain and loss under this ).
(B) Special rules for applying the asset method to assign section 987 gain or loss For purposes of assigning gross section gain or loss to the statutory and residual groupings under of this section, the proportions in which the tax book value of the assets of the section QBU are assigned to the groupings described in of this section are determined without regard to section gain or loss. Further, the section gain or loss is assigned after any reattribution of gross income required under or (or the principles thereof, as applicable), but before the allocation and apportionment of expenses or the application of provisions that are based on a net income computation, such as the high-tax exception to passive category income in , the high-tax exception to foreign base company income in , and the high-tax exclusion from tested income in .
(C) Election to treat section 987 gain or loss that is assigned to subpart F income groups relating to foreign personal holding company income as attributable to section 988 transactions
(1) In general If an election is made under this , section gain or loss assigned under and of this section to any grouping of passive foreign personal holding company income, as described in , is treated as foreign currency gain of the owner attributable to section transactions not directly related to the business needs of the controlled foreign corporation, or as loss allocated and apportioned to such foreign currency gain. See for rules that apply to section elections.
(2) Coordination with § 1.954-2(g) The rules of , and apply without regard to any section gain treated as gain from section transactions, or loss allocated and apportioned to such gain, by reason of an election under of this section.
(D) Section 987 gain or loss assigned to tentative tested income rather than tested income
(1) In general In the case of a controlled foreign corporation, section gain or loss is initially assigned to tentative tested income within a section category (a tentative tested income group) under and of this section as though the election described in is in effect for the taxable year. As a result, section gain or loss that would have initially been characterized as tested income if no election under was in effect is initially characterized as tentative tested income.
(2) For purposes of the GILTI high-tax exclusion, section 987 gain or loss is not attributable to any tested unit In the case of a controlled foreign corporation, the initial assignment of section gain or loss is made as though the section gain or loss was not attributable to any tested unit for purposes of applying (GILTI high-tax exclusion). See of this section (applying the GILTI high-tax exclusion by treating all section gain or loss in the same tentative tested income group as composing a single tentative tested income item).
(ii) Reassignment of section 987 gain or loss In the taxable year in which section gain or loss is recognized (determined by taking into account , , -12(c), and 1.987-13(b) through (d), if applicable), the section gain or loss is sourced and characterized based on the initial assignment in of this section, but with appropriate changes to account for the application of provisions that apply to the section gain or loss based on a net income computation such as the high-tax exception to passive category income in , the high-tax exception to foreign base company income in , and the high-tax exclusion to tested income in . Thus, for example, if an election under is in effect for the taxable year, section gain or loss initially assigned to a tentative tested income group will be reassigned to a tested income group (as defined in ) or to the residual income group (as defined in ), as applicable, depending on whether the item of income (as described in of this section) is subject to a high rate of tax (as determined under ). If no election is made under for a taxable year, all of the section gain or loss that is recognized in the taxable year that was initially assigned to tentative tested income under of this section, is reassigned to the appropriate tested income group (as defined in ).
(iii) Special rule for the application of the GILTI high-tax exclusion to section 987 gain or loss Section gain in a tentative tested income group that is recognized by a controlled foreign corporation in a taxable year comprises a single tentative gross tested income item (as if it were allocable to its own tested unit) within the meaning of , and section loss in a tentative tested income group that is recognized by a controlled foreign corporation in the taxable year is allocated and apportioned to the corresponding tentative gross tested income item for purposes of calculating the tentative tested income item within the meaning of . Thus, for purposes of applying the high-tax exclusion in , all of the section gain and loss in a tentative tested income group that is recognized by the controlled foreign corporation in a taxable year is a single tentative tested income item.
(3) Allocation and apportionment of foreign income tax to section 987 items under section 861 For purposes of applying the definition of a corresponding U.S. item in , an item of foreign gross income and an item of section gain or loss are treated as arising from the same transaction or other realization event only if the requirements in both and of this section are satisfied.
(i) The foreign gross income is an item of foreign currency gain or loss The owner of the section QBU, original deferral QBU owner, or original suspended loss QBU owner includes the foreign gross income under the laws of the foreign country in which it is a tax resident because under that foreign law it is required to recognize foreign currency gain or loss with respect to its interest in the section QBU or with respect to a successor deferral QBU or successor suspended loss QBU.
(ii) The same event or events give rise to both the foreign gross income and the section 987 gain or loss The remittance under that gave rise to the item of section gain or loss comprises one or more of the events that gave rise to the item of foreign gross income described in of this section.
(c) Examples The following examples illustrate the application of this section. For purposes of the examples, except as otherwise indicated, assume that no section elections are in effect.
(1) Example 1: Initial assignment and reassignment of section 987 gain or loss
(i) Facts CFC is a controlled foreign corporation with the Swiss franc (Sf) as its functional currency. CFC is the owner of Business A, a section QBU that has the euro as its functional currency. For year 1, CFC does not have an election described in in effect but is subject to an election under of this section. CFC recognizes section gain of Sf10,000 under . Business A has average total assets of Sf1,000,000 in year 1, which generate income (other than section gain) as follows: Sf750,000 of assets that produce gross income in the statutory grouping for foreign source general category tested income under sections and ; and Sf250,000 of assets that produce foreign source passive gross income in one of the groupings described in and -1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign personal holding company income).
