Recognition and Deferral of Section 987 Gain or Loss, 88854-88880 [2016-28380]

Download as PDF 88854 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 6T(d), 1.987–7T(d), 1.987–8T(g), 1.987– 12T(j), 1.988–1T(j), and 1.988–2T(j). FOR FURTHER INFORMATION CONTACT: Steven D. Jensen at (202) 317–6938 (not a toll-free number). SUPPLEMENTARY INFORMATION: DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9795] Paperwork Reduction Act RIN 1545–BL12 Recognition and Deferral of Section 987 Gain or Loss Internal Revenue Service (IRS), Treasury. ACTION: Final and temporary regulations. AGENCY: This document contains temporary regulations under section 987 of the Internal Revenue Code (Code) relating to the recognition and deferral of foreign currency gain or loss under section 987 with respect to a qualified business unit (QBU) in connection with certain QBU terminations and certain other transactions involving partnerships. This document also contains temporary regulations under section 987 providing: an annual deemed termination election for a section 987 QBU; an elective method, available to taxpayers that make the annual deemed termination election, for translating all items of income or loss with respect to a section 987 QBU at the yearly average exchange rate; rules regarding the treatment of section 988 transactions of a section 987 QBU; rules regarding QBUs with the U.S. dollar as their functional currency; rules regarding combinations and separations of section 987 QBUs; rules regarding the translation of income used to pay creditable foreign income taxes; and rules regarding the allocation of assets and liabilities of certain partnerships for purposes of section 987. Finally, this document contains temporary regulations under section 988 requiring the deferral of certain section 988 loss that arises with respect to related-party loans. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register. In addition, in the Rules and Regulations section of this issue of the Federal Register, final regulations are being issued under section 987 to provide general guidance under section 987 regarding the determination of the taxable income or loss of a taxpayer with respect to a QBU. DATES: Effective date. These regulations are effective on December 7, 2016. Applicability date. For dates of applicability, see §§ 1.987–1T(h), 1.987– 2T(e), 1.987–3T(f), 1.987–4T(h), 1.987– sradovich on DSK3GMQ082PROD with RULES4 SUMMARY: VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 These temporary regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545–2265. Responses to this collection of information are mandatory. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number. For further information concerning this collection of information, the accuracy of the estimated burden and suggestions for reducing this burden, and where to submit comments on the collection of information, please refer to the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register. Books and 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. Background This document contains temporary regulations under section 987 of the Code relating to the recognition and deferral of foreign currency gain or loss under section 987 with respect to a QBU in connection with certain QBU terminations and certain other transactions involving partnerships. This document also contains temporary regulations under section 987 providing (i) an annual deemed termination election for a section 987 QBU; (ii) an elective method, available to taxpayers that make the annual deemed termination election, for translating all items of income or loss with respect to a section 987 QBU at the yearly average exchange rate; (iii) rules regarding the treatment of section 988 transactions of a section 987 QBU; (iv) rules regarding QBUs with the U.S. dollar as their functional currency; (v) rules regarding PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 combinations and separations of section 987 QBUs; (vi) rules regarding the translation of income used to pay creditable foreign income taxes; and (vii) rules regarding the allocation of assets and liabilities of certain partnerships for purposes of section 987. Finally, this document contains temporary regulations under section 988 requiring the deferral of certain section 988 loss that arises with respect to related-party loans. Section 987 generally provides that, 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 such 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. Section 987 further requires the taxpayer to make ‘‘proper adjustments’’ (as prescribed by the Secretary of the Treasury (the Secretary)) for transfers of property between QBUs having different functional currencies, including by treating post-1986 remittances from each such QBU as made on a pro rata basis out of post-1986 accumulated earnings, by treating section 987 gain or loss as ordinary income or loss, and by sourcing such gain or loss by reference to the source of the income giving rise to post-1986 accumulated earnings. Section 989(c) directs the Secretary to ‘‘prescribe such regulations as may be necessary or appropriate to carry out the purposes of [subpart J], including regulations . . . limiting the recognition of foreign currency loss on certain remittances from qualified business units . . . [and] providing for the appropriate treatment of related party transactions (including transactions between qualified business units of the same taxpayer). . . .’’ On September 6, 2006, the Treasury Department and the IRS issued proposed regulations under section 987 (REG–208270–86, 71 FR 52876) (the 2006 proposed regulations). The Treasury Department and the IRS received many written comments in response to the 2006 proposed regulations and, after consideration of those comments, are issuing final regulations (TD 9794) under section 987 (the final regulations) that are being published contemporaneously with these temporary regulations. These temporary regulations also reflect the consideration of comments received on the 2006 proposed regulations, as well as other considerations described in this preamble. E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations Explanation of Provisions sradovich on DSK3GMQ082PROD with RULES4 1. Deferral of Section 987 Gain or Loss on Certain Terminations and Other Transactions Involving Partnerships A. Background Under the final regulations, the owner of a section 987 QBU that terminates includes in income all of the net unrecognized section 987 gain or loss with respect to the section 987 QBU in the year it terminates. See §§ 1.987– 5(c)(3) and 1.987–8(e). Section 1.987– 8(b) and (c) describe the circumstances in which a section 987 QBU terminates, which include the transfer (or deemed transfer) of substantially all of the assets of the section 987 QBU and when the section 987 QBU’s owner ceases to exist (except in connection with certain liquidations or reorganizations described in section 381(a)). Under these rules, a termination can result solely from a transfer of a section 987 QBU between related parties or, when a QBU is owned by an entity that is disregarded as an entity separate from its owner for Federal tax purposes (DE), from the deemed transfer that occurs when an election is made to treat the DE as a corporation for Federal tax purposes, notwithstanding that the QBU’s assets continue to be used in the same trade or business. The preamble to the 2006 proposed regulations requested comments regarding whether inbound liquidations under section 332 and inbound asset reorganizations under section 368(a) should result in terminations of section 987 QBUs. The preamble also requested comments on the interaction of the rules of § 1.1502–13 regarding intercompany transactions with the 2006 proposed regulations, including whether section 987 gain or loss resulting from the transfer of assets and liabilities of a section 987 QBU between members of the same consolidated group in a section 351 transaction should be deferred under § 1.1502–13. Many comments recommended that such a section 351 exchange should not trigger the recognition of section 987 gain or loss. Because a termination can result in the deemed remittance of all the assets of a section 987 QBU in circumstances in which the assets continue to be used by a related person in the conduct of the same trade or business that formerly was conducted by the section 987 QBU, terminations can facilitate the selective recognition of section 987 losses. Section 989(c)(2) provides the Treasury Department and the IRS with authority to ‘‘limit[] the recognition of foreign currency loss on certain remittances VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 from qualified business units.’’ The Treasury Department and the IRS have determined that terminations of section 987 QBUs generally should not be permitted to achieve the selective recognition of losses when the assets and liabilities of the section 987 QBU are transferred to a related person and remain subject to section 987 in the hands of the transferee, as in the case, for example, of a section 351 transfer of a section 987 QBU within a consolidated group. Similar policy considerations arise when the transfer of a partnership interest to a related person results in deemed transfers that cause the recognition of section 987 loss with respect to a section 987 QBU owned through the partnership, notwithstanding that the trade or business of the section 987 QBU continues without interruption and remains subject to section 987. In order to address these policy concerns, as described in greater detail in Part 1.C of this Explanation of Provisions, the temporary regulations defer section 987 losses resulting from certain termination events and partnership transactions in which the assets and liabilities of the section 987 QBU remain within a single controlled group (defined as all persons with the relationships to each other described in sections 267(b) or 707(b)) and remain subject to section 987. The Treasury Department and the IRS also acknowledge, however, that part of the rationale for deferring section 987 losses—that is, the continuity of ownership of the section 987 QBU within a single controlled group— applies equally to section 987 gains that otherwise would be triggered when taxpayers transfer a section 987 QBU within a single controlled group. Thus, consistent with the recommendations of comments on the 2006 proposed regulations, the temporary regulations generally apply to defer the recognition of section 987 gains as well as losses when the transferee is subject to section 987 with respect to the assets of the section 987 QBU. The Treasury Department and the IRS have determined, however, that gain should not be deferred to the extent the assets of a section 987 QBU are transferred by a U.S. person to a related foreign person. Since recognition of the deferred gain generally would occur only as a result of remittances to the foreign owner, the IRS could face administrative difficulty in attempting to ensure that such deferred gain is appropriately recognized and not indefinitely deferred. Treating gains differently than losses in the context of transfers to related foreign persons generally is PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 88855 consistent with the policies underlying sections 267 and 367. In particular, this rule is consistent with the policy of recognizing foreign currency gains and not losses with respect to property transferred outbound in a nonrecognition transaction. See section 367(a)(3)(B)(iii). In addition, the Treasury Department and the IRS have determined that selective recognition of losses should not be permitted in the context of certain outbound transfers even when the assets do not remain subject to section 987 in the hands of the transferee (because, for example, the transferee has the same functional currency as the QBU). Accordingly, consistent with the principles of sections 267 and 367(a), the temporary regulations also provide special rules to prevent the selective recognition of section 987 losses in certain other transactions involving outbound transfers. B. Scope of Application of § 1.987–12T Section 1.987–12T provides for the deferral of certain net unrecognized section 987 gain or loss that otherwise would be recognized in connection with specified events under § 1.987–5, which governs the recognition of section 987 gain or loss by the owner of a section 987 QBU to which the final regulations apply. In addition, because the policy concerns that motivate § 1.987–12T exist regardless of whether section 987 gain or loss is computed pursuant to the final regulations or some other reasonable method, § 1.987–12T applies to any foreign currency gain or loss realized under section 987(3), including foreign currency gain or loss realized under section 987 with respect to a QBU to which the final regulations generally are not applicable. In order to achieve this, the temporary regulations specify that references in § 1.987–12T to section 987 gain or loss refer to any foreign currency gain or loss realized under section 987(3) and that references to a section 987 QBU refer to any eligible QBU (as defined in § 1.987–1(b)(3)(i), but without regard to § 1.987–1(b)(3)(ii)) that is subject to section 987. Additionally, the temporary regulations specify that references in § 1.987–12T to the recognition of section 987 gain or loss under § 1.987–5 encompass any determination and recognition of gain or loss under section 987(3) that would occur but for § 1.987–12T. Accordingly, the temporary regulations require an owner of a QBU that is not subject to § 1.987–5 to adapt the rules set forth in § 1.987–12T to recognize section 987 gains or losses consistent with the principles of § 1.987–12T. E:\FR\FM\08DER4.SGM 08DER4 88856 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations The policy concerns regarding selective realization of section 987 losses do not apply, however, with respect to a section 987 QBU that has made the annual deemed termination election described in Part 2 of this Explanation of Provisions, because all section 987 gain and loss is recognized annually under that election. Accordingly, § 1.987–12T is not applicable to section 987 gain or loss of a section 987 QBU with respect to which the annual deemed termination election is in effect. Finally, in order to avoid any compliance burden associated with applying § 1.987–12T in circumstances involving relatively small amounts of section 987 gain or loss, § 1.987–12T includes a de minimis rule. That rule provides that § 1.987–12T does not apply to a section 987 QBU if the net unrecognized section 987 gain or loss of the section 987 QBU that, as a result of § 1.987–12T, would not be recognized under § 1.987–5 does not exceed $5 million. Section 1.987–12T defers the recognition of section 987 gains and losses in connection with two types of specified events, which are referred to as ‘‘deferral events’’ and ‘‘outbound loss events.’’ Parts 1.C and 1.D of this Explanation of Provisions describe the rules governing deferral events and outbound loss events, respectively. sradovich on DSK3GMQ082PROD with RULES4 C. Deferral Events As described in greater detail below, the temporary regulations provide that, notwithstanding § 1.987–5, the owner of a section 987 QBU with respect to which a deferral event occurs (a deferral QBU) must defer section 987 gain or loss that otherwise would be taken into account under § 1.987–5 in connection with the deferral event to the extent determined under § 1.987–12T(b)(3) and (c). Such deferred gain or loss is taken into account based on subsequent events in accordance with § 1.987– 12T(c). i. Deferral Events The temporary regulations provide that a deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy two conditions. Under the first condition, the transaction or series of transactions must be described in one of two categories. The first category, which is set forth in § 1.987–12T(b)(2)(ii)(A), is any termination of a section 987 QBU other than (i) a termination described in § 1.987–8(b)(3) (that is, a termination that results from the owner of the section 987 QBU ceasing to be a controlled foreign corporation (as VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 defined in section 957(a)) (CFC) after certain related-party transactions); (ii) a termination described in § 1.987–8(c) (that is, a termination that results from a liquidation or asset reorganization described in section 381(a) involving an inbound or outbound transfer, a transfer by a CFC to a related non-CFC foreign corporation, or a transfer to a transferee that has the same functional currency as the section 987 QBU); 1 or (iii) a termination described solely in § 1.987– 8(b)(1) (that is, a termination that results solely from the cessation of the trade or business of the section 987 QBU). Thus, the first category generally involves terminations that occur as a result of a transfer of substantially all the assets of a section 987 QBU other than a transfer as part of a transaction described in section 381(a) in which the owner ceases to exist. (A termination that results from an outbound section 381(a) transaction, however, may be an outbound loss event.) The second category, which is described in § 1.987–12T(b)(ii)(B), encompasses certain partnership transactions that result in a net deemed transfer from a section 987 QBU to its owner as a result of which section 987 gain or loss otherwise would be recognized under § 1.987–5. The second category refers to two types of transactions involving partnerships. First, the second category includes a disposition of part of an interest in a DE or partnership. Under § 1.987–2(c)(5), a transfer of part of an interest in a DE or section 987 aggregate partnership results in deemed transfers to the owner of a section 987 QBU held through that DE or partnership that may result in a remittance, but that generally do not cause a termination. For an illustration of the application of § 1.987–12T to a deferral event resulting from the conversion of a disregarded entity into a section 987 aggregate partnership, see § 1.987–12T(h), Example 4. The second type of transaction included in the second category is a contribution of assets by a related person to a partnership or DE through which a section 987 QBU is held, provided that the contributed assets are not included on the books and records of an eligible QBU and the contribution causes a net transfer from a section 987 QBU owned through the partnership or DE. The rules of § 1.987–2 must be applied to determine whether the contribution would cause a net transfer 1 The transfer of a section 987 QBU as part of a liquidation or asset reorganization described in section 381(a) in which the transferor and transferee have the same tax status is not a termination under § 1.987–8(b) and (c) and, therefore, cannot constitute a deferral event under the first category. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 from any section 987 QBUs held through a partnership. For example, if two partners (Partner A and Partner B) each own a 50% interest in an existing section 987 aggregate partnership with a single section 987 QBU, and Partner A contributes cash that is included on the books of the section 987 QBU after the contribution and Partner B contributes an equal amount of non-portfolio stock, the contributions would not cause either Partner A nor Partner B to have a net transfer from the section 987 QBU under § 1.987–2 and there would be no section 987 gain or loss to defer. As a result of the broad scope of application for § 1.987–12T specified in § 1.987– 12T(a)(2), the second category includes transactions involving partnerships that are not section 987 aggregate partnerships even though QBUs that are held through such partnerships generally are not subject to the final regulations. Accordingly, § 1.987–12T applies to a disposition of a partnership interest or a contribution to a partnership if it otherwise would result in recognition of gain or loss under a taxpayer’s reasonable method of applying section 987. The second condition described in § 1.987–12T(b)(2) is that, immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor QBU. For this purpose, a successor QBU with respect to a section 987 QBU (original QBU) generally means a section 987 QBU on whose books and records assets of the original QBU are reflected immediately after the deferral event, provided that, immediately after the deferral event, the section 987 QBU is owned by a member of the controlled group that includes the person that owned the original QBU immediately before the deferral event. This relatedness requirement would not be met, for example, if the person that owned the original QBU ceased to exist in connection with the deferral event. However, if the owner of the original QBU is a U.S. person, then a successor QBU does not include a section 987 QBU owned by a foreign person, except in the case of a deferral event that is solely described in the second category of transactions involving partnership and DE interests. This limitation on the definition of a successor QBU in the context of outbound transfers serves two purposes. First, consistent with the general policy of recognizing foreign currency gains upon an outbound transfer, the limitation ensures that section 987 gain is recognized to the extent section 987 QBU assets are transferred outbound in connection with a termination. Second, the E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations limitation coordinates the deferral event rules with the outbound loss event rules described in Part 1.D of this Explanation of Provisions, which contain different rules for the recognition of section 987 loss attributable to assets of a section 987 QBU that are transferred outbound in connection with a termination of the section 987 QBU. sradovich on DSK3GMQ082PROD with RULES4 ii. Recognition of Section 987 Gain or Loss Under § 1.987–5 in the Taxable Year of a Deferral Event The temporary regulations provide that, in the taxable year of a deferral event, the owner of the deferral QBU generally recognizes section 987 gain or loss as determined under § 1.987–5, except that, solely for purposes of applying § 1.987–5, all assets and liabilities of the deferral QBU that, immediately after the deferral event, are properly reflected on the balance sheet of a successor QBU are treated as not having been transferred and therefore as remaining on the balance sheet of the deferral QBU, notwithstanding the deferral event. The effect of these rules is that, in the taxable year of a deferral event, only assets and liabilities of the deferral QBU that are not reflected on the books and records of a successor QBU immediately after the deferral event are taken into account in determining the amount of a remittance from the deferral QBU. Section 987 gain or loss that, as a result of these rules, is not recognized under § 1.987–5 in the taxable year of the deferral event is referred to as deferred section 987 gain or loss. As discussed in Part 1.D of this Explanation of Provisions, if the deferral event also constitutes an outbound loss event, the amount of loss recognized by the owner may be further limited under the rules applicable to outbound loss events. iii. Recognition of Deferred Section 987 Gain or Loss in the Taxable Year of a Deferral Event and in Subsequent Taxable Years The temporary regulations provide rules for determining when a deferral QBU owner recognizes deferred section 987 gain or loss. For this purpose, a deferral QBU owner means, with respect to a deferral QBU, the owner of the deferral QBU immediately before the deferral event with respect to the deferral QBU or the owner’s qualified successor. The temporary regulations define a qualified successor with respect to a corporation (transferor corporation) as another corporation (acquiring corporation) that acquires the assets of the transferor corporation in a transaction described in section 381(a), but only if (A) the acquiring corporation VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 is a domestic corporation and the transferor corporation was a domestic corporation, or (B) the acquiring corporation is a CFC and the transferor corporation was a CFC. A qualified successor of a corporation includes a qualified successor of a qualified successor of the corporation. As described in the remainder of this Part 1.C.iii, the temporary regulations provide that deferred section 987 gain or loss is recognized upon subsequent remittances from a successor QBU, or upon a deemed remittance that occurs when a successor QBU ceases to be owned by a member of the deferral QBU owner’s controlled group, subject to an exception that applies when a successor QBU terminates in an outbound transfer. In general, these rules depend on the continued existence of a deferral QBU owner (which includes a qualified successor) and a successor QBU and preserve the location of the deferred section 987 gain or loss as gain or loss of the deferral QBU owner. a. Subsequent Remittances A deferral QBU owner generally recognizes deferred section 987 gain or loss in the taxable year of a remittance from a successor QBU to the owner of the successor QBU (successor QBU owner). The amount of deferred section 987 gain or loss that a deferral QBU owner recognizes upon a remittance is the outstanding deferred section 987 gain or loss (that is, the deferred section 987 gain or loss not previously recognized) multiplied by the remittance proportion of the successor QBU owner with respect to the successor QBU for the taxable year as determined under § 1.987–5(b) and, to the extent relevant, § 1.987–12T. For an illustration of this rule, see § 1.987– 12T(h), Example 5. In certain cases, there may be multiple successor QBUs with respect to a single deferral QBU. For instance, there may be multiple successor QBUs if the owner of a section 987 aggregate partnership interest transfers part of its interest or if a successor QBU separates into two or more separated QBUs under § 1.987–2T(c)(9)(ii). To ensure that a deferral QBU owner recognizes the appropriate amount of deferred section 987 gain or loss in connection with a remittance in such cases, the temporary regulations provide that multiple successor QBUs of the same deferral QBU are treated as a single successor QBU for purposes of determining the amount of deferred section 987 gain or loss that is recognized. For example, if the owner (Corp A) of a section 987 aggregate partnership interest transfers part of its interest to PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 88857 another member of Corp A’s consolidated group (Corp B), the transfer would give rise to a deferral event with respect to the section 987 QBU (QBU A) that Corp A indirectly owns through the partnership. QBU