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IRS pushes back effective date of foreign currency regs while considering further changes

In a Notice, IRS has announced that it intends to amend regs issued under Code Sec. 987, on income and currency gain or loss with respect to a Code Sec. 987 qualified business unit (QBU), to defer the effective date of the final regs as well as certain provisions of the temporary regs by one year. IRS is reviewing these regs pursuant to an executive order aimed at minimizing tax regulatory burdens, and is considering changes to the final regs that would allow taxpayers to elect to apply alternative rules for transitioning to the final regs and alternative rules for determining gain or loss under Code Sec. 987.

Statutory background. U.S. taxpayers are generally required to make all federal income tax determinations in their “functional currency.” (Code Sec. 985(a)) A U.S. taxpayer’s functional currency is generally the U.S. dollar (Code Sec. 985(b)(1)(A)), unless it has a QBU that uses the currency of the economic environment in which a significant part of its activities are conducted and which is used to keep its books and records. (Code Sec. 985(b)(1)(B)) A QBU may elect to use the U.S. dollar instead if it meets certain requirements. (Code Sec. 985(b)(3))

A QBU is any separate and clearly identified unit (or activity) of a trade or business of a taxpayer which maintains separate books and records. (Code Sec. 989(a))

Code Sec. 988 provides rules for the treatment of transactions in a currency other than the taxpayer’s functional currency, including treatment of foreign currency gain or loss attributable to a “Code Sec. 988 transaction” as ordinary income or loss. A Code Sec. 988 transaction is one of a series of specified transactions—e.g., the acquisition of a debt instrument (Code Sec. 988(c)(1)(B)(i))—if the amount which the taxpayer is entitled to receive, or required to pay, is either: (a) denominated in a nonfunctional currency, or (b) determined by reference to the value of one or more nonfunctional currencies. (Code Sec. 988(c)(1)(A))

Code Sec. 986 generally provides rules for translating into U.S. dollars the earnings and profits and foreign taxes of a foreign corporation whose functional currency is not the U.S. dollar. Code Sec. 987, in turn, generally provides rules for determining and translating income and currency gain and loss with respect to operations of a branch (i.e., a QBU) whose functional currency is other than the functional currency of the taxpayer.

Specifically, under Code Sec. 987, when a taxpayer owns one or more QBUs with a functional currency other than the U.S. dollar and such functional currency is different than that of the taxpayer, the taxable income or loss of the taxpayer with respect to each QBU is determined by computing the taxable income or loss of each QBU separately in its functional currency and translating such income or loss at the appropriate exchange rate, which Code Sec. 989(b)(4) generally defines as being the average exchange rate for the tax year of the QBU. Code Sec. 987 further requires the taxpayer to make “proper adjustments” for transfers of property between QBUs having different functional currencies.

Final and temporary regs. Late last year, IRS issued final regs under Code Sec. 987 that provide guidance regarding the determination of the taxable income or loss of a taxpayer with respect to a qualified business unit (QBU) subject to Code Sec. 987, as well as the timing, amount, character, and source of any Code Sec. 987 gain or loss. The final regs generally adopted proposed regs issued in 2006, but with a number of modifications to reduce complexity and improve administrability. The final regs were to be effective Dec. 7, 2016, and apply generally to tax years beginning on or after one year after the first day of the first tax year following Dec. 7, 2016; but a taxpayer could apply them to earlier years if certain requirements were met. (For more details, see Weekly Alert ¶  2  12/15/2016.)

On the same day, IRS issued temporary regs on the recognition and deferral of foreign currency gain or loss under Code Sec. 987 with respect to a QBU in connection with a QBU’s termination and certain transactions involving partnerships. The temporary regs also provided an annual deemed termination election with an elective yearly average exchange rate method, and other rules for a Code Sec. 987 QBU, as well as rules on the treatment of Code Sec. 988 transactions, dollar QBUs, and related party loans. Reg. § 1.987-1T (other than Reg. § 1.987-1T(g)(2)(i)(B) and Reg. § 1.987-1T(g)(3)(i)(H) ) through Reg. § 1.987-4T, Reg. § 1.987-6T, Reg. § 1.987-7T, Reg. § 1.988-1 , and Reg. § 1.988-1T (collectively, the “related temporary regs”) were to apply to tax years beginning on or after one year after the first day of the tax year following Dec. 7, 2016, but taxpayers could apply them to earlier years if certain requirements were met. Different sections of the temporary regs were subject to different applicability dates. (For more details, see Weekly Alert ¶  20  12/15/2016.)

Executive order. On Apr. 21, 2017, President Trump issued Executive Order 13789 which instructed the Treasury Secretary to review all “significant tax regulations” issued on or after Jan. 1, 2016, and submit two reports, and follow that review with concrete action to alleviate the burdens of regs that meet criteria outlined in the order.

In Notice 2017-38, 2017-30 IRB 147, IRS identified eight significant tax regs potentially qualifying for burden reduction under the Executive Order, including the final Code Sec. 987 regs. (See Weekly Alert ¶  24  07/13/2017 for more details.)

IRS to amend applicability date. IRS intends to amend Reg. § 1.861-9T, Reg. § 1.985-5, Reg. § 1.987-11, Reg. § 1.987-1T through Reg. § 1.987-4T, Reg. § 1.987-6T, Reg. § 1.987-7T, Reg. § 1.988-1 , Reg. § 1.988-1T, Reg. § 1.988-4, and Reg. § 1.989(a)-1 to provide that the final regs and related temporary regs will apply to tax years beginning on or after two years after the first day of the first tax year beginning after Dec. 7, 2016. Thus, for a taxpayer whose first tax year after Dec. 7, 2016, begins on Jan. 1, 2017, the final regs and the related temporary regs will apply for the tax year beginning on Jan. 1, 2019.

A taxpayer may, however, elect under Reg. § 1.987-11(b) to apply the final regs and the related temporary regs to tax years beginning after Dec. 7, 2016 (subject to certain conditions set out in Reg. § 1.987-11(b)), including tax years beginning on or after one year after the first day of the first tax year following Dec. 7, 2016 (i.e., the original applicability date). The amendments will not affect the applicability date of the temporary regs other than the related temporary regs. (Notice 2017-57, Sec. III)

Taxpayers may rely on the provisions of Notice 2017-57 regarding these proposed amendments pending the issuance of amended regs. (Notice 2017-57, Sec. IV)

References: For foreign currency gain or loss, see FTC 2d/FIN ¶  G-7002  ; United States Tax Reporter ¶  9884. For QBUs, see FTC 2d/FIN ¶  G-6912; United States Tax Reporter ¶  9874.

Notice 2017-57, 2017-42 IRB

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