(ii) Analysis Under , , and of this section, Sf7,500 (Sf750,000/Sf1,000,000 x Sf10,000) of the section gain is initially assigned to the statutory grouping of foreign source general category tentative tested income. Because an election under is not in effect for the taxable year in which the section gain is recognized, the section gain is reassigned under of this section to foreign source general category tested income. The remaining Sf2,500 (Sf250,000/Sf1,000,000 × Sf10,000) is characterized under and of this section by reference to assets that give rise to foreign source passive gross income in one of the groupings described in (subpart F income groups relating to passive foreign personal holding company income) and is therefore generally treated under the election in of this section as foreign source foreign currency gain of CFC attributable to section transactions not directly related to the business needs of the controlled foreign corporation. All of the section gain is treated as ordinary income under of this section.
(2) Example 2: Effect of GILTI high-tax exclusion
(i) Facts The facts are the same as in of this section (Example 1) except that CFC does have an election described in in effect. Without regard to the section gain or loss, CFC has two tentative gross tested income items: Sf100,000 of gross tentative tested income attributable to a CFC tested unit (the CFC item) and Sf5,000,000 of gross tentative tested income attributable to a Business A tested unit (the Business A item). CFC accrues Sf1,010,000 of current year taxes and has no other current year deductions. CFC is not required by its country of tax residence to include in foreign gross income foreign currency gain or loss with respect to its interest in a foreign QBU. For purposes of , Sf1,000,000 of current year tax is allocated and apportioned to the Business A item and Sf10,000 is allocated and apportioned to the CFC item. At all relevant times Sf1 = $1.
(ii) Analysis As in of this section (Example 1), Sf7,500 of section gain is initially assigned to the statutory grouping of foreign source general category tentative tested income. Under of this section, the section gain comprises a single tentative gross tested income item of the CFC (the section item). Therefore, the CFC has three tentative gross tested income items: the section item, the CFC item, and the Business A item. No tax is allocated and apportioned to the section item. See of this section. Applying , the effective tax rate of the section item is 0% ($0/$7,500), the effective tax rate of the CFC item is 10% ($10,000/$100,000), and the effective tax rate of the Business A item is 20% ($1,000,000/$5,000,000). An election under is in effect; therefore, the section gain is reassigned based on the application of . Because the section item was not subject to an effective tax rate of greater than 90 percent of the maximum rate of tax specified in section , it is reassigned under of this section to foreign source general category tested income. The remaining Sf2,500 of section gain is foreign source foreign currency gain of CFC attributable to section transactions not directly related to the business needs of the controlled foreign corporation for the reasons stated in of this section (Example 1).
(3) Example 3: Section 987 gain or loss treated as attributable to section 988 transactions
(i) Facts The facts are the same as in of this section (Example 1) except that CFC recognizes section loss of Sf40,000, Sf5,000 of which is characterized under and of this section by reference to assets that give rise to foreign source passive gross income in a separate subpart F income group for non-related party interest income of Business A and Sf5,000 of which is characterized by reference to assets that give rise to foreign source passive gross income in a separate subpart F income group for gains from certain property transactions of Business A not derived from the active conduct of a trade or business. CFC otherwise has Sf12,000 of net foreign currency gain determined under that is taken into account in determining the excess of foreign currency gain over foreign currency losses characterized as foreign personal holding company income under section .
(ii) Analysis Under of this section, the Sf10,000 total section loss characterized by reference to assets that give rise to foreign source passive gross income in one of the groupings described in and -1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign personal holding company income) is treated as foreign source foreign currency loss of CFC attributable to section transactions. Accordingly, CFC will aggregate the Sf10,000 section loss with the Sf12,000 net foreign currency gain and will have Sf2,000 of net foreign currency gain characterized as passive foreign personal holding company income under section .
(4) Example 4: Section 987 gain or loss assigned to passive foreign personal holding company income
(i) Facts The facts are the same as in of this section (Example 3) except that CFC is not subject to an election under of this section.
(ii) Analysis As the CFC is not subject to an election under of this section, Sf5,000 of section loss is initially assigned to the statutory grouping for foreign source passive gross income in a separate subpart F income group for non-related party interest income of Business A, and Sf5,000 is initially assigned to the statutory grouping for foreign source passive gross income in a separate subpart F income group for gains from certain property transactions of Business A not derived from the active conduct of a trade or business. The Sf12,000 net foreign currency gain is foreign source passive gross income in a separate subpart F income group for foreign currency gain of CFC attributable to section transactions of CFC. As a result, if the net income in a subpart F income group to which either section loss is assigned is less than zero, that loss will not reduce any other category of subpart F income, including CFC's foreign currency gain from section transactions, except by reason of the earnings and profit limitation in section . See .
[T.D. 10016, 89 FR 100165, Dec. 11, 2024]