A would be considered a deferral QBU, and Corp A would be considered a deferral QBU owner. In addition, QBU A would be considered a successor QBU with respect to itself, and the section 987 QBU (QBU B) that Corp B owns indirectly through the partnership interest it acquired also would be considered a successor QBU with respect to QBU A. In determining the amount of deferred section 987 gain or loss recognized upon subsequent remittances from successor QBUs, the two successor QBUs are treated as a single successor QBU, such that their remittance proportion is determined under § 1.987–5 on a combined basis, taking into account the assets and remittances of both successor QBUs. b. Deemed Remittance When a Successor QBU Ceases To Be Owned by a Member of the Deferral QBU Owner’s Controlled Group Solely for purposes of determining a deferral QBU owner’s recognition of any outstanding deferred section 987 gain or loss, a successor QBU owner is treated as having a remittance proportion of 1 in a taxable year in which its successor QBU ceases to be owned by a member of a controlled group that includes the deferral QBU owner, including as a result of the deferral QBU owner ceasing to exist without having a qualified successor. Accordingly, a deferral QBU owner would recognize all outstanding deferred section 987 gain or loss upon a successor QBU ceasing to be owned by a member of the deferral QBU owner’s controlled group if there is only one successor QBU, but would recognize only a proportional amount if there are multiple successor QBUs, one or more of which remain in the deferral QBU owner’s controlled group. c. Recognition of Deferred Section 987 Loss in Certain Outbound Successor QBU Terminations Notwithstanding that deferred section 987 gain or loss generally is recognized upon remittances from a successor QBU, § 1.987–12T(c)(3) provides that, if assets of a successor QBU are transferred (or deemed transferred) in an exchange that would constitute an outbound loss event if the successor QBU had a net accumulated section 987 loss at the time of the exchange, the deferral QBU owner recognizes any outstanding deferred section 987 loss on a similar basis as it would if it originally had transferred the E:\FR\FM\08DER4.SGM 08DER4 88858 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations deferral QBU in an outbound loss event. Any outstanding deferred section 987 loss with respect to the deferral QBU that, as a result of this rule, is not recognized is recognized by the deferral QBU owner in the first taxable year in which the deferral QBU owner (including any qualified successor) and the acquirer of the assets of the successor QBU (or any qualified successor) cease to be members of the same controlled group. Section 1.987– 12T(c)(4) ensures that the policy concerns that motivate the treatment of outbound loss events under the temporary regulations apply in comparable circumstances involving successor QBUs. See Part 1.D of this Explanation of Provisions for an explanation of outbound loss events. sradovich on DSK3GMQ082PROD with RULES4 d. Special Rules Regarding Successor QBUs The temporary regulations include three special rules regarding successor QBUs that are relevant to the recognition of deferred section 987 gain or loss. First, if a section 987 QBU is a successor QBU with respect to a deferral QBU that is a successor QBU with respect to another deferral QBU, the first-mentioned section 987 QBU is considered a successor QBU with respect to the second-mentioned deferral QBU. For example, if QBU A is a successor QBU with respect to QBU B, and QBU B is a successor QBU with respect to QBU C, then QBU A is a successor QBU with respect to QBU C. Second, if a successor QBU with respect to a deferral QBU separates into two or more separated QBUs (as defined in § 1.987–2T(c)(9)(iii)), each separated QBU is considered a successor QBU with respect to the deferral QBU. Third, if a successor QBU with respect to a deferral QBU combines with another section 987 QBU of the same owner, resulting in a combined QBU (as defined in § 1.987–2T(c)(9)(i)), the combined QBU is considered a successor QBU with respect to the deferral QBU. iv. Source and Character of Deferred Section 987 Gain and Loss The temporary regulations provide that the source and character of deferred section 987 gain or loss is determined under § 1.987–6 as if such gain or loss had been recognized with respect to the deferral QBU under § 1.987–5 on the date of the deferral event that gave rise to the deferred section 987 gain or loss. Thus, the source and character of deferred section 987 gain or loss is determined under § 1.987–6 without regard to the timing rules of § 1.987– 12T. VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 D. Outbound Loss Events Section 1.987–12T(d) of the temporary regulations contains rules that defer section 987 loss to the extent assets of a section 987 QBU are transferred outbound to a related foreign person in connection with an ‘‘outbound loss event.’’ Specifically, the temporary regulations provide that, notwithstanding § 1.987–5, the owner of a section 987 QBU with respect to which an outbound loss event occurs (outbound loss QBU) includes in taxable income in the year of the outbound loss event section 987 loss with respect to that section 987 QBU only to the extent provided in § 1.987–12T(d)(3). Sections 1.987–12T(d)(4) and (5) provide rules for the subsequent recognition of losses that are deferred under § 1.987–12T(d) that differ from the remittance-based rules that generally apply following deferral events. Like the definition of deferral event, an outbound loss event includes two categories of transactions with respect to a section 987 QBU with net unrecognized section 987 loss. First, an outbound loss event includes any termination of the section 987 QBU in connection with a transfer of assets of the section 987 QBU by a U.S. person to a foreign person that was a member of the same controlled group as the U.S. transferor immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person). The second category of outbound loss events includes any transfer by a U.S. person of part of an interest in a section 987 aggregate partnership or DE through which the U.S. person owns the section 987 QBU to a related foreign person that has the same functional currency as the section 987 QBU. The second category also includes a contribution of assets by such a related foreign person to the partnership or DE if the contribution has the effect of reducing the U.S. person’s interest in the section 987 QBU (and therefore causes a deemed transfer of assets and liabilities to the U.S. person from the section 987 QBU) and the contributed assets are not included on the books and records of an eligible QBU of the partnership or DE. The second category would be implicated, for example, if a U.S. person transferred part of the interest in a DE through which it owned a section 987 QBU to a foreign corporation that had the same functional currency as the section 987 QBU in an outbound section 351 transaction. Under these rules, the owner of the outbound loss QBU recognizes section PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 987 loss in the taxable year of the outbound loss event as determined under § 1.987–5 and the deferral event rules of § 1.987–12T(b) and (c), except that, solely for purposes of applying § 1.987–5, certain assets and liabilities of the outbound loss QBU are treated as not having been transferred and therefore as remaining on the balance sheet of the section 987 QBU, notwithstanding the outbound loss event. In the first category of outbound loss event (involving outbound asset transfers resulting in terminations), assets and liabilities that, immediately after the outbound loss event, are properly reflected on the books and records of the related foreign person or a section 987 QBU of the related foreign person are treated as not having been transferred. In the second category of outbound loss event (involving certain partnership and DE transactions), assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the eligible QBU from which the assets and liabilities of the outbound loss QBU are allocated, and not on the books and records of a section 987 QBU, are treated as not having been transferred. The difference between the amount that otherwise would have been recognized and the amount actually recognized under this rule is referred to as outbound section 987 loss. Although an outbound loss event in the second category also would constitute a deferral event, the rules governing deferral events only defer section 987 loss of a deferral QBU to the extent assets and liabilities are reflected on the books and records of a successor QBU immediately after the deferral event. Assets and liabilities of a deferral QBU that are reflected on the books and records of an eligible QBU of a partnership and allocated to a partner that has the same functional currency as the eligible QBU, as would occur in an outbound loss event, are not reflected on the books and records of a successor QBU and so would not cause section 987 loss to be deferred under the deferral event rules. Thus, there is no overlap in terms of the effect of the outbound loss event rules and the deferral event rules. If an outbound loss event results from the transfer of assets of the outbound loss QBU in a nonrecognition transaction, the basis of the stock that is received in the transaction is increased by an amount equal to the outbound section 987 loss. In effect, this rule converts a section 987 loss into an unrealized stock loss, which may be recognized upon a recognition event with respect to the stock. This treatment E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations is similar to the treatment under section 367(a) of foreign currency losses with respect to foreign-currency denominated property that is transferred outbound in a nonrecognition event to a foreign corporation that has as its functional currency the currency in which the property is denominated. Outbound section 987 loss attributable to an outbound loss event that does not occur in connection with a nonrecognition transaction is recognized by the owner of the outbound loss QBU in the first taxable year in which the owner (or any qualified successor) and the related foreign person that participated in the outbound loss event (or any qualified successor) cease to be members of the same controlled group. In many circumstances this treatment will provide similar results as converting section 987 loss into stock basis as in the case of outbound loss events that result from a nonrecognition transaction. The temporary regulations provide that, if loss is recognized on the sale or exchange of stock within two years of an outbound loss event that gave rise to an adjustment to the basis of the stock, then, to the extent of the outbound section 987 loss, the source and character of the loss recognized on the sale or exchange will be determined under § 1.987–6 as if such loss were section 987 loss recognized pursuant to § 1.987–5 without regard to § 1.987–12T on the date of the outbound loss event. sradovich on DSK3GMQ082PROD with RULES4 E. Anti-Abuse Rule The temporary regulations provide an anti-abuse rule to address transactions structured to avoid the deferral rules in § 1.987–12T. This rule provides that no section 987 loss is recognized under § 1.987–5 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of § 1.987–12T. This rule would apply, for example, if, with a principal purpose of recognizing a deferred section 987 loss, a taxpayer engaged in a transaction that caused a deferral QBU owner to cease to exist without a qualified successor or caused a successor QBU to cease to exist, such that deferred section 987 loss otherwise would be recognized under § 1.987– 12T(c). F. Coordination With Fresh Start Transition Method The temporary regulations require adjustments to coordinate the application of § 1.987–12T with the fresh start transition method described in § 1.987–10(b) for transitioning to the final regulations. If a deferral QBU owner is required under § 1.987–10(a) to VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 apply the fresh start transition method with respect to the deferral QBU on the transition date, or if a deferral QBU owner would have been so required if it had owned the deferral QBU on the transition date, the outstanding deferred section 987 gain or loss of the deferral QBU owner with respect to the deferral QBU must be adjusted on the transition date to equal the amount of outstanding deferred section 987 gain or loss that the deferral QBU owner would have had with respect to the deferral QBU on the transition date if, immediately before the deferral event, the deferral QBU had transitioned to the final regulations pursuant to the fresh start transition method. Additionally, if the owner of an outbound loss QBU is required under § 1.987–10(a) to apply the fresh start transition method with respect to the outbound loss QBU on the transition date, or if the owner would have been so required if it had owned the outbound loss QBU on the transition date, the basis of any stock that was subject to a basis adjustment under § 1.987–12T as a result of the outbound loss event must be adjusted to equal the basis that such stock would have had on the transition date if, immediately prior to the outbound loss event, the outbound loss QBU had transitioned to the final regulations pursuant to the fresh start transition method. Outbound section 987 loss that is not reflected in stock basis but that will be recognized when the owner and the related foreign person that participated in the outbound loss event cease to be members of the same controlled group must be adjusted in a similar manner. These adjustments to coordinate the application of § 1.987– 12T with the fresh start transition method must be made even if the deferral QBU owner or the owner of the outbound loss QBU continues to own the deferral QBU or the outbound loss QBU on the transition date, as in the case of a deferral event or outbound loss event resulting from a transfer of part of an interest in a section 987 aggregate partnership that does not result in the termination of the deferral QBU or outbound loss QBU. G. Effective Date The temporary regulations under § 1.987–12T generally apply to any deferral event or outbound loss event that occurs on or after January 6, 2017. However, if the deferral event or outbound loss event is undertaken with a principal purpose of recognizing section 987 loss, the 30 day delayed effective date does not apply and § 1.987–12T is effective immediately on December 7, 2016. PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 88859 2. Annual Deemed Termination Election A comment on the 2006 proposed regulations recommended that taxpayers be permitted to make a one-time election under § 1.987–5 to deem a section 987 QBU as having terminated at the end of each year, thereby requiring the owner to recognize all section 987 gains or losses with respect to the QBU on an annual basis. The comment suggested that such an election would allow taxpayers to reduce the complexity and administrative cost of complying with section 987 because taxpayers would not be required to track transactions between an owner and its section 987 QBU or unrecognized section 987 gains and losses carried over from previous years. The Treasury Department and the IRS have determined that an annual deemed termination election would not obviate the need to track transactions between an owner and its section 987 QBU, since the net transfer would remain relevant to the annual calculation of section 987 gain or loss. Nonetheless, the Treasury Department and the IRS agree that an annual deemed termination election could enhance administrability of the final regulations by reducing the recordkeeping requirements necessary to apply the final regulations. Additionally, when an annual deemed termination election is in effect, taxpayers could not strategically time remittances in order to selectively recognize section 987 losses but not section 987 gains. Eliminating this planning opportunity would obviate the need for the deferral provisions of § 1.987–12T. Furthermore, as discussed in Part 3 of this Explanation of Provisions, an annual deemed termination election would address a policy concern with permitting the hybrid approach to section 987 suggested by comments on the 2006 proposed regulations. Based on the foregoing considerations, § 1.987–8T(d) provides an election for a taxpayer to deem its section 987 QBUs to terminate on the last day of each taxable year for which the election is in effect. Because the considerations supporting an annual deemed termination election generally are relevant regardless of whether a taxpayer is subject to the final regulations, the election under § 1.987– 8T(d) is available to any taxpayer without regard to the applicability of the final regulations to that taxpayer or any of its section 987 QBUs. A section 987 QBU to which this election applies is treated as having made a remittance of all of its gross assets to its owner E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88860 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations immediately before the section 987 QBU terminates on the last day of each taxable year, resulting in the recognition of any net unrecognized section 987 gain or loss of the section 987 QBU. See §§ 1.987–5(c)(3) and 1.987–8(e). The owner is then treated as having transferred all of the assets and liabilities of the terminated section 987 QBU to a new section 987 QBU on the first day of the following taxable year. As noted in Part 1 of this Explanation of Provisions, the temporary regulations provide that the deferral provisions of § 1.987–12T do not apply with respect to section 987 QBUs for which the annual deemed termination election is in effect. Consequently, a taxpayer that finds the annual deemed termination election preferable to § 1.987–12T based on ease of compliance or other reasons may make the annual deemed termination election. Moreover, as discussed in Part 3 of this Explanation of Provisions, a taxpayer that makes the annual deemed termination election with respect to a section 987 QBU may reduce the compliance burden associated with computing taxable income or loss under the final regulations by electing to translate taxable income or loss of the section 987 QBU into the owner’s functional currency at the yearly average exchange rate without any adjustments. The Treasury Department and the IRS have determined that special consistency and effective date rules are needed for the annual deemed termination election to prevent taxpayers from using the election to selectively recognize section 987 losses without recognizing section 987 gains. Unless the annual deemed termination election is required to be made with respect to all section QBUs owned by related persons at the time of the election, taxpayers could choose to make the election only with respect to section 987 QBUs that have net unrecognized section 987 losses at the time of the election. Accordingly, § 1.987–1T(g)(2)(i)(B)(1) provides that the annual deemed termination election generally applies to all section 987 QBUs owned by an electing taxpayer, as well as to all section 987 QBUs owned by any person that has a relationship to the taxpayer described in section 267(b) or section 707(b) (substituting ‘‘and the profits interest’’ for ‘‘or the profits interest’’ in section 707(b)(1)(A) and substituting ‘‘and profits interests’’ for ‘‘or profits interests’’ in section 707(b)(1)(B)) on the last day of the first taxable year for which the election applies to the taxpayer (a related person). VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 A taxpayer that is subject to the final regulations and that must transition to the final regulations under the fresh start transition method of § 1.987–10(b) (fresh start taxpayer) may make the annual deemed termination election only if the first taxable year for which the election would apply is either (i) the first taxable year beginning on or after the transition date (as defined in § 1.987–11(c)) with respect to the taxpayer or (ii) a subsequent taxable year in which the ‘‘taxpayer’s controlled group aggregate section 987 loss’’ (if any) does not exceed $5 million. For this purpose, a ‘‘taxpayer’s controlled group aggregate section 987 loss’’ means the aggregate net amount of section 987 gain or loss that would be recognized pursuant to the election under § 1.987– 8T(d) by the taxpayer and all related persons in the first taxable year of each person for which the election would apply. Taxpayers that used a method based on a reasonable application of the 2006 proposed regulations prior to the transition date, and which therefore are not subject to the fresh start transition method pursuant to § 1.987–10(c), and taxpayers for which the final regulations are not applicable, must follow the election rules for fresh start taxpayers if any related party is a fresh start taxpayer. If no related party is a fresh start taxpayer, the annual deemed termination election may be made only if the first taxable year for which the election would apply is either (i) the first taxable year beginning on or after December 7, 2016, in which the election is relevant in determining section 987 taxable income or loss or section 987 gain or loss or (ii) a subsequent taxable year in which the ‘‘taxpayer’s controlled group aggregate section 987 loss’’ (if any) does not exceed $5 million. If a taxpayer makes the annual deemed termination election, the election will apply to the first taxable year of a related person that ends with or within a taxable year of the taxpayer to which the taxpayer’s election applies. Once made, the annual deemed termination election may not be revoked. As provided in § 1.987– 1T(g)(2)(i)(B)(2), the special consistency and effective date rules in § 1.987– 1T(g)(2)(i)(B)(1) do not apply and a taxpayer may make a separate election under § 1.987–8T(d) with respect to any section 987 QBU owned by the taxpayer if the first taxable year for which the election would apply to the taxpayer with respect to the section 987 QBU is a taxable year in which the deemed termination results in the recognition of section 987 gain with respect to the PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 section 987 QBU or the deemed termination results in the recognition of $1 million or less of section 987 loss with respect to the section 987 QBU. 3. Election To Translate All Items at the Yearly Average Exchange Rate As discussed in the preamble to the final regulations, comments on the 2006 proposed regulations recommended a hybrid approach that would combine the methodology of the regulations proposed under section 987 in 1991 (INTL–965–86, 56 FR 48457) for computing a section 987 QBU’s net income with the methodology of the 2006 proposed regulations for computing section 987 gain or loss. Under the proposed hybrid approach, section 987 gain or loss generally would be determined under the method of the 2006 proposed regulations, but taxable income or loss would be translated into the owner’s functional currency at the yearly average exchange rate without any adjustments. Although a hybrid approach would simplify the calculation of section 987 taxable income or loss, the preamble to the final regulations observes that the hybrid approach gives rise to offsetting effects in section 987 taxable income or loss and in the foreign exchange exposure pool (FEEP) that raise concerns similar to those addressed by Congress in enacting section 1092. In particular, under the hybrid approach, exchange rate effects with respect to historic assets would be reflected in section 987 taxable income or loss to the extent of any cost recovery deductions with respect to those assets, but equal and offsetting amounts would be reflected in the FEEP and would be recognized only upon remittances. Thus, offsetting effects arising from a single asset would be taken into account at different times. The Treasury Department and the IRS have determined that it would be inappropriate for regulations under section 987 to permit distortions to section 987 taxable income or loss that have the effect of causing potentially large offsetting amounts of loss or gain to be reflected in the FEEP with respect to the same asset, since the loss or gain in the FEEP would be recognized only upon voluntary remittances from the QBU. Nonetheless, the Treasury Department and the IRS acknowledge the concerns expressed in comments regarding the complexity of the 2006 proposed regulations that underlie the recommendation to adopt the hybrid approach. Concerns about offsetting amounts recognized at different times under the hybrid approach would not E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations arise for taxpayers that make the annual deemed termination election set forth in § 1.987–8T(d). A taxpayer that recognizes all section 987 gain or loss with respect to its section 987 QBUs annually would take into account in recognized section 987 gain or loss the exchange rate effects with respect to historic assets that are reflected in the FEEP in the same taxable year in which the offsetting effects are taken into account in section 987 taxable income or loss. Although the hybrid approach could result in differences in character of exchange gain or loss relative to the final regulations even for taxpayers that make the annual deemed termination election, the Treasury Department and the IRS have determined that the administrative convenience of allowing taxpayers to translate a section 987 QBU’s taxable income at the yearly average exchange rate outweighs that consideration. Accordingly, the temporary regulations provide that a taxpayer that is otherwise generally subject to the final regulations may elect to apply the hybrid approach with respect to a section 987 QBU that is subject to the annual deemed termination election. In particular, § 1.987–3T(d) provides that, notwithstanding the rules of § 1.987– 3(c) for translating items determined under § 1.987–3(b) in a section 987 QBU’s functional currency into the owner’s functional currency, a taxpayer may elect to translate all items of income, gain, deduction, and loss of a section 987 QBU with respect to which the annual deemed termination election described in § 1.987–8T(d) is in effect into the owner’s functional currency, if necessary, at the yearly average exchange rate for the taxable year. An owner of multiple section 987 QBUs may make the election described in § 1.987–3T(d) with respect to all of its section 987 QBUs or only certain designated section 987 QBUs. sradovich on DSK3GMQ082PROD with RULES4 4. Section 988 Transactions of a Section 987 QBU A. Background Regarding the Treatment of Section 988 Transactions Under the Proposed Regulations The 2006 proposed regulations reflected a two-pronged approach to the application of section 988 to transactions of a section 987 QBU, with different consequences generally depending on whether a transaction is denominated in (or determined by reference to) the owner’s functional currency or a currency that is a nonfunctional currency with respect to both the owner and the section 987 QBU (third currency). As a general rule, VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 § 1.987–3(e)(1) of the 2006 proposed regulations provided that section 988 applies to section 988 transactions attributable to a section 987 QBU and that the timing of any gain or loss is determined under the applicable provisions of the Code, but the 2006 proposed regulations did not clearly specify whether section 988 gain or loss would be determined with respect to the functional currency of the section 987 QBU or the owner’s functional currency. Assets and liabilities giving rise to section 988 transactions were defined under proposed § 1.987–1(d) and (e) as historic items. Under § 1.987–3(e)(2) of the 2006 proposed regulations, transactions of a section 987 QBU described in section 988(c)(1)(B)(i) (relating to the acquisition of, or becoming an obligor under, a debt instrument), section 988(c)(1)(B)(ii) (relating to accrual of items of expense or gross income or receipts) or section 988(c)(1)(C) (relating to the disposition of nonfunctional currency) that are denominated in (or determined by reference to) the owner’s functional currency, however, were not treated as section 988 transactions of the section 987 QBU, and no gain or loss was recognized under section 988 with respect to such transactions. Assets and liabilities giving rise to such transactions were required to be reflected on the balance sheet of the section 987 QBU in the owner’s functional currency under § 1.987– 2(d)(2) of the 2006 proposed regulations. Additionally, § 1.987–3(d) of the 2006 proposed regulations provided that an item of income, gain, deduction, or loss of a section 987 QBU denominated in a currency other than the functional currency of the owner is translated at the spot rate on date the item is appropriately taken into account. Under § 1.987–3(c) of the 2006 proposed regulations, an item of income, gain, deduction, or loss of a section 987 QBU denominated in the owner’s functional currency is not translated and is taken into account by the section 987 QBU in the owner’s functional currency. One comment indicated that the 2006 proposed regulations were unclear regarding the interaction of the rules for the treatment of section 988 transactions denominated in a third currency with the treatment of assets that give rise to section 988 transactions as historic assets. Upon the disposition of a historic asset, the 2006 proposed regulations required translation of the basis of the historic asset at the historic rate and the amount realized with respect to the asset at the yearly average exchange rate for the taxable year of the disposition or, if properly elected, the appropriate spot PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 88861 rate. Yet, § 1.987–3(f), Example 10 of the 2006 proposed regulations illustrated the determination of section 988 gain or loss on a third-currency section 988 transaction in, and by reference to, the section 987 QBU’s functional currency and translation of that amount into the owner’s functional currency at the yearly average exchange rate. Under the approach of the example, historic asset basis is effectively translated at the yearly average exchange rate rather than the appropriate historic rate. B. General Rules for Section 988 Transactions in the Temporary Regulations In light of the comment regarding the uncertain application of section 988 to transactions of a section 987 QBU under the 2006 proposed regulations and further consideration of the appropriate rules, the temporary regulations clarify and elaborate upon the application of section 988 to transactions attributable to a section 987 QBU. In this regard, the Treasury Department and the IRS have determined that computing section 988 gain or loss by reference to the functional currency of the section 987 QBU, rather than the owner’s functional currency, and translating that amount at the yearly average exchange rate would be inconsistent with the treatment of items that give rise to section 988 transactions as historic items. Such items were treated as historic items under the 2006 proposed regulations because they do not economically expose the owner to fluctuations in the section 987 QBU’s functional currency. Taking these considerations into account, the Treasury Department and the IRS have determined that it is appropriate to continue to treat assets and liabilities giving rise to section 988 transactions of a section 987 QBU as historic items under §§ 1.987–1(d) and (e) of the final regulations. Thus, for example, a note denominated in a nonfunctional currency that gives rise to a section 988 transaction when acquired is a historic asset. However, the temporary regulations generally provide that section 988 gain or loss arising from section 988 transactions of a section 987 QBU is determined by reference to the owner’s functional currency, rather than the functional currency of the section 987 QBU. See § 1.987–3T(b)(4)(i). Accordingly, in determining section 988 gain or loss with respect to a section 988 transaction of a section 987 QBU, the amounts required under section 988 to be translated on the applicable booking date or payment date with respect to the section 988 transaction are translated from the currency in which the amounts are denominated (or by reference to E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88862 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations which they are determined) into the owner’s functional currency at the rate required under section 988 and the section 988 regulations, which provide for translation at the appropriate spot rate. When a section 987 QBU recognizes gain or loss on the disposition of a historic asset that gives rise to a section 988 transaction, some or all of the total gain or loss that is realized on the disposition may be section 988 gain or loss that, under section 988, is ordinary income that is sourced by reference to the residence of the section 987 QBU. For example, on the disposition of a nonfunctional currency note, the total gain or loss realized may be comprised of section 988 gain or loss that reflects exchange rate changes and other gain or loss that reflects other factors, such as changes in prevailing interest rates or in the creditworthiness of the note issuer. The total gain or loss on the disposition of a historic asset that gives rise to a section 988 transaction is determined under the general rules of section 987 by reference to the functional currency of the section 987 QBU. Section 988 gain or loss on the note is determined under §§ 1.988–2(b)(5) and (8) and 1.987– 3T(b)(4)(i) by comparing the section 987 QBU’s acquisition price for the note in nonfunctional currency translated into the owner’s functional currency at the spot rates on the date of acquisition and the date of disposition, respectively. See § 1.987–3T(e), Example 11. To provide for consistent translation rates for determining both the total gain or loss on such a historic asset and the portion of the total gain or loss that is section 988 gain or loss, § 1.987–3T(c)(2)(ii) specifies that the spot rate also must be used to translate the amount received with respect to a historic asset if the acquisition of the historic asset gave rise to a section 988 transaction. Additionally, consistent with the regulations under § 1.988–1(d) regarding the use of spot rate conventions for section 988 transactions, § 1.987– 1T(c)(1)(ii)(B) specifies that the election in § 1.987–1(c)(1)(ii)(A) to use a spot rate convention generally does not apply for purposes of determining section 987 taxable income or loss with respect to a historic item (as defined in § 1.987–1(e)) if acquiring, accruing, or entering into such item gave rise to a section 988 transaction or a specified owner functional currency transaction (discussed in this Part B). Because assets and liabilities that give rise to section 988 transactions generally are historic items that have a spot rate as the historic rate under § 1.987– 1T(c)(3)(i)(E), such assets and liabilities are translated at historic rates and do VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 not give rise to section 987 gain or loss. Thus, when the general rules for section 988 transactions of a section 987 QBU apply, the owner will take into account under subpart J foreign currency exposure with respect to a section 988 transaction of a section 987 QBU only to the extent of the owner’s economic exposure to fluctuations of its functional currency relative to the currency in which the section 988 transaction is denominated. Additionally, consistent with the 2006 proposed regulations, the temporary regulations confirm that certain transactions that are denominated in (or determined by reference to) the owner’s functional currency are not subject to section 988. Specifically, § 1.987–3T(b)(4)(ii) provides that specified owner functional currency transactions, which are defined as transactions described in section 988(c)(1)(B)(i) or (ii) or section 988(c)(1)(C) (including the acquisition of nonfunctional currency described in § 1.988–1(a)(1)) that are denominated in (or determined by reference to) the owner’s functional currency, other than certain transactions described in § 1.987–3T(b)(4)(iii)(A) that are subject to a mark-to-market regime (discussed in Part 4.C of this Explanation of Provisions), are not treated as section 988 transactions. Although the temporary regulations do not follow the 2006 proposed regulations in specifying that assets and liabilities that give rise to specified owner functional currency transactions must be reflected on the balance sheet of the section 987 QBU in the owner’s functional currency, the temporary regulations treat items that give rise to specified owner functional currency transactions as historic items that generally have a spot rate as the historic rate under § 1.987–1T(c)(3)(i)(E) and provide under § 1.987–3T(b)(2)(ii) that the basis and amount realized of a historic asset that gives rise to a specified owner functional currency transactions are not translated if denominated in the owner’s functional currency. Together, these rules have the same effect as the treatment of specified owner functional currency transactions under the 2006 proposed regulations. C. Special Rules To Allow Greater Conformity With the Financial Accounting Treatment for Certain Section 988 Transactions As discussed in the preamble to the final regulations, under the financial accounting standard described in Accounting Standards Codification, Foreign Currency Matters, section 830 (ASC 830), gains and losses from changes in exchange rates with respect PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 to transactions that are denominated in a currency other than the entity’s functional currency are referred to as ‘‘transaction’’ gains and losses. The category of foreign currency transactions that give rise to transaction gains and losses for financial accounting purposes overlaps considerably with the definition of a section 988 transaction for tax purposes, such that transaction gains and losses under financial accounting rules are conceptually similar to section 988 gains and losses. The financial accounting rules require the inclusion of transaction gains and losses in net income for the period in which the exchange rate changes occur. See ASC 830–20–35–1. Moreover, transaction gain or loss is always determined by reference to the functional currency of the entity that entered into the transaction. Thus, the financial accounting rules differ from the general tax rules applicable to section 988 transactions entered into by a section 987 QBU in two respects. First, the financial accounting rules require transaction gain or loss to be determined on a mark-to-market basis, whereas gain or loss from a section 988 transaction generally is not recognized until there is a realization event under general tax principles and the applicable provisions of the Code. Second, the financial accounting rules require transaction gain or loss to be determined by reference to the entity’s functional currency, even when it differs from the reporting currency used in the consolidated financial statements and the transaction is denominated in the reporting currency. As noted in the preamble to the final regulations, comments on the 2006 proposed regulations expressed a preference for greater consistency of the section 987 regulations with financial accounting rules. Taking these comments into account, the Treasury Department and the IRS have determined that providing treatment similar to the financial accounting treatment for certain section 988 transactions of section 987 QBUs will enhance administrability of the section 987 regulations with respect to such transactions and is consistent with the policies of sections 987 and 988. Accordingly, as discussed in Part 1.C.i of this Explanation of Provisions, the temporary regulations permit a taxpayer to elect to determine section 987 gain or loss with respect to qualified short-term section 988 transactions (described in Part 1.C.i of this Explanation of Provisions) of a section 987 QBU under a foreign currency mark-to-market method of accounting. In addition, as discussed in Part 4.C.ii of this E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations Explanation of Provisions, the temporary regulations provide that section 988 gain or loss with respect to qualified short-term section 988 transactions that are accounted for under a mark-to-market method of accounting for Federal tax purposes (including the elective method described in Part 1.C.i of this Explanation of Provisions) is determined in, and by reference to, the functional currency of the section 987 QBU rather than the functional currency of its owner. sradovich on DSK3GMQ082PROD with RULES4 i. Election To Apply a Foreign Currency Mark-to-Market Method of Accounting for Certain Section 988 Transactions The Treasury Department and the IRS have determined that allowing a taxpayer to mark to market foreign currency gain or loss with respect to qualified short-term section 988 transactions of a section 987 QBU will enhance administrability by aligning the timing for recognizing gain or loss with respect to such transactions with the financial accounting rules. Accordingly, a taxpayer may elect, on a QBU-by-QBU basis, under § 1.987–3T(b)(4)(iii)(C) to apply the foreign currency mark-tomarket method of accounting to qualified short-term section 988 transactions. Under this election, the timing of section 988 gain or loss is determined for applicable transactions under the principles of section 1256(a)(1). Thus, when the election applies, section 988 gain or loss with respect to a qualified short-term section 988 transaction is recognized on an annual basis, but other gain or loss with respect to any property underlying the transaction (e.g., gain or loss on a debt instrument due to interest rate fluctuations) is determined under the otherwise applicable recognition provisions. A qualified short-term section 988 transaction is defined in § 1.987– 3T(b)(4)(iii)(B) as a section 988 transaction, including a transaction denominated in the owner’s functional currency, that both (1) occurs in the ordinary course of the section 987 QBU’s business and (2) has an original term of one year or less on the day it is entered into by the section 987 QBU. The holding of currency that is nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) to the section 987 QBU in the ordinary course of a section 987 QBU’s trade or business also is treated as a qualified short-term section 988 transaction. VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 ii. Special Rule Requiring Gain or Loss From Certain Section 988 Transactions That Are Subject to a Mark-to-Market Method of Accounting To Be Determined by Reference to the Functional Currency of the Section 987 QBU The temporary regulations include a special rule for determining section 988 gain or loss with respect to qualified short-term section 988 transactions (as described in Part 4.C.i of this Explanation of Provisions) of a section 987 QBU that are accounted for under a mark-to-market method of accounting. Specifically, § 1.987–3T(b)(4)(iii)(A) provides that section 988 gain or loss with respect to qualified short-term section 988 transactions of a section 987 QBU, and certain related hedges, that are accounted for under a mark-tomarket method of accounting under section 475, section 1256, or § 1.987– 3T(b)(4)(iii)(C) (discussed in Part 4.C.i of this Explanation of Provisions) is determined in, and by reference to, the functional currency of the section 987 QBU rather than the owner’s functional currency. Items that give rise to qualified short-term section 988 transactions for which section 988 gain or loss is determined under § 1.987– 3T(b)(4)(iii)(A) by reference to the section 987 QBU’s functional currency are treated as marked items under § 1.987–1T(d)(3), with the result that gain or loss attributable to such items is translated at the yearly average exchange rate and that such items give rise to net unrecognized section 987 gain or loss. Under the rules for qualified shortterm section 988 transactions accounted for under a mark-to-market method of accounting, a section 987 QBU owner will take into account the full amount of its economic foreign currency exposure arising from such transactions, but the effects of such exposure generally will be bifurcated into a component reflected in section 987 taxable income or loss and a component reflected in the FEEP pool and recognized upon a remittance. These components could offset each other if the currency in which the section 988 transaction is denominated and the owner’s functional currency moved in opposite directions relative to the section 987 QBU’s functional currency. Restricting this treatment to qualified short-term section 988 transactions accounted for under a mark-to-market method of accounting limits the potential for abusive planning. In particular, the restriction to transactions accounted for under a mark-to-market method of accounting prevents selective PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 88863 realization of section 988 losses that would be taken into account in section 987 taxable income or loss in situations in which an offsetting gain is reflected in the FEEP. Additionally, short-term, ordinary-course section 988 transactions are less likely than other section 988 transactions to give rise to substantial offsetting effects in section 987 taxable income or loss and in the FEEP. 5. Application of Section 987 to QBUs With the U.S. Dollar as a Functional Currency Consistent with the opening clause of section 987, which indicates that section 987 applies to the determination of the taxable income of any taxpayer ‘‘having 1 or more qualified business units with a functional currency other than the dollar,’’ § 1.987–1T(b)(6)(i) sets forth a general rule that section 987 and the regulations thereunder do not apply with respect to an eligible QBU (determined without regard to the scope limitations of § 1.987–1(b)(3)(ii)) that has the U.S. dollar as its functional currency and that would be subject to section 987 if it had a functional currency other than the U.S. dollar (dollar QBU). The Treasury Department and the IRS have determined, however, that it is appropriate for a CFC that is the owner of a dollar QBU to recognize foreign currency gain or loss with respect to transactions of the dollar QBU that would be section 988 transactions if entered into directly by the owner. Accordingly, pursuant to the authority granted in section 985(a), § 1.987– 1T(b)(6)(ii)(A) provides that the CFC owner of a dollar QBU will be subject to section 988 with respect to any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU. For purposes of applying section 988 to such items, § 1.987–1T(b)(6)(ii)(A) provides that such items are treated as properly reflected on the books and records of the dollar QBU’s owner. Thus, except as provided in the special rule described later in this Part 5 of this Explanation of Provisions for computing income that is effectively connected with the conduct of a trade or business within the United States (ECI), a CFC would determine section 988 gain or loss from transactions of a dollar QBU by reference to the CFC’s functional currency. For example, for purposes of determining its earnings and profits, a CFC that has a euro functional currency and that is the owner of a dollar QBU with a U.S. dollar-denominated liability E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88864 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations would apply section 988 with respect to that U.S. dollar-denominated liability, measuring section 988 gain or loss on the section 988 transaction arising from the liability by reference to the euro. As a result of treating such items as properly reflected on the books and records of the CFC, instead of those of the dollar QBU, the CFC’s section 988 gain or loss with respect to such items generally would be treated as foreign source income because section 988(a)(3) generally provides that the source of section 988 gain or loss is determined by reference to the residence of the taxpayer or QBU on whose books the asset, liability, or other item giving rise to the section 988 transaction is properly reflected. Section 1.988–4 then would apply to determine whether the section 988 gain or loss would be treated as ECI. Because a QBU with ECI must have the U.S. dollar as its functional currency (§ 1.985–1(b)(1)(v)), section 988 gain or loss measured by reference to the owner CFC’s functional currency would not be ECI. However, the temporary regulations provide a special rule for certain section 988 transactions of a dollar QBU (including section 988 transactions denominated in the owner’s functional currency) that arise from the conduct of a United States trade or business. The special rule applies to a CFC owner of a dollar QBU that would have a section 988 transaction that would give rise to section 988 gain or loss that would be treated as ECI under § 1.988– 4(c) if the item that would give rise to the section 988 transaction were treated as properly reflected on the books and records of the dollar QBU. Under § 1.987–1T(b)(6)(ii)(B), solely for purposes of determining the amount of section 988 gain or loss of the CFC that is ECI, any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU and, consequently, is determined by reference to the U.S. dollar. The application of § 1.987–1T(b)(6)(ii) to a section 988 transaction that is denominated in a third currency (that is, neither the CFC’s functional currency nor the U.S. dollar) could result in the same section 988 transaction generating ECI (determined by reference to the U.S. dollar) and generating subpart F income (determined by reference to the CFC owner’s functional currency), subject to any limitation imposed by section 952(b). Under section 952(b), if the VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 amount determined under § 1.987– 1T(b)(6)(ii)(A) by reference to the owner’s functional currency and the amount of ECI determined under § 1.987–1T(b)(6)(ii)(B) were both gains, only the excess, if any, of the gain determined by reference to the owner’s functional currency over the ECI gain would be taken into account in determining subpart F income. If the amount determined under § 1.987– 1T(b)(6)(ii)(A) by reference to the owner’s functional currency and the amount of ECI determined under § 1.987–1T(b)(6)(ii)(B) were both losses, the loss determined by reference to the owner’s functional currency would be taken into account in determining subpart F income only to the extent it exceeds the ECI loss. The Treasury Department and the IRS recognize the potential administrative burden associated with applying the foregoing rules to a dollar QBU, which may give rise to a large number of section 988 transactions. Accordingly, § 1.987–1T(b)(6)(iii) provides an election for a CFC that directly or indirectly owns a dollar QBU to apply section 987 and the regulations thereunder in lieu of applying section 988 pursuant to § 1.987–1T(b)(6)(ii). The Treasury Department and the IRS have determined that, when this election applies, the source of foreign currency gain or loss that is determined under section 987 pursuant to the election should be consistent with the source that would have been determined under section 988 in the absence of the election. Accordingly, consistent with the source rule in section 988(a)(3), § 1.987–6T(b)(4) provides that the source of section 987 gain or loss determined with respect to a dollar QBU for which the owner has elected to apply section 987 is determined by reference to the residence of the CFC owner. Thus, such section 987 gain or loss will have a foreign source. As is the case for dollar QBUs of CFCs that do not make the election under § 1.987–1T(b)(6)(iii) to apply section 987, CFCs that make the election and that have a dollar QBU that engages in a U.S. trade or business must apply a special rule to determine the amount of ECI that arises from transactions that would give rise to section 988 gain or loss if determined by reference to the dollar QBU’s U.S. dollar functional currency. This special rule for determining the amount of ECI applies only to dollar QBUs that generate ECI because, under § 1.985–1(b)(1)(v), a QBU that produces income or loss that is, or is treated as, ECI must use the dollar as its functional currency. The special rule is needed for dollar QBUs PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 that elect to be treated as section 987 QBUs because, under the general rules of § 1.987–3T(b)(4)(i) and (ii), which apply to all section 987 QBUs other than with respect to certain short-term transactions described in § 1.987– 3T(b)(4)(iii)(B) that are accounted for under a mark-to-market method of accounting, section 988 gain or loss of a section 987 QBU with respect to transactions denominated in a third currency is determined in, and by reference to, the functional currency of the owner of the section 987 QBU, and section 988 gain or loss generally is not determined with respect to specified owner functional currency transactions described in Part 4.B of this Explanation of Provisions. Thus, in order to determine the appropriate amount of ECI from transactions of a dollar QBU for which an election to apply section 987 is in effect, § 1.987–1T(b)(6)(iii)(B) provides that, solely for purposes of determining the amount of section 988 gain or loss that is ECI, any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under § 1.988–4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating the item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. For purposes of determining the amount of section 988 gain or loss for other purposes, including to determine the earnings and profits of the CFC, the rules in § 1.987–3T(b)(4)(i) and (ii) continue to apply. As is the case for a CFC that has not made the election to apply section 987 in lieu of section 988, a transaction to which the special rule applies could generate both ECI and subpart F income. 6. Combinations and Separations of QBUs A. Combinations and Separations Do Not Give Rise to Transfers Under § 1.987–2(c), an asset or liability is treated as transferred to a section 987 QBU from its owner if, as a result of a disregarded transaction, the asset or liability is reflected on the books and records of the section 987 QBU. Similarly, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of a disregarded transaction, the asset or liability is no longer reflected on the books and records of the section 987 QBU. For this purpose, a disregarded transaction generally means a E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations transaction that is not regarded for Federal income tax purposes. Absent a special rule, the combination of multiple section 987 QBUs that have the same owner, or the separation of a section 987 QBU into two or more section 987 QBUs that have the same owner, would give rise to a transfer between an owner and one or more section 987 QBUs under the final regulations. Consistent with the policy of deferring section 987 gain or loss under § 1.987–12T when assets of a section 987 QBU are reflected on the books and records of another section 987 QBU in the same controlled group as a result of certain transactions that result in deemed transfers, the Treasury Department and the IRS have determined that it would not be appropriate for combinations or separations of section 987 QBUs of the same owner to give rise to transfers to or from the section 987 QBUs. Accordingly, under the temporary regulations, section 987 gain or loss generally is not recognized when two or more section 987 QBUs (combining QBUs) with the same owner combine into a single section 987 QBU (combined QBU) or when a section 987 QBU (separating QBU) separates into multiple section 987 QBUs (each, a separated QBU). Specifically, notwithstanding the general rule of the final regulations, § 1.987–2T(c)(9)(i) provides that the combination of two or more combining QBUs that have the same owner into a combined QBU does not give rise to a transfer of any combining QBU’s assets or liabilities to the owner. In addition, § 1.987–2T(c)(9)(i) provides that transactions between the combining QBUs occurring in the taxable year of the combination, which otherwise would give rise to transfers, do not result in a transfer of the combining QBUs’ assets or liabilities to the owner under § 1.987–2(c). For this purpose, a combination occurs when the assets and liabilities that are properly reflected on the books and records of two or more combining QBUs begin to be properly reflected on the books and records of a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which combining QBUs become a combined QBU. Similarly, § 1.987–2T(c)(9)(iii) provides that the separation of a separating QBU into two or more separated QBUs that have the same owner after the separation does not give rise to a transfer of any of the separating QBU’s assets or liabilities to the owner. VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 For this purpose, a separation occurs when assets and liabilities that are properly reflected on the books and records of a separating QBU begin to be properly reflected on the books and records of two or more separated QBUs. A separation may result from any transaction or series of transactions in which the separating QBU becomes two or more separated QBUs. B. Determination of Net Unrecognized Section 987 Gain or Loss of Combined QBUs and Separated QBUs The temporary regulations generally require combining the aggregate net unrecognized section 987 gain or loss of combining QBUs for purposes of determining net unrecognized section 987 gain or loss of the combined QBU and require apportioning the net unrecognized section 987 gain or loss of a separating QBU among separated QBUs in proportion to their respective shares of the aggregate adjusted basis of the separating QBU’s gross assets. Specifically, § 1.987–4T(f)(1) provides that the net unrecognized section 987 gain or loss of a combined QBU for a taxable year is determined by taking into account the net accumulated unrecognized section 987 gain or loss of each combining QBU for all prior taxable years for which the final regulations apply and treating the combining QBUs as having combined immediately prior to the beginning of the taxable year of combination. Additionally, § 1.987–4T(f)(2) provides that the net unrecognized section 987 gain or loss of a separated QBU for a taxable year is determined by taking into account the separated QBU’s share of the net accumulated unrecognized section 987 gain or loss of the separating QBU for all prior taxable years for which the final regulations apply and treating the separating QBU as having separated immediately prior to the beginning of the taxable year of separation. No transactions are deemed to occur between the separating QBUs in the taxable year of separation prior to the completion of the separation. A separated QBU’s share of the separating QBU’s net accumulated unrecognized section 987 gain or loss for all prior taxable years is determined by apportioning the separating QBU’s net accumulated unrecognized section 987 gain or loss for all prior taxable years to each separated QBU in proportion to the aggregate adjusted basis of the gross assets properly reflected on the books and records of each separated QBU immediately after the separation. The temporary regulations also clarify at § 1.987–2T(c)(9)(ii) that, if a combining section 987 QBU has a PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 88865 different functional currency than the combined QBU, the combining section 987 QBU will be deemed to have automatically changed its functional currency to the functional currency of the combined section 987 QBU immediately prior to the combination. A combining section 987 QBU that is deemed to change its functional currency under this paragraph must make the adjustments described in § 1.985–5. 7. Translation of Foreign Taxes Claimed as a Foreign Tax Credit and Related Income Under the general rule of § 1.987– 3(c)(1), the owner of a section 987 QBU uses the yearly average exchange rate (as defined in § 1.987–1(c)(2)) to translate an item of income, gain, deduction, or loss of a section 987 QBU into the owner’s functional currency. Alternatively, the owner of a section 987 QBU may elect to use the spot rate (as defined in § 1.987–1(c)(1)) for the day each item is taken into account. Under section 986(a)(1)(A), for purposes of determining the amount of its foreign tax credit, a taxpayer that takes foreign income taxes into account when accrued generally translates the amount of any foreign income taxes (and any adjustments thereto) into dollars using the average exchange rate for the taxable year to which such taxes relate. However, sections 986(a)(1)(B) and (C) contain exceptions to this general rule, including for taxes that are not paid within two years of the close of the taxable year to which the taxes relate (two-year rule). In addition, section 986(a)(1)(D) provides that a taxpayer may elect to translate foreign income taxes denominated in a functional currency other than the taxpayer’s functional currency using a spot rate in lieu of using the yearly average exchange rate. Section 986(a)(2)(A) generally provides that, for purposes of determining the amount of the foreign tax credit with respect to any foreign income taxes not subject to section 986(a)(1)(A) (or section 986(a)(1)(E), which provides a special rule for regulated investment companies), including by reason of the two-year rule or an election under section 986(a)(1)(D), the taxes are translated into dollars using the spot rate on the date such taxes were paid. Adjustments to such taxes are subject to the same rule, except that any refund or credit is translated into dollars using the exchange rate that applied to the original payment of such foreign income taxes. Taking into account the translation rules of § 1.987–3(c) and section 986(a), E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88866 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations a mismatch could arise between the owner functional currency value of income used to pay foreign income taxes and the owner functional currency value of the foreign income taxes claimed as a credit. In the case of foreign income taxes deemed paid under section 902, section 78 generally prevents such a mismatch at the level of the domestic shareholder claiming the credit by requiring the domestic shareholder to include in income an amount equal to the taxes deemed paid, but where a U.S. person claims a credit under section 901 that is not for taxes deemed paid under section 902 or section 960, foreign income taxes and the income used to pay those taxes could be translated at different translation rates. To address this potential mismatch, Notice 89–74, 1989–1 C.B. 739, provides that when a U.S. taxpayer with a foreign branch that has a functional currency other than the dollar claims a foreign tax credit with respect to a foreign tax, the taxpayer is required to translate a functional currency amount equal to the foreign taxes paid on branch income using the exchange rate at the time of payment of such taxes. Consistent with Notice 89–74, § 1.987–3T(c)(2)(v) includes a special translation rule providing that income in an amount equal to the functional currency amount of the section 987 QBU’s foreign income taxes claimed as a credit must be translated at the same rate used to translate the taxes. This translation rule applies to the owner of a section 987 QBU claiming a credit under section 901 for foreign income taxes, other than income taxes deemed paid under section 902 or section 960, that are properly reflected on the books of the section 987 QBU. Mechanically, this rule requires the owner to reduce the amount of section 987 taxable income or loss that otherwise would be determined under § 1.987–3 by an amount equal to the creditable tax amount, translated into U.S. dollars at the yearly average exchange rate for the taxable year in which the creditable tax is accrued, and then to increase the resulting amount by an amount equal to the creditable tax amount translated into U.S. dollars at the same exchange rate used to translate the creditable taxes into U.S. dollars under section 986(a). If the foreign taxes and the income are both translated at the same rate (that is, the same yearly average exchange rate), no adjustment is necessary under § 1.987–3T(c)(2)(v). VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 8. Determination of a Partner’s Share of Assets and Liabilities of a Section 987 Aggregate Partnership As discussed in the preamble to the final regulations, the final regulations apply an aggregate approach with respect to section 987 aggregate partnerships, which are defined in § 1.987–1(b)(5) as partnerships for which all of the capital and profits interests are owned, directly or indirectly, by persons that are related within the meaning of section 267(b) or section 707(b). This approach is consistent with the aggregate approach to partnerships reflected in the 2006 proposed regulations, but the 2006 proposed regulations would have applied to all partnerships. Under the aggregate approach, assets and liabilities reflected on the books and records of an eligible QBU of a partnership are allocated to each partner, which is considered an indirect owner of the eligible QBU. If the eligible QBU has a different functional currency than its indirect owner, then the assets and liabilities of the eligible QBU that are allocated to the partner are treated as a section 987 QBU of the indirect owner. The 2006 proposed regulations provided a rule for determining a partner’s share of the assets and liabilities of an eligible QBU that is owned indirectly through a section 987 aggregate partnership. Specifically, proposed § 1.987–7(b) provided that a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU owned through a section 987 aggregate partnership must be determined in a manner consistent with how the partners have agreed to share the economic benefits and burdens corresponding to partnership assets and liabilities, taking into account the rules and principles of subchapter K. One comment noted that this rule for allocating assets and liabilities to a partner’s indirectly owned section 987 QBU was ambiguous and that the rules and principles of subchapter K do not provide sufficient guidance in this regard. The Treasury Department and the IRS acknowledge the ambiguity in the 2006 proposed regulations regarding the manner in which assets and liabilities of a partnership are allocated to a partner’s indirectly owned section 987 QBU under the aggregate approach. Accordingly, the temporary regulations provide more specific rules for determining a partner’s share of the assets and liabilities reflected on the books and records of an eligible QBU owned indirectly through a section 987 aggregate partnership. Specifically, PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 § 1.987–7T(b) provides that, in any taxable year, a partner’s share of each asset and liability of a section 987 aggregate partnership is proportional to the partner’s liquidation value percentage with respect to the aggregate partnership. A partner’s liquidation value percentage is defined as the ratio of the liquidation value of the partner’s interest in the partnership to the aggregate liquidation value of all the partners’ interests in the partnership. The liquidation value of the partner’s interest in the partnership is the amount of cash the partner would receive with respect to its interest if, immediately following the applicable determination date, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in § 1.752–7), paid an unrelated third party to assume all of its § 1.752–7 liabilities in a fully taxable transaction, and then liquidated. In general, the temporary regulations provide that the determination date for determining a partner’s liquidation value percentage is the date of the most recent event described in § 1.704– 1(b)(2)(iv)(f)(5) or § 1.704– 1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether the capital accounts of the partners are adjusted under § 1.704–1(b)(2)(iv)(f), or, if there has been no revaluation event, the date of the formation of the partnership. However, if a partnership agreement provides for the allocation of any item of income, gain, deduction, or loss from partnership property to a partner other than in accordance with the partner’s liquidation value percentage in a particular taxable year, the determination date is the last day of the partner’s taxable year, or, if the partner’s section 987 QBU owned indirectly through a section 987 aggregate partnership terminates during the partner’s taxable year, the date such section 987 QBU is terminated. Without this requirement to redetermine liquidation value percentages at yearend when such an allocation is in effect, the allocation could result in section 987 taxable income or loss, which necessarily would reflect the allocation, being taken into account in determining section 987 gain or loss under § 1.987– 4 even though the allocation was not taken into account in computing the owner functional currency value of the section 987 QBU, such that distortions would arise in the computation of section 987 gain or loss. The Treasury Department and the IRS have determined that the liquidation value percentage methodology reflected E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations sradovich on DSK3GMQ082PROD with RULES4 in § 1.987–7T(b) reflects an administrable approach to allocating assets and liabilities of a section 987 aggregate partnership to eligible QBUs of its partners in a manner consistent with the partners’ economic interests in the assets and liabilities of the partnership. The Treasury Department and the IRS request comments on the application of the liquidation value percentage approach reflected in the temporary regulations, including whether any alternative measure could better satisfy the criteria of administrability and consistency with the economics of the partners’ arrangement. 9. Deferral of Certain Section 988 Loss Realized by a Debtor With Respect to a Related-Party Loan Section 267(a)(1) provides that no deduction is allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons who have a relationship described in section 267(b). Section 267(f)(2) modifies the general rule of section 267(a)(1) in the case of a sale or exchange of property between corporations that are members of the same controlled group (as defined in section 267(f)(1)), generally providing that a loss realized upon such a sale or exchange is deferred until the property is transferred outside the group such that there would be recognition of loss under consolidated return principles. Section 267(f)(3)(C) provides that, to the extent provided in regulations, section 267(a)(1) does not apply to any loss sustained by a member of a controlled group on the repayment of a loan made to another member of such controlled group if such loan is payable or denominated in a foreign currency and attributable to a reduction in the value of that foreign currency. Section 1.267(f)–1(e) provides that section 267(a) generally does not apply to an exchange loss realized with respect to a loan of nonfunctional currency to another controlled group member if the transaction that causes the realization of the loss does not have as a significant purpose the avoidance of Federal income tax. Additionally, § 1.267(f)–1(h) provides that if a transaction is engaged in with a principal purpose to avoid the purposes of § 1.267(f)–1, including by distorting the timing of losses, adjustments may be made to carry out such purposes. Section 1.988–2(b)(16)(i) cross-references the regulations under section 267 regarding the coordination of sections 267 and 988 with respect to the treatment of a creditor under a debt instrument, but § 1.988–2(b)(16)(ii) is reserved with respect to the treatment of VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 a debtor. The temporary regulations correct the cross-reference in § 1.988– 2(b)(16)(i) to refer to § 1.267(f)–1(e) rather than § 1.267(f)–1(h). The Treasury Department and the IRS have determined that the policy considerations underlying section 267(f)(3)(C) and § 1.267(f)–1(e) with respect to creditors on loans to related persons also apply with respect to debtors on such loans and that there is no reason to distinguish between a creditor and debtor with regard to the application of an anti-avoidance rule to the same transaction. Accordingly, pursuant to the authority granted to the Secretary in section 989(c)(5) to prescribe regulations providing for the appropriate treatment of related-party transactions, § 1.988–2T(b)(16)(ii) provides that exchange loss of a debtor with respect to a loan (original loan) from a person with whom the debtor has a relationship described in section 267(b) or section 707(b) is deferred if the transaction resulting in realization of the loss has a principal purpose of avoiding Federal income tax. Such deferred loss will be recognized at the end of the term of the original loan. Certain IRS regulations, including these, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory assessment is not required. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), please refer to the Special Analyses section in the preamble to the crossreferenced notice of proposed rulemaking in the Proposed Rules section of this issue of the Federal Register. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business. Drafting Information The principal author of these regulations is Mark E. Erwin of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Amendment to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PO 00000 Frm 00015 Fmt 4701 PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: ■ Authority: 26 U.S.C. 985, 987, 989(c) and 7805 * * * Par. 2. Section 1.987–0 is amended by adding entries for §§ 1.987–6(b)(4) and 1.987–12(a) through (h) to read as follows: ■ § 1.987–0 * * Sfmt 4700 Section 987; table of contents. * * * § 1.987–6 Character and source of section 987 gain or loss. * * * * (b) * * * (4) [Reserved]. * * * * § 1.987–12 loss. * * Deferral of section 987 gain or (a) through (h) [Reserved]. Par. 3. Section 1.987–1 is amended by adding paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(B) and (C), and (g)(3)(i)(E) through (H) to read as follows: ■ § 1.987–1 rules. Special Analyses 88867 Scope, definitions, and special * * * * * (b) * * * (1) * * * (iii) [Reserved]. For further guidance, see § 1.987–1T(b)(1)(iii). * * * * * (b) * * * (6) [Reserved]. For further guidance, see § 1.987–1T(b)(6). * * * * * (c) * * * (1) * * * (ii) * * * (B) [Reserved]. For further guidance, see § 1.987–1T(c)(1)(ii)(B). * * * * * (c) * * * (3) * * * (i) * * * (E) [Reserved]. For further guidance, see § 1.987–1T(c)(3)(i)(E). * * * * * (d) * * * (3) [Reserved]. For further guidance, see § 1.987–1T(d)(3). * * * * * (f) [Reserved]. For further guidance, see § 1.987–1T(f). * * * * * (g) * * * (2) * * * (i) * * * (B) through (C) [Reserved]. For further guidance, see § 1.987–1T(g)(2)(i)(B) through (C). * * * * * E:\FR\FM\08DER4.SGM 08DER4 88868 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations (g) * * * (3) * * * (i) * * * (E) through (H) [Reserved]. For further guidance, see § 1.987–1T(g)(3)(i)(E) through (H). * * * * * ■ Par. 4. Section 1.987–1T is added to read as follows: sradovich on DSK3GMQ082PROD with RULES4 § 1.987–1T Scope, definitions, and special rules (temporary). (a) through (b)(1)(ii) [Reserved]. For further guidance, see § 1.987–1(a) through (b)(1)(ii). (iii) Certain provisions applicable to all taxpayers. Notwithstanding § 1.987– 1(b)(1)(ii), paragraphs (b)(6) and (g)(3)(i)(E) of this section and § 1.987– 6T(b)(4) apply to any taxpayer that is an owner of a dollar QBU (as defined in paragraph (b)(6) of this section), and paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of this section and §§ 1.987–8T(d) and 1.987–12T apply to any taxpayer that is an owner of an eligible QBU (determined without regard to § 1.987– 1(b)(3)(ii)) that is subject to section 987. (b)(2) through (b)(5) [Reserved]. For further guidance, see § 1.987–1(b)(2) through (b)(5). (6) Dollar QBUs—(i) In general. Except as provided in paragraphs (b)(1)(iii) and (b)(6)(iii) of this section, section 987 and the regulations thereunder do not apply with respect to an eligible QBU (determined without regard to § 1.987–1(b)(3)(ii)) that has the U.S. dollar as its functional currency and that would be subject to section 987 if it had a functional currency other than the dollar (dollar QBU). This paragraph (b)(6) applies to all taxpayers, including entities described in § 1.987– 1(b)(1)(ii). (ii) Application of section 988 to a dollar QBU—(A) In general. Except as provided in paragraphs (b)(6)(ii)(B) and (b)(6)(iii) of this section, a controlled foreign corporation (as defined in section 957(a)) (CFC) that is the owner of a dollar QBU applies section 988 with respect to any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU. Except as provided in paragraph (b)(6)(ii)(B) of this section, for purposes of determining the amount of section 988 gain or loss of the CFC, any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU is treated as properly reflected on the books and VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 records of the owner of the dollar QBU, such that the amount of section 988 gain or loss with respect to such item is determined by reference to the owner’s functional currency. (B) Section 988 gain or loss characterized as effectively connected income. Solely for the purpose of determining the amount of section 988 gain or loss of a CFC described in paragraph (b)(6)(ii)(A) of this section that is effectively connected with the conduct of a trade or business within the United States (ECI), any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under § 1.988–4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. (iii) Election for a CFC to apply section 987 to a dollar QBU—(A) In general. A CFC that is the owner of a dollar QBU may elect to apply section 987 and the regulations thereunder with respect to the dollar QBU in lieu of applying section 988 pursuant to paragraph (b)(6)(ii) of this section. If the dollar QBU or CFC is described in § 1.987–1(b)(1)(ii), however, the CFC must apply section 987 to the dollar QBU using the method it applied to the dollar QBU immediately prior to the effective date of this paragraph (b)(6) as provided in paragraph (h) of this section, provided such method was a reasonable interpretation of section 987, or, if no such method exists, a reasonable method. (B) Section 988 gain or loss characterized as effectively connected income. Solely for the purpose of determining the amount of section 988 gain or loss of a dollar QBU that is the subject of an election described in paragraph (b)(6)(iii)(A) of this section that is ECI, § 1.987–3T(b)(4)(i) and (ii) do not apply, and any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under § 1.988–4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. See § 1.987–6T(b)(4) for rules regarding the source of section 987 gain PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 or loss with respect to a dollar QBU for which the CFC owner has made the election described in this paragraph. (b)(7) through (c)(1)(ii)(A) [Reserved]. For further guidance, see § 1.987–1(b)(7) through (c)(1)(ii)(A). (B) Election inapplicable with respect to certain amounts. Except as provided in this paragraph (c)(1)(ii)(B), the election provided in § 1.987– 1(c)(1)(ii)(A) does not apply for purposes of determining section 987 taxable income or loss (as defined in § 1.987–3(a)) with respect to a historic item (as defined in § 1.987–1(e)) if acquiring, accruing, or entering into such item gives rise to a section 988 transaction or specified owner functional currency transaction. However, the election provided in § 1.987–1(c)(1)(ii)(A) does apply for purposes of determining section 987 taxable income or loss with respect to a payable or receivable described in § 1.988–1(d)(3) under the circumstances described in § 1.988–1(d)(3). (c)(2) through (c)(3)(i)(D) [Reserved]. For further guidance, see § 1.987–1(c)(2) through (c)(3)(i)(D). (E) Section 988 transactions and specified owner functional currency transactions. If acquiring, accruing, or entering into a historic item gives rise to a section 988 transaction of a section 987 QBU or a specified owner functional currency transaction described in § 1.987–3T(b)(4)(ii), the historic rate is the spot rate (as defined in paragraph (c)(1) of this section) on the date such item is acquired, accrued, or entered into. For this purpose, use of a spot rate convention under § 1.987– 1(c)(1)(ii) is permitted only with respect to a payable or receivable described in § 1.988–1(d)(3) and only to the extent provided therein. (c)(3)(ii) through (d)(2) [Reserved]. For further guidance, see § 1.987–1(c)(3)(ii) through (d)(2). (3) Gives rise to a qualified short-term section 988 transaction (as defined in § 1.987–3T(b)(4)(iii)(B)) of the section 987 QBU, whether denominated in the functional currency of the owner or other nonfunctional currency with respect to the section 987 QBU, for which section 988 gain or loss is determined under § 1.987– 3T(b)(4)(iii)(A) in, and by reference to, the functional currency of the section 987 QBU. (e) [Reserved]. For further guidance, see § 1.987–1(e). (f) Examples. The following examples illustrate the application of § 1.987–1(d) and (e). Example 1. U.S. Corp is a domestic corporation with the U.S. dollar as its E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations sradovich on DSK3GMQ082PROD with RULES4 functional currency and is the owner of Business A, a section 987 QBU that has the pound as its functional currency. Assume all transactions of Business A are entered into in the ordinary course of its business. U.S. Corp has not made an election under § 1.987– 3T(b)(4)(iii)(C) to adopt a foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions. Items reflected on Business A’s balance sheet include £10,000, $1,000, a building with a basis of £100,000, a light general purpose truck with a basis of £30,000, a computer with a basis of £1,000, a 60-day receivable for ¥15,000, an account payable of £5,000, and a foreign currency contract within the meaning of section 1256(g)(2) that requires Business A to exchange £100 for $125 in 90 days. Under paragraph (d) of this section, the £10,000, the £5,000 account payable and the £/$ section 1256 foreign currency contract are marked items. The other items are historic items under this paragraph (e) of this section. Example 2. The facts are the same as Example 1 except that U.S. Corp has elected under § 1.987–3T(b)(4)(iii)(C) to adopt the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions of Business A. Under paragraphs (d) and (e) of this section, the £10,000, the $1,000, the ¥15,000 receivable, the £5,000 account payable, and the £/$ section 1256 foreign currency contract are marked items. (g)(1) through (g)(2)(i)(A) [Reserved]. For further guidance, see § 1.987–1(g)(1) through (g)(2)(i)(A). (B) Annual deemed termination election—(1) In general. Except as provided in paragraph (g)(2)(i)(B)(2) of this section, an election under § 1.987– 8T(d) (annual deemed termination election) applies to all section 987 QBUs owned by the taxpayer, as well as to all section 987 QBUs owned by any person that has a relationship to the taxpayer described in section 267(b) or section 707(b) (substituting ‘‘and the profits interest’’ for ‘‘or the profits interest’’ in section 707(b)(1)(A) and substituting ‘‘and profits interests’’ for ‘‘or profits interests’’ in section 707(b)(1)(B)) on the last day of the first taxable year for which the election applies (a related person). If a taxpayer makes the election under § 1.987–8T(d), the first taxable year of a related person for which the election applies is the first taxable year that ends with or within a taxable year of the taxpayer for which the taxpayer’s election applies. An election under § 1.987–8T(d) may not be revoked. (i) Fresh start taxpayers. A taxpayer to which § 1.987–10 applies that is required under § 1.987–10(a) to apply the fresh start transition method described in § 1.987–10(b) (fresh start taxpayer) may make the election under § 1.987–8T(d) only if the first taxable year for which the election would apply to the taxpayer is either the first taxable VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 year beginning on or after the transition date (as defined in § 1.987–11(c)) in which the election is relevant or a subsequent taxable year in which the taxpayer’s controlled group aggregate section 987 loss, if any, does not exceed $5 million. For purposes of this paragraph (g)(2)(i)(B), a taxpayer’s controlled group aggregate section 987 loss means the aggregate net amount of section 987 loss that would be recognized pursuant to the election by the taxpayer and all other persons to whom the taxpayer’s election would apply in the first taxable year of each person for which the election would apply. (ii) Other taxpayers. Other taxpayers, including taxpayers described in § 1.987–1(b)(1)(ii) and taxpayers described in § 1.987–10(c), must follow the election rules provided in paragraph (g)(2)(i)(B)(1)(i) of this section if any related party is a fresh start taxpayer. If no related party is a fresh start taxpayer, the election under § 1.987–8T(d) may be made only if the first taxable year for which the election would apply to the taxpayer is either the first taxable year beginning on or after December 7, 2016, in which the election is relevant or a subsequent taxable year in which the taxpayer’s controlled group aggregate section 987 loss, if any, does not exceed $5 million. (2) QBU-by-QBU elections in certain circumstances. Notwithstanding paragraph (g)(2)(i)(B)(1) of this section, a taxpayer may make a separate election under § 1.987–8T(d) with respect to any section 987 QBU owned by the taxpayer if the first taxable year for which the election would apply to the taxpayer with respect to the section 987 QBU is a taxable year in which there is a section 987 gain recognized with respect to the section 987 QBU pursuant to the election, or is a taxable year in which there is a section 987 loss of $1 million or less that would be recognized with respect to the section 987 QBU pursuant to the election (C) Election to translate all items at the yearly average exchange rate. An election under § 1.987–3T(d) (election to translate all items at the yearly average exchange rate) may be made with respect to a section 987 QBU only if the first taxable year for which the election would apply is the first taxable year for which an election under § 1.987–8T(d) (annual deemed termination election) applies with respect to the section 987 QBU. (g)(2)(ii) through (g)(3)(i)(D) [Reserved]. For further guidance, see § 1.987–1(g)(2)(ii) through (g)(3)(i)(D). (E) Election for a CFC to apply section 987 to a dollar QBU. An election under PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 88869 § 1.987–1T(b)(6)(iii) for a CFC to apply section 987 to a dollar QBU must be titled ‘‘Section 987 Election for a CFC to Apply Section 987 to a Dollar QBU Under § 1.987–1T(b)(6)(iii)’’ and must provide the name and address of each QBU for which the election is being made. (F) Election to apply the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions. An election under § 1.987–3T(b)(4)(iii)(C) to apply the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions must be titled ‘‘Section 987 Election to Use Foreign Currency Mark-to-Market Method of Accounting for Qualified Short-Term Section 988 Transactions Under § 1.987–3(b)T(4)(iii)(C)’’ and must provide the name and address of each section 987 QBU for which the election is being made. (G) Election to translate all items at the yearly average exchange rate. An election under § 1.987–3T(d) to translate all items at the yearly average exchange rate must be titled ‘‘Section 987 Election to Translate All Items at the Yearly Average Exchange Rate Under § 1.987– 3T(d)’’ and must provide the name and address of each section 987 QBU for which the election is being made. (H) Annual deemed termination election. An election under § 1.987– 8T(d) for an owner to deem all of its section 987 QBUs to terminate on the last day of each taxable year must be titled ‘‘Section 987 Annual Deemed Termination Election Under § 1.987– 8T(d)’’ and must provide the name and address of each section 987 QBU to which the election applies, including a section 987 QBU owned by a related person (within the meaning of paragraph (g)(2)(i)(B)(1) of this section). (g)(4) through (6) [Reserved]. For further guidance, see § 1.987–1(g)(4) through (6). (h) Effective/applicability date. Paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of this section apply to the first taxable year beginning on or after December 7, 2016. Paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and (g)(3)(i)(E) through (G) of this section apply to taxable years beginning 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 § 1.987–11(b), then paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and (g)(3)(i)(E) through (G) of this section apply to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. E:\FR\FM\08DER4.SGM 08DER4 88870 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations (i) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 5. Section 1.987–2 is amended by adding paragraph (c)(9) to read as follows: § 1.987–2 Attribution of items to eligible QBUs; definition of a transfer and related rules. * * * * * (c) * * * (9) [Reserved]. For further guidance, see § 1.987–2T(c)(9). * * * * * ■ Par. 6. Section 1.987–2T is added to read as follows: sradovich on DSK3GMQ082PROD with RULES4 § 1.987–2T Attribution of items to eligible QBUs; definition of a transfer and related rules (temporary). (a) through (c)(8) [Reserved]. For further guidance, see § 1.987–2(a) through (c)(8). (9) Certain disregarded transactions not treated as transfers—(i) Combinations of section 987 QBUs. The combination of two or more separate section 987 QBUs (combining QBUs) that are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, into one section 987 QBU (combined QBU) does not give rise to a transfer of any combining QBU’s assets or liabilities to the owner under § 1.987–2(c). In addition, transactions between the combining QBUs occurring in the taxable year of the combination do not result in a transfer of the combining QBUs’ assets or liabilities to the owner under § 1.987–2(c). For this purpose, a combination occurs when the assets and liabilities that are properly reflected on the books and records of two or more combining QBUs begin to be properly reflected on the books and records of a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which the combining QBUs become a combined QBU. For rules regarding the determination of net unrecognized section 987 gain or loss of a combined QBU, see § 1.987–4T(f)(1). (ii) Change in functional currency from a combination. If, following a combination of section 987 QBUs described in paragraph (c)(9)(i) of this section, the combined section 987 QBU has a different functional currency than one or more of the combining section 987 QBUs, any such combining section 987 QBU is treated as changing its functional currency and the owner of the combined section 987 QBU must comply with the regulations under VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 section 985 regarding the change in functional currency. See §§ 1.985– 1(c)(6) and 1.985–5. (iii) Separation of section 987 QBUs. The separation of a section 987 QBU (separating QBU) into two or more section 987 QBUs (separated QBUs) that, after the separation, are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, does not give rise to a transfer of the separating QBU’s assets or liabilities to the owner under § 1.987– 2(c). Additionally, transactions that occurred between the separating QBUs in the taxable year of the separation prior to the completion of the separation do not give rise to transfers for purposes of section 987. For this purpose, a separation occurs when the assets and liabilities that are properly reflected on the books and records of a separating QBU begin to be properly reflected on the books and records of two or more separated QBUs. A separation may result from any transaction or series of transactions in which a separating QBU becomes two or more separated QBUs. A separation may also result when a section 987 QBU that is subject to a grouping election under § 1.987– 1(b)(2)(ii)(A) changes its functional currency. For rules regarding the determination of net unrecognized section 987 gain or loss of a separated QBU, see § 1.987–4T(f)(2). (c)(10) through (d) [Reserved]. For further guidance see § 1.987–2(c)(10) through (d). (e) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (f) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 7. Section 1.987–3 is amended by adding paragraphs (b)(2)(ii), (b)(4), (c)(2)(ii) and (v), and (d), and Example 9 through Example 14 at the end of paragraph (e) to read as follows: § 1.987–3 Determination of section 987 taxable income or loss of an owner of a section 987 QBU. * * * * * (b) * * * (2) * * * (ii) [Reserved]. For further guidance, see § 1.987–3T(b)(2)(ii). * * * * * PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 (b) * * * (4) [Reserved]. For further guidance, see § 1.987–3T(b)(4). * * * * * (c) * * * (2) * * * (ii) [Reserved]. For further guidance, see § 1.987–3T(c)(2)(ii). * * * * * (c) * * * (2) * * * (v) through (d) [Reserved]. For further guidance, see § 1.987–3T(c)(2)(v) through (d). (e) Examples. * * * Example 9 through Example 14 [Reserved]. For further guidance, see § 1.987–3T(e), Example 9 through Example 14. ■ Par. 8. Section 1.987–3T is added to read as follows: § 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 § 1.987–3(a) through (b)(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 paragraph (b)(4)(ii) 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 § 1.987–3(b)(3). (4) Special rule for section 988 transactions—(i) In general. Section 988 and the regulations thereunder apply to section 988 transactions of a section 987 QBU. For this purpose, whether a transaction is a section 988 transaction is determined by reference to the functional currency of the section 987 QBU. (But see paragraph (b)(4)(ii) of this section, providing that specified owner functional currency transactions are not treated as section 988 transactions.) However, except as provided in paragraph (b)(4)(iii)(A) of this section, section 988 gain or loss is determined in, and by reference to, the functional currency of the owner of the section 987 QBU rather than the functional currency of the section 987 QBU. Accordingly, in determining section 988 gain or loss of a section 987 QBU with respect to a section 988 transaction of the section 987 QBU, the amounts required under section 988 and the regulations thereunder to be translated on the E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations applicable booking date or payment date with respect to the section 988 transaction are translated into the owner’s functional currency at the rate required under section 988 and the regulations thereunder. (ii) Specified owner functional currency transactions not treated as section 988 transactions. Transactions of a section 987 QBU described in sections 988(c)(1)(B)(i), 988(c)(1)(B)(ii), and 988(c)(1)(C) (including the acquisition of nonfunctional currency as described in § 1.988–1(a)(1)), other than transactions described in paragraph (b)(4)(iii)(A) 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 988 transactions. Thus, no currency gain or loss is recognized by a section 987 QBU under section 988 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 988 gain or loss with respect to section 988 transactions described in paragraph (b)(4)(iii)(B) 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 paragraph (b)(4)(iii)(C) of this section, and any hedges entered into to manage risk with respect to such transactions within the meaning of § 1.1221–2(c)(4) (related hedges), must be determined in, and by reference to, the functional currency of the section 987 QBU (rather than the functional currency of its owner). (B) Qualified short-term section 988 transaction. A qualified short-term section 988 transaction is a section 988 transaction that occurs in the ordinary course of a section 987 QBU’s business and has an original term of one year or less on the date the transaction is entered into by the section 987 QBU. The holding of currency that is nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) to the section 987 QBU in the ordinary course of a section 987 QBU’s trade or business also is treated as a qualified short-term section 988 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 988 transaction. See §§ 1.988–2(b)(15), 1.988–2(d)(5), and VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 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 paragraph (b)(4)(iii)(C) to apply the foreign currency mark-to-market method of accounting described in this paragraph for all qualified short-term section 988 transactions described in paragraph (b)(4)(iii)(B) of this section, and any related hedges, that are properly attributable to a section 987 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 475 or section 1256. Under the foreign currency mark-to-market method of accounting, the timing of section 988 gain or loss on section 988 transactions is determined under the principles of section 1256(a)(1). Thus, only section 988 gain or loss is taken into account under the foreign currency mark-tomarket method of accounting. Appropriate adjustments must be made to prevent the section 988 gain or loss from being taken into account again under section 988 or another provision of the Code or regulations. A section 988 transaction subject to this election is not subject to the ‘‘netting rule’’ of section 988(b) and § 1.988–2(b)(8), 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 988 gain or loss would be recognized with respect to such section 988 transaction but for this election. (iv) Examples. Examples 10 through 13 of paragraph (e) of this section illustrate the application of this paragraph (b)(4). (c)(1) through (c)(2)(i) [Reserved]. For further guidance, see § 1.987–3(c)(1) through (c)(2)(i). (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 988 transaction described in paragraph (b)(4)(i) 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 988 gain or loss described in section 988(b) and paragraph (b)(4)(i) of this section), the amount realized (determined, if necessary, under § 1.987–3(b)(2)(i)) 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 § 1.987– PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 88871 1T(c)(1)(ii)(B) regarding the use of a spot rate convention. (iii) through (iv) [Reserved]. For further guidance, see § 1.987–3(c)(2)(iii) through (iv). (v) Translation of income to account for certain foreign income tax claimed as a credit. The owner of a section 987 QBU claiming a credit under section 901 for foreign income taxes, other than foreign income taxes deemed paid under section 902 or section 960, that are properly reflected on the books and records of the section 987 QBU (the creditable tax amount) must determine section 987 taxable income or loss attributable to the section 987 QBU by reducing the amount of section 987 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 986(a). See Example 14 of paragraph (e) of this section,, for an illustration of this rule. (d) Election to translate all items at the yearly average exchange rate. Notwithstanding § 1.987–3(c), a taxpayer that has made the annual deemed termination election described in § 1.987–8T(d) may elect under this paragraph (d) to translate all items of income, gain, deduction, and loss with respect to a section 987 QBU determined under § 1.987–3(b) in the functional currency of the section 987 QBU into the owner’s functional currency, if necessary, at the yearly average exchange rate for the taxable year. Example 9 of paragraph (e) of this section illustrates the application of this election. (e) Example 1 through Example 8 [Reserved]. For further guidance, see § 1.987–3(e), Example 1 through Example 8. Example 9. The facts are the same as in Example 7, except that U.S. Corp properly elects under paragraph (d) 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 Ö2,000 gain on the sale of the land is translated at the yearly average exchange rate for 2021 of Ö1 = $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 Ö120 and sells the pounds on November 17, 2021, for Ö125. The dollar-pound spot rate (without the use of a spot rate convention) is £1 = $1 on August E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88872 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 27, 2021, and £1 = $1.10 on November 17, 2021. The disposition of the pounds is a section 988 transaction of Business A under paragraph (b)(4)(i) of this section, and the pounds are a historic asset under § 1.987– 1(e). Section 988 gain or loss with respect to the disposition of the pounds is determined under paragraph (b)(4)(i) of this section and § 1.988–2(a)(2) by reference to the dollar functional currency of Business A’s owner. The dollar amount realized for the pounds is determined under paragraph (c)(2)(ii) 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 § 1.987–3(c)(2)(i) by translating £100 into $100 using the historic rate described in § 1.987–1T(c)(3)(i)(E), 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 988 gain with respect to Business A’s disposition of £100. Example 11. (i) Business A purchases a £100 2-year note for Ö75 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 § 1.987–1(c)(1)), without the use of a spot rate convention, Business A’s Ö75 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 Ö90 and $130, and £80 translates into $104. (ii) The acquisition of the note is a section 988 transaction of Business A under paragraph (b)(4)(i) of this section, and the note is a historic asset under § 1.987–1(e). To determine its section 987 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 § 1.988–2(b)(8), U.S. Corp also must determine whether some or all of that gain or loss constitutes section 987 gain or loss described in section 988(b). (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 § 1.987–3(b), if necessary, and translated into dollars under § 1.987–3(c). Business A has a Ö75 basis in the note that is translated into $95 under § 1.987–3(c)(2)(i) at the historic rate described in § 1.987–1T(c)(3)(i)(E), 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 Ö90 under § 1.987–3(b)(2)(i) using the spot rate on December 31, 2021, without the use of a spot rate convention. That Ö90 amount realized is then translated into $130 under paragraph (c)(2)(ii) 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 987 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 988 gain. The VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 amount of section 988 gain realized with respect to the note is determined under § 1.988–2(b)(5), 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 paragraph (b)(4)(i) of this section, section 988 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 988 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 987 taxable income with respect to the note is section 988 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 988. 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 paragraph (b)(4)(ii) 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 988 transaction of Business A. Because the note is a historic asset under § 1.987–1(e), Business A’s Ö75 basis in the note translates into £80 at the historic rate described in § 1.987– 1T(c)(3)(i)(E), 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 Ö75, then pursuant to paragraph (b)(2)(ii) 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 paragraph (b)(2)(ii) 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 987 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. dollardenominated demand deposit at a bank on December 31, 2021. U.S. Corp has elected under paragraph (b)(4)(iii)(C) of this section to use the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions entered into by Business A. The euro-dollar spot rate without the use of a spot rate convention is Ö1 = $1 on January 1, 2021, and Ö1 = $2 on December 31, 2021, and the yearly average exchange rate for 2021 is Ö1 = $1.50. (ii) Under § 1.987–3(b)(2)(i), the $100 earned by Business A is translated into Ö100 PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 at the spot rate on January 1, 2021, as defined in § 1.987–1(c)(1) without the use of a spot rate convention. In determining U.S. Corp’s taxable income, the Ö100 of service income is translated into $150 at the yearly average exchange rate for 2021, as provided in § 1.987–3(c)(1). (iii) The $100 demand deposit constitutes a qualified short-term section 988 transaction under paragraph (b)(4)(iii)(B) of this section because the demand deposit is treated as nonfunctional currency within the meaning of section 988(c)(1)(C)(ii). Because Business A uses the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions, under paragraph (b)(4)(iii)(A) of this section, section 988 gain or loss for such transactions is determined in, and by reference to, euros, the functional currency of Business A. Accordingly, section 988 gain or loss must be determined on Business A’s holding of the $100 demand deposit in, and by reference to, the euro. Under § 1.988–2(a)(2), Business A is treated as having an amount realized of Ö50 when the $100 is marked to market at the end of 2021 under paragraph (b)(4)(iii)(C) of this section. Marking the dollars to market gives rise to a section 988 loss of Ö50 (Ö50 amount realized, less Business A’s Ö100 basis in the $100). In determining U.S. Corp’s taxable income, that Ö50 loss is translated into a $75 loss at the yearly average exchange rate for 2021, as provided in § 1.987–3(c)(1). Example 14. (i) Facts. Business A earns Ö100 of revenue from the provision of services and incurs Ö30 of general expenses and Ö10 of depreciation expense during 2021. Except as otherwise provided, U.S. Corp uses the yearly average exchange rate described in § 1.987–1(c)(2) 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 986(a)(1)(D) 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 Ö1 = $1.50. The historic rate used to translate the depreciation expense is Ö1 = $1.00. The spot rate on the date that Business A paid its foreign income taxes was Ö1 = $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 paragraph (c)(2)(v) of this section. Accordingly, U.S. Corp determines its section 987 taxable income by reducing the section 987 taxable income or loss that otherwise would be determined under this section by Ö15, translated into U.S. dollars at the yearly average exchange rate (Ö1 = $1.50), and increasing the resulting amount by Ö15, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section 986(a) (Ö1 = $1.60). Following these adjustments, Business A’s section 987 taxable income for 2021 is $96.50, computed as follows: E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations Amount in Ö Translation rate 88873 Amount in $ Revenue ....................................................................................................................................... General Expenses ....................................................................................................................... Depreciation ................................................................................................................................. Ö100 (30) (10) Ö1 = $1.50 Ö1 = $1.50 Ö1 = $1.00 $150.00 (45.00) (10.00) Tentative section 987 taxable income ......................................................................................... Adjustments under paragraph (c)(2)(v) of this section: Decrease by Ö15 tax translated at yearly average exchange rate (Ö1 = $1.50) ................ Increase by Ö15 tax translated at spot rate on payment date (Ö1 = $1.60) ....................... Ö60 ........................ $95.00 ........................ ........................ ........................ ........................ ($22.50) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (g) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 9. Section 1.987–4 is amended by adding paragraphs (c)(2) and (f) to read as follows: § 1.987–4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU. * * * * * (c) * * * (2) [Reserved]. For further guidance, see § 1.987–4T(c)(2). * * * * * (f) [Reserved]. For further guidance, see § 1.987–4T(f). * * * * * ■ Par. 10. Section 1.987–4T is added to read as follows: sradovich on DSK3GMQ082PROD with RULES4 § 1.987–4T Determination of net unrecognized section 987 gain or loss of a section 987 QBU (temporary). (a) through (c)(1) [Reserved]. For further guidance, see § 1.987–4(a) through (c)(1). (2) Coordination with § 1.987–12T. For purposes of paragraph (c)(1) of this section, amounts taken into account under § 1.987–5 are determined without regard to § 1.987–12T. (d) through (e) [Reserved]. For further guidance, see § 1.987–4(d) through (e). (f) Combinations and separations—(1) Combinations. The net unrecognized section 987 gain or loss of a combined QBU (as defined in § 1.987–2T(c)(9)(i)) for a taxable year is determined under § 1.987–4(b) by taking into account the net accumulated unrecognized section 987 gain or loss of each combining QBU (as defined in § 1.987–2T(c)(9)(i)) for all prior taxable years to which the VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 regulations under section 987 apply, as determined under § 1.987–4(c), and by treating the combining QBUs as having combined immediately prior to the beginning of the taxable year of combination. (2) Separations. The net unrecognized section 987 gain or loss of a separated QBU (as defined in § 1.987–2T(c)(9)(iii)) for a taxable year is determined under § 1.987–4(b) by taking into account the separated QBU’s share of the net accumulated unrecognized section 987 gain or loss of the separating QBU (as defined in § 1.987–2T(c)(9)(iii)) for all prior taxable years to which the regulations under section 987 apply, as determined under § 1.987–4(c), and by treating the separating QBU as having separated immediately prior to the beginning of the taxable year of separation. A separated QBU’s share of the separating QBU’s net accumulated unrecognized section 987 gain or loss for all such prior taxable years is determined by apportioning the separating QBU’s net accumulated unrecognized section 987 gain or loss for all such prior taxable years to each separated QBU in proportion to the aggregate adjusted basis of the gross assets properly reflected on the books and records of each separated QBU immediately after the separation. For purposes of determining the owner functional currency net value of the separated QBUs on the last day of the taxable year preceding the taxable year of separation under § 1.987–5(d)(1)(B) and (e), the balance sheets of the separated QBUs on that day will be deemed to reflect the assets and liabilities reflected on the balance sheet of the separating QBU on that day, apportioned between the separated QBUs in a reasonable manner that takes into account the assets and liabilities reflected on the balance sheets of the separated QBUs immediately after the separation. (3) Examples. The following examples illustrate the rules of paragraphs (f)(1) and (2) of this section. PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 Example 1. Combination of two section 987 QBUs that have the same owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in France that constitutes a section 987 QBU (French QBU) that has the euro as its functional currency. French QBU has a net accumulated unrecognized section 987 loss from all prior taxable years to which the regulations under section 987 apply of $100. DC1 also owns Entity B, a DE. Entity B conducts a business in Germany that constitutes a section 987 QBU (German QBU) that has the euro as its functional currency. German QBU has a net accumulated unrecognized section 987 gain from all prior taxable years to which the regulations under section 987 apply of $110. During the taxable year, Entity A and Entity B merge under local law. As a result, the books and records of French QBU and German QBU are combined into a new single set of books and records. The combined entity has the euro as its functional currency. (ii) Analysis. Pursuant to § 1.987– 2T(c)(9)(i), French QBU and German 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 § 1.987–5(c)). For purposes of computing net unrecognized section 987 gain or loss under § 1.987–4 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 987 QBU at the end of that taxable year described under § 1.987– 4(d)(1)(B) takes into account items reflected on the balance sheets of both French QBU and German QBU at that time. Additionally, any transactions between French QBU and German QBU occurring during the year of the merger will not result in transfers to or from a section 987 QBU. Pursuant to paragraph (f)(1) of this section, the combined QBU will have a net accumulated unrecognized section 987 gain from all prior taxable years of $10 (the $100 loss from French QBU plus the $110 gain from German QBU). Example 2. Separation of two section 987 QBUs that have the same owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in the Netherlands that constitutes a section 987 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 Ö1,000. In Year 2, the E:\FR\FM\08DER4.SGM 08DER4 88874 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations net accumulated unrecognized section 987 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 987 QBU under § 1.987–1(b)(2) (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 Ö600 and the aggregate adjusted basis of scooter QBU’s assets is Ö400. Each section 987 QBU continues to have the euro as its functional currency. (ii) Analysis. Pursuant to § 1.987– 2T(c)(9)(iii), 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 (as defined in § 1.987–5(c)). For purposes of computing net unrecognized section 987 gain or loss under § 1.987–4 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 paragraph (f)(2) of this section, bicycle QBU will have a net accumulated unrecognized section 987 loss of $120 (Ö600/Ö1,000 × $200), and scooter QBU will have a net accumulated unrecognized section 987 loss of $80 (Ö400/ Ö1,000 × $200). to a dollar QBU (as defined in § 1.987– 1T(b)(6)(i)) for which the CFC owner has elected under § 1.987–1T(b)(6)(iii) to apply section 987 is determined by reference to the residence of the CFC owner. This paragraph (b)(4) applies to any CFC that has made the election under § 1.987–1T(b)(6)(iii), including a CFC described in § 1.987–1(b)(1)(ii). (c) [Reserved]. For further guidance, see § 1.987–6(c). (d) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (e) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 13. Section 1.987–7 is amended by adding paragraph (b) to read as follows: (g) [Reserved]. For further guidance, see § 1.987–4(g). (h) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (i) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 11. Section 1.987–6 is amended by adding paragraph (b)(4) to read as follows: * § 1.987–6 Character and source of section 987 gain or loss. * * * * (b) * * * (4) [Reserved]. For further guidance, see § 1.987–6T(b)(4). * * * * * ■ Par. 12. Section 1.987–6T is added to read as follows: sradovich on DSK3GMQ082PROD with RULES4 * § 1.987–6T Character and source of section 987 gain or loss (temporary) (a) through (b)(3) [Reserved]. For further guidance, see § 1.987–6(a) through (b)(3). (4) Source of section 987 gain or loss with respect to a dollar QBU. The source of section 987 gain or loss with respect VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 § 1.987–7 Section 987 aggregate partnerships. * * * * (b) [Reserved]. For further guidance, see § 1.987–7T(b). * * * * * ■ Par. 14. Section 1.987–7T is added to read as follows: § 1.987–7T Section 987 aggregate partnerships (temporary). (a) [Reserved]. For further guidance, see § 1.987–7(a). (b) Liquidation value percentage methodology—(1) In general. In any taxable year, a partner’s share of each asset, including its basis in each asset, and the amount of each liability reflected under § 1.987–2(b) on the books and records of an eligible QBU owned indirectly through a section 987 aggregate partnership is proportional to the partner’s liquidation value percentage with respect to the aggregate partnership for that taxable year, as determined under paragraph (b)(2) of this section. (2) Liquidation value percentage—(i) In general. For purposes of this paragraph (b), a partner’s liquidation value percentage is the ratio (expressed as a percentage) of the liquidation value of the partner’s interest in the partnership to the aggregate liquidation value of all of the partners’ interests in the partnership. The liquidation value of a partner’s interest in a partnership is the amount of cash the partner would receive with respect to the interest if, immediately following the applicable PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 determination date, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in § 1.752–7), paid an unrelated third party to assume all of its § 1.752–7 liabilities in a fully taxable transaction, and then liquidated. (ii) Determination date.—(A) In general. Except as provided in paragraph (b)(2)(ii)(B) of this section, the determination date is the date of the most recent event described in § 1.704– 1(b)(2)(iv)(f)(5) or § 1.704– 1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether the capital accounts of the partners are adjusted under § 1.704–1(b)(2)(iv)(f), or, if there has been no revaluation event, the date of the formation of the partnership. (B) Allocations not in accordance with liquidation value percentage. If a partnership agreement provides for the allocation of any item of income, gain, deduction, or loss from partnership property to a partner other than in accordance with the partner’s liquidation value percentage, the determination date is the last day of the partner’s taxable year, or, if the partner’s section 987 QBU owned indirectly through a section 987 aggregate partnership terminates during the partner’s taxable year, the date such section 987 QBU is terminated. (3) Example. The following example illustrates the rule of this paragraph (b). Example. (i) Facts. DC, a domestic corporation, owns all of the stock of FS, a controlled foreign corporation (as defined in section 957(a)) with the U.S. dollar as its functional currency. FS owns a capital and profits interest in FPRS, a foreign partnership. The remaining capital and profits interest in FPRS is owned by DC. FPRS is a section 987 aggregate partnership with the euro as its functional currency. The balance sheet of FPRS reflects one asset (Asset A) with a basis of Ö60x and a fair market value of Ö100x, another asset (Asset B) with a basis of Ö100x and a fair market value of Ö200x, and a liability (Liability) of Ö50x. At the end of year 1, the liquidation value percentage, as determined under paragraph (b)(2) of this section, of DC with respect to FPRS is 75 percent, and the liquidation value percentage of FS with respect to FPRS is 25 percent. (ii) Result. Under § 1.987–1(b)(4), DC and FS are each treated as indirectly owning an eligible QBU with a balance sheet that reflects their respective shares of any assets and liabilities of FPRS. Under paragraph (b)(1) of this section, DC and FS’s shares of FPRS’s assets and liabilities are determined in accordance with DC and FS’s respective liquidation value percentages. Accordingly, because DC has a liquidation value percentage of 75 percent with respect to FPRS, Ö75x of Asset A (with a Ö45x basis), Ö150x of Asset B (with a Ö75x basis), and E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations Ö37.50x of Liability will be attributed to the DC–FPRS QBU. Additionally, because FS has a liquidation value percentage of 25 percent with respect to FPRS, Ö25x of Asset A (with a Ö15x basis), Ö50x of Asset B (with a Ö25x basis), and Ö12.50x of Liability will be attributed to the FS–FPRS QBU. (c) [Reserved]. For further guidance, see § 1.987–7(c). (d) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (e) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 15. Section 1.987–8 is amended by adding paragraph (d) to read as follows: § 1.987–8 QBU. Termination of a section 987 * * * * * (d) [Reserved]. For further guidance, see § 1.987–8T(d). * * * * * ■ Par. 16. Section 1.987–8T is added to read as follows sradovich on DSK3GMQ082PROD with RULES4 § 1.987–8T Termination of a section 987 QBU (temporary). (a) through (c) [Reserved]. For further guidance, see § 1.987–8(a) through (c). (d) Annual deemed termination election. A taxpayer, including a taxpayer described in § 1.987–1(b)(1)(ii) to which §§ 1.987–1 through 1.987–11 generally do not apply, may elect under this paragraph (d) to deem all of the section 987 QBUs of which it is an owner to terminate on the last day of each taxable year for which the election is in effect. See § 1.987–8(e) regarding the effect of such a deemed termination. The owner of a section 987 QBU that is deemed to terminate under this paragraph is treated as having transferred all of the assets and liabilities attributable to such section 987 QBU to a new section 987 QBU on the first day of the following taxable year. (e) through (f) [Reserved]. For further guidance, see § 1.987–8(e) through (f). (g) Effective/applicability date. This section applies to taxable years beginning on or after December 7, 2016. (h) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 17. Section 1.987–12 is added to read as follows: VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 § 1.987–12 loss. Deferral of section 987 gain or (a) through (h) [Reserved]. For further guidance, see § 1.987–12T(a) through (h). ■ Par. 18. Section 1.987–12T is added to read as follows: § 1.987–12T Deferral of section 987 gain or loss (temporary). (a) In general—(1) Overview. This section provides rules that defer the recognition of section 987 gain or loss that, but for this section, would be recognized in connection with certain QBU terminations and certain other transactions involving partnerships. This paragraph (a) provides an overview of this section and describes the section’s scope of application, including with respect to QBUs subject to section 987 but to which §§ 1.987–1 through 1.987–11 generally do not apply. Paragraph (b) of this section describes the extent to which section 987 gain or loss is recognized under § 1.987–5 or similar principles in the taxable year of a deferral event (as defined in paragraph (b)(2) of this section) with respect to a QBU. Paragraph (c) of this section describes the extent to which section 987 gain or loss that, as a result of paragraph (b), is not recognized under § 1.987–5 or similar principles is recognized upon the occurrence of subsequent events. Paragraph (d) of this section describes the extent to which section 987 loss is recognized under § 1.987–5 or similar principles in the taxable year of an outbound loss event (as defined in paragraph (d)(2) of this section) with respect to a QBU. Paragraph (e) of this section provides rules for determining the source and character of gains and losses that, as a result of this section, are not recognized under § 1.987–5 or similar principles in the taxable year of a deferral event or outbound loss event. Paragraph (f) of this section defines controlled group and qualified successor for purposes of this section. Paragraph (g) of this section provides an anti-abuse rule. Paragraph (h) of this section provides examples illustrating the rules described in this section. (2) Scope. This section applies to any foreign currency gain or loss realized under section 987(3), including foreign currency gain or loss of an entity described in § 1.987–1(b)(1)(ii). References in this section to section 987 gain or loss refer to any foreign currency gain or loss realized under section 987(3), references to a section 987 QBU refer to any eligible QBU (as defined in § 1.987–1(b)(3)(i), but without regard to § 1.987–1(b)(3)(ii)) that is subject to section 987, and references to a section PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 88875 987 aggregate partnership refer to any partnership for which the acquisition or disposition of a partnership interest could give rise to foreign currency gain or loss realized under section 987(3). Additionally, references to recognition of section 987 gain or loss under § 1.987–5 encompass any determination and recognition of gain or loss under section 987(3) that would occur but for this section. Accordingly, the principles of this section apply to a QBU subject to section 987 regardless of whether the QBU otherwise is subject to §§ 1.987–1 through 1.987–11. An owner of a QBU that is not subject to § 1.987–5 must adapt the rules set forth in this section as necessary to recognize section 987 gains or losses that are subject to this section consistent with the principles of this section. (3) Exceptions—(i) Annual deemed termination elections. This section does not apply to section 987 gain or loss of a section 987 QBU with respect to which the annual deemed termination election described in § 1.987–8T(d) is in effect. (ii) De minimis exception. This section does not apply to a section 987 QBU for a taxable year if the net unrecognized section 987 gain or loss of the section 987 QBU that, as a result of this section, would not be recognized under § 1.987–5 in the taxable year does not exceed $5 million. (b) Gain and loss recognition in connection with a deferral event—(1) In general. Notwithstanding § 1.987–5, the owner of a section 987 QBU with respect to which a deferral event occurs (a deferral QBU) includes in taxable income section 987 gain or loss in connection with the deferral event only to the extent provided in paragraphs (b)(3) and (c) of this section. However, if the deferral event also constitutes an outbound loss event described in paragraph (d) of this section, the amount of loss recognized by the owner may be further limited under that paragraph. (2) Deferral event—(i) In general. A deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy the conditions described in paragraphs (b)(2)(ii) and (b)(2)(iii) of this section. (ii) Transactions. The transaction or series of transactions include either: (A) A termination of the section 987 QBU other than any of the following terminations: a termination described in § 1.987–8(b)(3), a termination described in § 1.987–8(c), or a termination described solely in § 1.987–8(b)(1); or (B) A disposition of part of an interest in a section 987 aggregate partnership or DE through which the section 987 QBU is owned or any contribution by another E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88876 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations person to such a partnership or DE of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the contribution gives rise to a deemed transfer from the section 987 QBU to the owner. (iii) Assets on books of successor QBU. Immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor QBU (as defined in paragraph (b)(4) of this section). (3) Gain or loss recognized under § 1.987–5 in the taxable year of a deferral event. In the taxable year of a deferral event with respect to a deferral QBU, the owner of the deferral QBU recognizes section 987 gain or loss as determined under § 1.987–5, except that, solely for purposes of applying § 1.987–5, all assets and liabilities of the deferral QBU that, immediately after the deferral event, are reflected on the books and records of a successor QBU are treated as not having been transferred and therefore as remaining on the books and records of the deferral QBU notwithstanding the deferral event. (4) Successor QBU. For purposes of this section, a section 987 QBU (potential successor QBU) is a successor QBU with respect to a section 987 QBU referred to in paragraph (b)(2)(ii) of this section if, immediately after the transaction or series of transactions described in that paragraph, the potential successor QBU satisfies all of the conditions described in paragraphs (b)(4)(i) through (b)(4)(iii) of this section. (i) The books and records of the potential successor QBU reflect assets that, immediately before the transaction or series of transactions described in paragraph (b)(2)(ii) of this section, were reflected on the books and records of the section 987 QBU referred to in that paragraph. (ii) The owner of the potential successor QBU and the owner of the section 987 QBU referred to in paragraph (b)(2)(ii) of this section immediately before the transaction or series of transactions described in that paragraph are members of the same controlled group. (iii) In the case of a section 987 QBU referred to in paragraph (b)(2)(ii)(A) of this section, if the owner of the section 987 QBU immediately before the transaction or series of transactions described in that paragraph was a U.S. person, the potential successor QBU is owned by a U.S. person. (c) Recognition of deferred section 987 gain or loss in the taxable year of a VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 deferral event and in subsequent taxable years—(1) In general—(i) Deferred section 987 gain or loss. A deferral QBU owner (as defined in paragraph (c)(1)(ii) of this section) recognizes section 987 gain or loss attributable to the deferral QBU that, as a result of paragraph (b) of this section, is not recognized in the taxable year of the deferral event under § 1.987–5 (deferred section 987 gain or loss) in the taxable year of the deferral event and in subsequent taxable years as provided in paragraphs (c)(2) through (4) of this section. (ii) Deferral QBU owner. For purposes of this paragraph (c), a deferral QBU owner means, with respect to a deferral QBU, the owner of the deferral QBU immediately before the deferral event, or the owner’s qualified successor. (2) Recognition upon a subsequent remittance—(i) In general. Except as provided in paragraph (c)(3) of this section, a deferral QBU owner recognizes deferred section 987 gain or loss in the taxable year of the deferral event and in subsequent taxable years upon a remittance from a successor QBU to the owner of the successor QBU (successor QBU owner) in the amount described in paragraph (c)(2)(ii) of this section. (ii) Amount. The amount of deferred section 987 gain or loss that is recognized pursuant to this paragraph (c)(2) in a taxable year of the deferral QBU owner is the outstanding deferred section 987 gain or loss (that is, the amount of deferred section 987 gain or loss not previously recognized) multiplied by the remittance proportion of the successor QBU owner with respect to the successor QBU for the taxable year ending with or within the taxable year of the deferral QBU owner, as determined under § 1.987–5(b) (and, to the extent relevant, paragraphs (b) and (c)(2)(iii) of this section) without regard to any election under § 1.987– 8T(d). For purposes of computing this remittance proportion, multiple successor QBUs of the same deferral QBU are treated as a single successor QBU. (iii) Deemed remittance when a successor QBU ceases to be owned by a member of the deferral QBU owner’s controlled group. For purposes of this paragraph (c)(2), in a taxable year of the deferral QBU owner in which a successor QBU ceases to be owned by a member of a controlled group that includes the deferral QBU owner, the successor QBU owner is treated as having a remittance proportion of 1. Accordingly, if there is only one successor QBU with respect to a deferral QBU and that successor QBU ceases to be owned by a member of the controlled PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 group that includes the deferral QBU owner, all outstanding deferred section 987 gain or loss with respect to that deferral QBU will be recognized. This paragraph (c)(2)(iii) does not affect the application of §§ 1.987–1 through 1.987–11 to the successor QBU owner with respect to its ownership of the successor QBU. (3) Recognition of deferred section 987 loss in certain outbound successor QBU terminations. Notwithstanding paragraph (c)(2) of this section, if assets of the successor QBU (transferred assets) are transferred (or deemed transferred) in a transaction that would constitute an outbound loss event if the successor QBU had a net accumulated section 987 loss at the time of the exchange, then the deferral QBU owner recognizes outstanding deferred section 987 loss, if any, to the extent it would recognize loss under paragraph (d)(1) of this section if (i) the deferral QBU owner owned the successor QBU, (ii) the deferral QBU owner had net unrecognized section 987 loss with respect to the successor QBU equal to its outstanding deferred section 987 loss with respect to the deferral QBU, and (iii) the transferred assets were transferred (or deemed transferred) in an outbound loss event. Any outstanding deferred section 987 loss with respect to the deferral QBU that is not recognized as a result of the preceding sentence is recognized by the deferral QBU owner in the first taxable year in which the deferral QBU owner (including any qualified successor) ceases to be a member of a controlled group that includes the acquirer of the transferred assets or any qualified successor of such acquirer. (4) Special rules regarding successor QBUs—(i) Successor QBU with respect to a deferral QBU that is a successor QBU. If a section 987 QBU is a successor QBU with respect to a deferral QBU that is a successor QBU with respect to another deferral QBU, the firstmentioned section 987 QBU is considered a successor QBU with respect to the second-mentioned deferral QBU. For example, if QBU A is a successor QBU with respect to QBU B, and QBU B is a successor QBU with respect to QBU C, then QBU A is a successor QBU with respect to QBU C. (ii) Separation of a successor QBU. If a successor QBU with respect to a deferral QBU separates into two or more separated QBUs (as defined in § 1.987– 2T(c)(9)(iii)), each separated QBU is considered a successor QBU with respect to the deferral QBU. (iii) Combination of a successor QBU. If a successor QBU with respect to a deferral QBU combines with another E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations section 987 QBU of the same owner, resulting in a combined QBU (as defined in § 1.987–2T(c)(9)(i)), the combined QBU is considered a successor QBU with respect to the deferral QBU. (d) Loss recognition upon an outbound loss event—(1) In general. Notwithstanding § 1.987–5, the owner of a section 987 QBU with respect to which an outbound loss event occurs (an outbound loss QBU) includes in taxable income in the taxable year of an outbound loss event section 987 loss with respect to that section 987 QBU only to the extent provided in paragraph (d)(3) of this section. (2) Outbound loss event. An outbound loss event means, with respect to a section 987 QBU: (i) Any termination of the section 987 QBU in connection with a transfer by a U.S. person of assets of the section 987 QBU to a foreign person that is a member of the same controlled group as the U.S. transferor immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person), provided that the termination would result in the recognition of section 987 loss with respect to the section 987 QBU under § 1.987–5 and paragraph (b) of this section but for this paragraph (d); (ii) Any transfer by a U.S. person of part of an interest in a section 987 aggregate partnership or DE through which the U.S. person owns the section 987 QBU to a related foreign person that has the same functional currency as the section 987 QBU, or any contribution by such a related foreign person to such a partnership or DE of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the transfer would result in the recognition of section 987 loss with respect to the section 987 QBU under § 1.987–5 and paragraph (b) of this section but for this paragraph (d). (3) Loss recognized upon an outbound loss event. In the taxable year of an outbound loss event with respect to an outbound loss QBU, the owner of the outbound loss QBU recognizes section 987 loss as determined under § 1.987–5 and paragraphs (b) and (c) of this section, except that, solely for purposes of applying § 1.987–5, the following assets and liabilities of the outbound loss QBU are treated as not having been transferred and therefore as remaining on the books and records of the outbound loss QBU notwithstanding the outbound loss event: (i) In the case of an outbound loss event described in paragraph (d)(2)(i) of VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 this section, assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the related foreign person described in that paragraph or of a section 987 QBU owned by such related foreign person; and (ii) In the case of an outbound loss event described in paragraph (d)(2)(ii) of this section, assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the eligible QBU from which the assets and liabilities of the outbound loss QBU are allocated and not on the books and records of a section 987 QBU. (4) Adjustment of basis of stock received in certain nonrecognition transactions. If an outbound loss event results from the transfer of assets of the outbound loss QBU in a transaction described in section 351 or section 361, the basis of the stock that is received in the transaction is increased by an amount equal to the section 987 loss that, as a result of this paragraph (d), is not recognized with respect to the outbound loss QBU in the taxable year of the outbound loss event (outbound section 987 loss). (5) Recognition of outbound section 987 loss that is not converted into stock basis. Outbound section 987 loss attributable to an outbound loss event that is not described in paragraph (d)(4) of this section is recognized by the owner of the outbound loss QBU in the first taxable year in which the owner or any qualified successor of the owner ceases to be a member of a controlled group that includes the related foreign person referred to in paragraph (d)(2)(i) or (ii) of this section, or any qualified successor of such person. (e) Source and character—(1) Deferred section 987 gain or loss and certain outbound section 987 loss. The source and character of deferred section 987 gain or loss recognized pursuant to paragraph (c) of this section, and of outbound section 987 loss recognized pursuant to paragraph (d)(5) of this section, is determined under § 1.987–6 as if such deferred section 987 gain or loss were recognized pursuant to § 1.987–5 without regard to this section on the date of the related deferral event or outbound loss event. (2) Outbound section 987 loss reflected in stock basis. If loss is recognized on the sale or exchange of stock described in paragraph (d)(4) of this section within two years of the outbound loss event described in that paragraph, then, to the extent of the outbound section 987 loss, the source and character of the loss recognized on the sale or exchange is determined under § 1.987–6 as if such loss were PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 88877 section 987 loss recognized pursuant to § 1.987–5 without regard to this section on the date of the outbound loss event. (f) Definitions—(1) Controlled group. For purposes of this section, a controlled group means all persons with the relationships to each other specified in sections 267(b) or 707(b). (2) Qualified successor. For purposes of this section, a qualified successor with respect to a corporation (transferor corporation) means another corporation (acquiring corporation) that acquires the assets of the transferor corporation in a transaction described in section 381(a), but only if (A) the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or (B) the acquiring corporation is a controlled foreign corporation (as defined in section 957(a)) (CFC) and the transferor corporation was a CFC. A qualified successor of a corporation includes the qualified successor of a qualified successor of the corporation. (g) Anti-abuse. No section 987 loss is recognized under § 1.987–5 or this section in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section. (h) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the stock of DC2, which is also a domestic corporation, and CFC1 and CFC2 are CFCs. In addition, DC1, DC2, CFC1, and CFC2 are members of a controlled group as defined in paragraph (f)(1) of this section, and the de minimis rule of paragraph (a)(3)(ii) of this section is not applicable. Finally, except as otherwise provided, Business A is a section 987 QBU with the euro as its functional currency, there are no transfers between Business A and its owner, and Business A’s assets are not depreciable or amortizable. Example 1. Contribution of a section 987 QBU to a member of the controlled group. (i) Facts. DC1 owns all of the interests in Business A. The balance sheet of Business A reflects assets with an aggregate adjusted basis of Ö1,000x and no liabilities. DC1 contributes Ö900x of Business A’s assets to DC2 in an exchange to which section 351 applies. Immediately after the contribution, the remaining Ö100x of Business A’s assets are no longer reflected on the books and records of a section 987 QBU. DC2, which has the U.S. dollar as its functional currency, uses the former Business A assets in a business (Business B) that constitutes a section 987 QBU. At the time of the contribution, Business A has net accumulated unrecognized section 987 gain of $100x. (ii) Analysis. (A) Under § 1.987–2(c)(2)(ii), DC1’s contribution of Ö900x of Business A’s E:\FR\FM\08DER4.SGM 08DER4 sradovich on DSK3GMQ082PROD with RULES4 88878 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations assets to DC2 is treated as a transfer of all of the assets of Business A to DC1, immediately followed by DC1’s contribution of Ö900x of Business A’s assets to DC2. The contribution of Business A’s assets is a deferral event within the meaning of paragraph (b)(2) of this section because: (1) The transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, resulting in a termination of Business A under § 1.987–8(b)(2); and (2) immediately after the transaction, assets of Business A are reflected on the books and records of Business B, a section 987 QBU owned by a member of DC1’s controlled group and a successor QBU within the meaning of paragraph (b)(4) of this section. Accordingly, Business A is a deferral QBU within the meaning of paragraph (b)(1) of this section, and DC1 is a deferral QBU owner of Business A within the meaning of paragraph (c)(1)(ii) of this section. (B) Under paragraph (b)(3) of this section, DC1’s taxable income in the taxable year of the deferral event includes DC1’s section 987 gain or loss determined with respect to Business A under § 1.987–5, except that, for purposes of applying § 1.987–5, all assets and liabilities of Business A that are reflected on the books and records of Business B immediately after Business A’s termination are treated as not having been transferred and therefore as though they remained on Business A’s books and records (notwithstanding the deemed transfer of those assets under § 1.987–8(e)). Accordingly, in the taxable year of the deferral event, DC1 is treated as making a remittance of Ö100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the Ö100x remittance by the sum of the remittance and the Ö900x aggregate adjusted basis of the gross assets deemed to remain on Business A’s books at the end of the year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year of the deferral event. DC1’s deferred section 987 gain equals $90x, which is the amount of section 987 gain that, but for the application of paragraph (b) of this section, DC1 would have recognized under § 1.987–5 ($100x), less the amount of section 987 gain recognized by DC1 under § 1.987–5 and this section ($10x). Example 2. Election to be classified as a corporation. (i) Facts. DC1 owns all of the interests in Entity A, a DE. Entity A conducts Business A, which has net accumulated unrecognized section 987 gain of $500x. Entity A elects to be classified as a corporation under § 301.7701–3(a). As a result of the election and pursuant to § 301.7701–3(g)(1)(iv), DC1 is treated as contributing all of the assets and liabilities of Business A to newly-formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1’s balance sheet. (ii) Analysis. Under § 1.987–2(c)(2)(ii), DC1’s contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 of Business A to DC1, followed immediately by DC1’s contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, the Business A QBU terminates under § 1.987–8(b)(2). The contribution of Business A’s assets is not a deferral event within the meaning of paragraph (b)(2) of this section because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor QBU within the meaning of paragraph (b)(4) of this section due to the fact that the assets of Business A are not reflected on a section 987 QBU immediately after the termination as well as the fact that the requirement of paragraph (b)(4)(iii) of this section is not met. Accordingly, DC1 recognizes section 987 gain with respect to Business A under § 1.987–5 without regard to this section. Because the requirement of paragraph (b)(4)(iii) of this section is not met, the result would be the same even if the assets of Business A were transferred in a section 351 exchange to an existing foreign corporation that had a different functional currency than Business A. Example 3. Outbound loss event. (i) Facts. The facts are the same as in Example 2, except that Business A has net accumulated unrecognized section 987 loss of $500x rather than net accumulated unrecognized section 987 gain of $500x. (ii) Analysis. (A) The analysis of the transactions under §§ 1.987–2(c)(2)(ii), 1.987–8(b)(2), and paragraph (b) of this section is the same as in Example 2. However, the termination of Business A as a result of the transfer of the assets of Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a member of DC1’s controlled group is an outbound loss event described in paragraph (d)(2) of this section. (B) Under paragraphs (d)(1) and (d)(3) of this section, in the taxable year of the outbound loss event, DC1 includes in taxable income section 987 loss recognized with respect to Business A as determined under § 1.987–5, except that, for purposes of applying § 1.987–5, all assets and liabilities of Business A that are reflected on the books and records of CFC1, a related foreign person described in paragraph (d)(2) of this section, are treated as not having been transferred. Accordingly, DC1’s remittance proportion with respect to Business A is 0, and DC1 recognizes no section 987 loss with respect to Business A. DC1’s outbound section 987 loss is $500x, which is the amount of section 987 loss that DC1 would have recognized under § 1.987–5 ($500x) without regard to paragraph (d) of this section, less the amount of section 987 loss recognized by DC1 under paragraph (d)(3) of this section ($0). Under paragraph (d)(4) of this section, DC1 must increase its basis in its CFC1 shares by the amount of the outbound section 987 loss ($500x). Example 4. Conversion of a DE to a partnership. (i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A. On the last day of Year 1, DC1 sells 50 percent of its interest in Entity A to DC2 (the Entity A sale). (ii) Analysis. (A) For Federal income tax purposes, Entity A is converted to a PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 partnership when DC2 purchases the 50 percent interest in Entity A. DC2’s purchase is treated as the purchase of 50 percent of the assets of Entity A (that is, the assets of Business A), which, prior to the purchase, were treated as held directly by DC1 for Federal income tax purposes. Immediately after DC2’s deemed purchase of 50 percent of Business A assets, DC1 and DC2 are treated as contributing their respective interests in Business A assets to a partnership. See Rev. Rul. 99–5 (1999–1 CB 434) (situation 1). These deemed transactions are not taken into account for purposes of this section, but the Entity A sale and resulting existence of a partnership have consequences under section 987 and this section, as described in paragraphs (ii)(B) through (D) of this Example 4. (B) Immediately after the Entity A sale, Entity A is a section 987 aggregate partnership within the meaning of § 1.987– 1(b)(5) because DC1 and DC2 own all the interests in partnership capital and profits, DC1 and DC2 are related within the meaning of section 267(b), and the partnership has an eligible QBU (Business A) that would be a section 987 QBU with respect to a partner if owned by the partner directly. As a result of the Entity A sale, 50 percent of the assets and liabilities of Business A ceased to be reflected on the books and records of DC1’s Business A section 987 QBU. As a result, such assets and liabilities are treated as if they were transferred from DC1’s Business A section 987 QBU to DC1. Additionally, following DC2’s acquisition of 50 percent of the interest in Entity A, DC2 is allocated 50 percent of the assets and liabilities of Business A under §§ 1.987–2(b), 1.987–7(a), and 1.987–7T(b). Because DC2 and Business A have different functional currencies, DC2’s portion of the Business A assets and liabilities constitutes a section 987 QBU. Accordingly, 50 percent of the assets and liabilities of Business A are treated as transferred by DC2 to DC2’s Business A section 987 QBU. (C) The Entity A sale is a deferral event described in paragraph (b)(2) of this section because: (1) The sale constitutes the disposition of part of an interest in a DE; and (2) immediately after the transaction, assets of DC1’s Business A section 987 QBU are reflected on the books and records of DC1’s Business A section 987 QBU and DC2’s Business A section 987 QBU, each of which is a successor QBU with respect to DC1’s Business A section 987 QBU within the meaning of paragraph (b)(4) of this section. Accordingly, DC1’s Business A section 987 QBU is a deferral QBU within the meaning of paragraph (b)(1) of this section, and DC1 is a deferral QBU owner within the meaning of paragraph (c)(1)(ii) of this section. Under paragraph (b)(1) of this section, DC1 includes in taxable income section 987 gain or loss with respect to Business A in connection with the deferral event to the extent provided in paragraphs (b)(3) and (c) of this section. (D) Under paragraph (b) of this section, in the taxable year of the Entity A sale, DC1 includes in taxable income section 987 gain or loss with respect to Business A as determined under § 1.987–5, except that, for purposes of applying § 1.987–5, all assets and liabilities of Business A that, immediately E:\FR\FM\08DER4.SGM 08DER4 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations sradovich on DSK3GMQ082PROD with RULES4 after the Entity A sale, are reflected on the books and records of successor QBUs are treated as though they were not transferred and therefore as remaining on the books and records of DC1’s Business A section 987 QBU notwithstanding the Entity A sale. Accordingly, DC1’s remittance amount under § 1.987–5 is $0, and DC1 recognizes no section 987 gain or loss with respect to Business A. Example 5. Partial recognition of deferred gain or loss. (i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A in Country X. During Year 1, DC1 contributes all of its interests in Entity A to DC2 in an exchange to which section 351 applies. At the time of the contribution, Business A has net accumulated unrecognized section 987 gain of $100x. After the contribution, Entity A continues to conduct business in Country X (Business B). In Year 3, as a result of a net transfer of property from Business B to DC2, DC2’s remittance proportion with respect to Business B, as determined under § 1.987–5, is 0.25. (ii) Analysis. (A) For the reasons described in Example 1, the contribution of Entity A by DC1 to DC2 results in a termination of Business A and a deferral event with respect to Business A, a deferral QBU; DC1 is a deferral QBU owner within the meaning of paragraph (c)(1)(ii) of this section; Business B is a successor QBU with respect to Business A; DC2 is a successor QBU owner; and the $100x of net accumulated unrecognized section 987 gain with respect to Business A becomes deferred section 987 gain as a result of the deferral event. (B) Under paragraph (c)(1) of this section, DC1 recognizes deferred section 987 gain with respect to Business A in accordance with paragraphs (c)(2) through (4) of this section. Under paragraph (c)(2)(i) of this section, DC1 recognizes deferred section 987 gain in Year 3 as a result of the remittance from Business B to DC2. Under paragraph (c)(2)(ii) of this section, the amount of deferred section 987 gain that DC1 recognizes is $25x, which is DC1’s outstanding deferred section 987 gain or loss ($100x) with respect to Business A multiplied by the remittance proportion (0.25) of DC2 with respect to Business B for the taxable year as determined under § 1.987–5(b). (i) Coordination with fresh start transition method—(1) In general. If a taxpayer is a deferral QBU owner, or is or was the owner of an outbound loss QBU, and the taxpayer is required under § 1.987–10(a) to apply the fresh start transition method described in § 1.987– 10(b) to the deferral QBU or outbound loss QBU, or would have been so required if the taxpayer had owned the deferral QBU or outbound loss QBU on the transition date (as defined in § 1.987–11(c)), the adjustments described in paragraphs (i)(2) and (i)(3) of this section, as applicable, must be made on the transition date. (2) Adjustment to deferred section 987 gain or loss. The amount of any outstanding deferred section 987 gain or VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 loss of a deferral QBU owner with respect to a deferral QBU described in paragraph (i)(1) of this section must be adjusted to equal the amount of outstanding deferred section 987 gain or loss that the deferral QBU owner would have had with respect to the deferral QBU on the transition date if, immediately before the deferral event, the deferral QBU had transitioned to the method prescribed by §§ 1.987–1 through 1.987–10 pursuant to the fresh start transition method. (3) Adjustments in the case of an outbound loss event. The basis of any stock described in paragraph (d)(4) of this section that was received in connection with the transfer (or deemed transfer) of assets of an outbound loss QBU described in paragraph (i)(1) of this section and that is held on the transition date must be adjusted to equal the basis that such stock would have had on the transition date if, immediately prior to the outbound loss event, the outbound loss QBU had transitioned to the method prescribed by §§ 1.987–1 through 1.987–10 pursuant to the fresh start transition method. If no such stock was received, the amount of any outbound section 987 loss with respect to the outbound loss QBU that may be recognized on or after the transition date pursuant to paragraph (d)(5) of this section must be adjusted to equal the amount of such loss that would be outstanding and that may be recognized pursuant to that paragraph if, immediately before the outbound loss event, the outbound loss QBU had transitioned to the method prescribed by §§ 1.987–1 through 1.987– 10 pursuant to the fresh start transition method. (j) Effective/applicability date—(1) In general. Except as described in paragraph (j)(2) of this section, this section applies to any deferral event or outbound loss event that occurs on or after January 6, 2017. (2) Exception. This section applies to any deferral event or outbound loss event that occurs on or after December 7, 2016, if such deferral event or outbound loss event is undertaken with a principal purpose of recognizing section 987 loss. (k) Expiration date. The applicability of this section expires December 6, 2019. ■ Par. 19. Section 1.988–0 is amended by revising the entry for § 1.988–2(b)(16) and adding an entry for § 1.988–2(i) to read as follows: § 1.988–0 Taxation of gain or loss from a section 988 transaction; Table of contents. * PO 00000 * * Frm 00027 * Fmt 4701 * Sfmt 4700 88879 § 1.988–2 Recognition and computation of exchange gain or loss. * * * * * (b) * * * (16) [Reserved]. * * * * * (i) [Reserved]. ■ Par. 20. Section 1.988–1 is amended by adding paragraph (a)(3) to read as follows: § 1.988–1 rules. Certain definitions and special * * * * * (a) * * * (3) [Reserved]. For further guidance, see § 1.988–1T(a)(3). * * * * * ■ Par. 21. Section 1.988–1T is added to read as follows: § 1.988–1T Certain definitions and special rules (temporary). (a)(1) through (a)(2) [Reserved]. For further guidance, see § 1.988–1(a)(1) through (2). (3) Specified owner functional currency transactions of a section 987 QBU not treated as section 988 transactions. Specified owner functional currency transactions, as defined in § 1.987–3T(b)(4)(ii), held by a section 987 QBU are not treated as section 988 transactions. Thus, no currency gain or loss shall be recognized by a section 987 QBU under section 988 with respect to such transactions. (4) through (i) [Reserved]. For further guidance, see § 1.988–1(a)(4) through (i). (j) 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 § 1.987–11(b), then this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (k) Expiration date. The applicability of this section expires on December 6, 2019. ■ Par. 22. Section 1.988–2 is amended by revising paragraph (b)(16) and adding paragraph (i) to read as follows: § 1.988–2 Recognition and computation of exchange gain or loss. * * * * * (b) * * * (16) [Reserved]. For further guidance, see § 1.988–2T(b)(16). * * * * * (i) [Reserved]. For further guidance, see § 1.988–2T(i). ■ Par. 23. Section 1.988–2T is added to read as follows: E:\FR\FM\08DER4.SGM 08DER4 88880 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations § 1.988–2T Recognition and computation of exchange gain or loss (temporary). sradovich on DSK3GMQ082PROD with RULES4 (a) through (b)(15) [Reserved]. For further guidance, see § 1.988–2(a) through (b)(15). (16) Deferral of loss on certain related-party debt instruments.—(i) Treatment of creditor. For rules applicable to a corporation included in a controlled group that is a creditor under a debt instrument see § 1.267(f)– 1(e). (ii) Treatment of debtor—(A) In general. Exchange loss realized under § 1.988–2(b)(4) or (b)(6) is deferred if— (1) The loss is realized by a debtor with respect to a loan from a person that has a relationship to the debtor described in section 267(b) or section 707(b); and (2) The transaction resulting in the realization of exchange loss has as a VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 principal purpose the avoidance of Federal income tax. (B) Recognition of deferred loss. Any exchange loss that is deferred under paragraph (b)(16)(ii)(A) of this section is deferred until the end of the term of the loan, determined immediately prior to the transaction. (17) through (h) [Reserved]. For further guidance, see § 1.988–2(b)(17) through (h). (i) Special rules for section 988 transactions of a section 987 QBU. For rules regarding section 988 transactions of a section 987 QBU, see § 1.987– 3T(b)(4) for section 987 QBUs in general and § 1.987–1T(b)(6) for dollar QBUs. (j) Effective/applicability date. Paragraph (b)(16) of this section applies to any exchange loss realized on or after December 7, 2016. Paragraph (i) of this section applies to taxable years beginning on or after one year after the PO 00000 Frm 00028 Fmt 4701 Sfmt 9990 first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under § 1.987–11(b), then paragraph (i) of this section applies to taxable years to which §§ 1.987–1 through 1.987–10 apply as a result of such election. (k) Expiration date. The applicability of this section expires on December 6, 2019. John Dalrymple, Deputy Commissioner for Services and Enforcement. Approved: November 14, 2016. Mark J. Mazur, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2016–28380 Filed 12–7–16; 8:45 am] BILLING CODE 4830–01–P E:\FR\FM\08DER4.SGM 08DER4

Agencies

[Federal Register Volume 81, Number 236 (Thursday, December 8, 2016)]
[Rules and Regulations]
[Pages 88854-88880]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-28380]



[[Page 88853]]

Vol. 81

Thursday,

No. 236

December 8, 2016

Part IV





 Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





Recognition and Deferral of Section 987 Gain or Loss; Final Rule

Federal Register / Vol. 81 , No. 236 / Thursday, December 8, 2016 / 
Rules and Regulations

[[Page 88854]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9795]
RIN 1545-BL12


Recognition and Deferral of Section 987 Gain or Loss

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains temporary regulations under section 987 
of the Internal Revenue Code (Code) relating to the recognition and 
deferral of foreign currency gain or loss under section 987 with 
respect to a qualified business unit (QBU) in connection with certain 
QBU terminations and certain other transactions involving partnerships. 
This document also contains temporary regulations under section 987 
providing: an annual deemed termination election for a section 987 QBU; 
an elective method, available to taxpayers that make the annual deemed 
termination election, for translating all items of income or loss with 
respect to a section 987 QBU at the yearly average exchange rate; rules 
regarding the treatment of section 988 transactions of a section 987 
QBU; rules regarding QBUs with the U.S. dollar as their functional 
currency; rules regarding combinations and separations of section 987 
QBUs; rules regarding the translation of income used to pay creditable 
foreign income taxes; and rules regarding the allocation of assets and 
liabilities of certain partnerships for purposes of section 987. 
Finally, this document contains temporary regulations under section 988 
requiring the deferral of certain section 988 loss that arises with 
respect to related-party loans. The text of these temporary regulations 
also serves as the text of the proposed regulations set forth in the 
Proposed Rules section in this issue of the Federal Register. In 
addition, in the Rules and Regulations section of this issue of the 
Federal Register, final regulations are being issued under section 987 
to provide general guidance under section 987 regarding the 
determination of the taxable income or loss of a taxpayer with respect 
to a QBU.

DATES: Effective date. These regulations are effective on December 7, 
2016.
    Applicability date. For dates of applicability, see Sec. Sec.  
1.987-1T(h), 1.987-2T(e), 1.987-3T(f), 1.987-4T(h), 1.987-6T(d), 1.987-
7T(d), 1.987-8T(g), 1.987-12T(j), 1.988-1T(j), and 1.988-2T(j).

FOR FURTHER INFORMATION CONTACT: Steven D. Jensen at (202) 317-6938 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    These temporary regulations are being issued without prior notice 
and public procedure pursuant to the Administrative Procedure Act (5 
U.S.C. 553). For this reason, the collection of information contained 
in these regulations has been reviewed and, pending receipt and 
evaluation of public comments, approved by the Office of Management and 
Budget under control number 1545-2265. Responses to this collection of 
information are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    For further information concerning this collection of information, 
the accuracy of the estimated burden and suggestions for reducing this 
burden, and where to submit comments on the collection of information, 
please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    Books and 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.

Background

    This document contains temporary regulations under section 987 of 
the Code relating to the recognition and deferral of foreign currency 
gain or loss under section 987 with respect to a QBU in connection with 
certain QBU terminations and certain other transactions involving 
partnerships. This document also contains temporary regulations under 
section 987 providing (i) an annual deemed termination election for a 
section 987 QBU; (ii) an elective method, available to taxpayers that 
make the annual deemed termination election, for translating all items 
of income or loss with respect to a section 987 QBU at the yearly 
average exchange rate; (iii) rules regarding the treatment of section 
988 transactions of a section 987 QBU; (iv) rules regarding QBUs with 
the U.S. dollar as their functional currency; (v) rules regarding 
combinations and separations of section 987 QBUs; (vi) rules regarding 
the translation of income used to pay creditable foreign income taxes; 
and (vii) rules regarding the allocation of assets and liabilities of 
certain partnerships for purposes of section 987. Finally, this 
document contains temporary regulations under section 988 requiring the 
deferral of certain section 988 loss that arises with respect to 
related-party loans.
    Section 987 generally provides that, 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 such 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. Section 987 further requires the 
taxpayer to make ``proper adjustments'' (as prescribed by the Secretary 
of the Treasury (the Secretary)) for transfers of property between QBUs 
having different functional currencies, including by treating post-1986 
remittances from each such QBU as made on a pro rata basis out of post-
1986 accumulated earnings, by treating section 987 gain or loss as 
ordinary income or loss, and by sourcing such gain or loss by reference 
to the source of the income giving rise to post-1986 accumulated 
earnings.
    Section 989(c) directs the Secretary to ``prescribe such 
regulations as may be necessary or appropriate to carry out the 
purposes of [subpart J], including regulations . . . limiting the 
recognition of foreign currency loss on certain remittances from 
qualified business units . . . [and] providing for the appropriate 
treatment of related party transactions (including transactions between 
qualified business units of the same taxpayer). . . .''
    On September 6, 2006, the Treasury Department and the IRS issued 
proposed regulations under section 987 (REG-208270-86, 71 FR 52876) 
(the 2006 proposed regulations). The Treasury Department and the IRS 
received many written comments in response to the 2006 proposed 
regulations and, after consideration of those comments, are issuing 
final regulations (TD 9794) under section 987 (the final regulations) 
that are being published contemporaneously with these temporary 
regulations. These temporary regulations also reflect the consideration 
of comments received on the 2006 proposed regulations, as well as other 
considerations described in this preamble.

[[Page 88855]]

Explanation of Provisions

1. Deferral of Section 987 Gain or Loss on Certain Terminations and 
Other Transactions Involving Partnerships

A. Background
    Under the final regulations, the owner of a section 987 QBU that 
terminates includes in income all of the net unrecognized section 987 
gain or loss with respect to the section 987 QBU in the year it 
terminates. See Sec. Sec.  1.987-5(c)(3) and 1.987-8(e). Section 1.987-
8(b) and (c) describe the circumstances in which a section 987 QBU 
terminates, which include the transfer (or deemed transfer) of 
substantially all of the assets of the section 987 QBU and when the 
section 987 QBU's owner ceases to exist (except in connection with 
certain liquidations or reorganizations described in section 381(a)). 
Under these rules, a termination can result solely from a transfer of a 
section 987 QBU between related parties or, when a QBU is owned by an 
entity that is disregarded as an entity separate from its owner for 
Federal tax purposes (DE), from the deemed transfer that occurs when an 
election is made to treat the DE as a corporation for Federal tax 
purposes, notwithstanding that the QBU's assets continue to be used in 
the same trade or business.
    The preamble to the 2006 proposed regulations requested comments 
regarding whether inbound liquidations under section 332 and inbound 
asset reorganizations under section 368(a) should result in 
terminations of section 987 QBUs. The preamble also requested comments 
on the interaction of the rules of Sec.  1.1502-13 regarding 
intercompany transactions with the 2006 proposed regulations, including 
whether section 987 gain or loss resulting from the transfer of assets 
and liabilities of a section 987 QBU between members of the same 
consolidated group in a section 351 transaction should be deferred 
under Sec.  1.1502-13. Many comments recommended that such a section 
351 exchange should not trigger the recognition of section 987 gain or 
loss.
    Because a termination can result in the deemed remittance of all 
the assets of a section 987 QBU in circumstances in which the assets 
continue to be used by a related person in the conduct of the same 
trade or business that formerly was conducted by the section 987 QBU, 
terminations can facilitate the selective recognition of section 987 
losses. Section 989(c)(2) provides the Treasury Department and the IRS 
with authority to ``limit[] the recognition of foreign currency loss on 
certain remittances from qualified business units.'' The Treasury 
Department and the IRS have determined that terminations of section 987 
QBUs generally should not be permitted to achieve the selective 
recognition of losses when the assets and liabilities of the section 
987 QBU are transferred to a related person and remain subject to 
section 987 in the hands of the transferee, as in the case, for 
example, of a section 351 transfer of a section 987 QBU within a 
consolidated group. Similar policy considerations arise when the 
transfer of a partnership interest to a related person results in 
deemed transfers that cause the recognition of section 987 loss with 
respect to a section 987 QBU owned through the partnership, 
notwithstanding that the trade or business of the section 987 QBU 
continues without interruption and remains subject to section 987. In 
order to address these policy concerns, as described in greater detail 
in Part 1.C of this Explanation of Provisions, the temporary 
regulations defer section 987 losses resulting from certain termination 
events and partnership transactions in which the assets and liabilities 
of the section 987 QBU remain within a single controlled group (defined 
as all persons with the relationships to each other described in 
sections 267(b) or 707(b)) and remain subject to section 987.
    The Treasury Department and the IRS also acknowledge, however, that 
part of the rationale for deferring section 987 losses--that is, the 
continuity of ownership of the section 987 QBU within a single 
controlled group--applies equally to section 987 gains that otherwise 
would be triggered when taxpayers transfer a section 987 QBU within a 
single controlled group. Thus, consistent with the recommendations of 
comments on the 2006 proposed regulations, the temporary regulations 
generally apply to defer the recognition of section 987 gains as well 
as losses when the transferee is subject to section 987 with respect to 
the assets of the section 987 QBU. The Treasury Department and the IRS 
have determined, however, that gain should not be deferred to the 
extent the assets of a section 987 QBU are transferred by a U.S. person 
to a related foreign person. Since recognition of the deferred gain 
generally would occur only as a result of remittances to the foreign 
owner, the IRS could face administrative difficulty in attempting to 
ensure that such deferred gain is appropriately recognized and not 
indefinitely deferred. Treating gains differently than losses in the 
context of transfers to related foreign persons generally is consistent 
with the policies underlying sections 267 and 367. In particular, this 
rule is consistent with the policy of recognizing foreign currency 
gains and not losses with respect to property transferred outbound in a 
nonrecognition transaction. See section 367(a)(3)(B)(iii).
    In addition, the Treasury Department and the IRS have determined 
that selective recognition of losses should not be permitted in the 
context of certain outbound transfers even when the assets do not 
remain subject to section 987 in the hands of the transferee (because, 
for example, the transferee has the same functional currency as the 
QBU). Accordingly, consistent with the principles of sections 267 and 
367(a), the temporary regulations also provide special rules to prevent 
the selective recognition of section 987 losses in certain other 
transactions involving outbound transfers.
B. Scope of Application of Sec.  1.987-12T
    Section 1.987-12T provides for the deferral of certain net 
unrecognized section 987 gain or loss that otherwise would be 
recognized in connection with specified events under Sec.  1.987-5, 
which governs the recognition of section 987 gain or loss by the owner 
of a section 987 QBU to which the final regulations apply. In addition, 
because the policy concerns that motivate Sec.  1.987-12T exist 
regardless of whether section 987 gain or loss is computed pursuant to 
the final regulations or some other reasonable method, Sec.  1.987-12T 
applies to any foreign currency gain or loss realized under section 
987(3), including foreign currency gain or loss realized under section 
987 with respect to a QBU to which the final regulations generally are 
not applicable. In order to achieve this, the temporary regulations 
specify that references in Sec.  1.987-12T to section 987 gain or loss 
refer to any foreign currency gain or loss realized under section 
987(3) and that references to a section 987 QBU refer to any eligible 
QBU (as defined in Sec.  1.987-1(b)(3)(i), but without regard to Sec.  
1.987-1(b)(3)(ii)) that is subject to section 987. Additionally, the 
temporary regulations specify that references in Sec.  1.987-12T to the 
recognition of section 987 gain or loss under Sec.  1.987-5 encompass 
any determination and recognition of gain or loss under section 987(3) 
that would occur but for Sec.  1.987-12T. Accordingly, the temporary 
regulations require an owner of a QBU that is not subject to Sec.  
1.987-5 to adapt the rules set forth in Sec.  1.987-12T to recognize 
section 987 gains or losses consistent with the principles of Sec.  
1.987-12T.

[[Page 88856]]

    The policy concerns regarding selective realization of section 987 
losses do not apply, however, with respect to a section 987 QBU that 
has made the annual deemed termination election described in Part 2 of 
this Explanation of Provisions, because all section 987 gain and loss 
is recognized annually under that election. Accordingly, Sec.  1.987-
12T is not applicable to section 987 gain or loss of a section 987 QBU 
with respect to which the annual deemed termination election is in 
effect.
    Finally, in order to avoid any compliance burden associated with 
applying Sec.  1.987-12T in circumstances involving relatively small 
amounts of section 987 gain or loss, Sec.  1.987-12T includes a de 
minimis rule. That rule provides that Sec.  1.987-12T does not apply to 
a section 987 QBU if the net unrecognized section 987 gain or loss of 
the section 987 QBU that, as a result of Sec.  1.987-12T, would not be 
recognized under Sec.  1.987-5 does not exceed $5 million.
    Section 1.987-12T defers the recognition of section 987 gains and 
losses in connection with two types of specified events, which are 
referred to as ``deferral events'' and ``outbound loss events.'' Parts 
1.C and 1.D of this Explanation of Provisions describe the rules 
governing deferral events and outbound loss events, respectively.
C. Deferral Events
    As described in greater detail below, the temporary regulations 
provide that, notwithstanding Sec.  1.987-5, the owner of a section 987 
QBU with respect to which a deferral event occurs (a deferral QBU) must 
defer section 987 gain or loss that otherwise would be taken into 
account under Sec.  1.987-5 in connection with the deferral event to 
the extent determined under Sec.  1.987-12T(b)(3) and (c). Such 
deferred gain or loss is taken into account based on subsequent events 
in accordance with Sec.  1.987-12T(c).
i. Deferral Events
    The temporary regulations provide that a deferral event with 
respect to a section 987 QBU means any transaction or series of 
transactions that satisfy two conditions. Under the first condition, 
the transaction or series of transactions must be described in one of 
two categories. The first category, which is set forth in Sec.  1.987-
12T(b)(2)(ii)(A), is any termination of a section 987 QBU other than 
(i) a termination described in Sec.  1.987-8(b)(3) (that is, a 
termination that results from the owner of the section 987 QBU ceasing 
to be a controlled foreign corporation (as defined in section 957(a)) 
(CFC) after certain related-party transactions); (ii) a termination 
described in Sec.  1.987-8(c) (that is, a termination that results from 
a liquidation or asset reorganization described in section 381(a) 
involving an inbound or outbound transfer, a transfer by a CFC to a 
related non-CFC foreign corporation, or a transfer to a transferee that 
has the same functional currency as the section 987 QBU); \1\ or (iii) 
a termination described solely in Sec.  1.987-8(b)(1) (that is, a 
termination that results solely from the cessation of the trade or 
business of the section 987 QBU). Thus, the first category generally 
involves terminations that occur as a result of a transfer of 
substantially all the assets of a section 987 QBU other than a transfer 
as part of a transaction described in section 381(a) in which the owner 
ceases to exist. (A termination that results from an outbound section 
381(a) transaction, however, may be an outbound loss event.)
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    \1\ The transfer of a section 987 QBU as part of a liquidation 
or asset reorganization described in section 381(a) in which the 
transferor and transferee have the same tax status is not a 
termination under Sec.  1.987-8(b) and (c) and, therefore, cannot 
constitute a deferral event under the first category.
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    The second category, which is described in Sec.  1.987-
12T(b)(ii)(B), encompasses certain partnership transactions that result 
in a net deemed transfer from a section 987 QBU to its owner as a 
result of which section 987 gain or loss otherwise would be recognized 
under Sec.  1.987-5. The second category refers to two types of 
transactions involving partnerships.
    First, the second category includes a disposition of part of an 
interest in a DE or partnership. Under Sec.  1.987-2(c)(5), a transfer 
of part of an interest in a DE or section 987 aggregate partnership 
results in deemed transfers to the owner of a section 987 QBU held 
through that DE or partnership that may result in a remittance, but 
that generally do not cause a termination. For an illustration of the 
application of Sec.  1.987-12T to a deferral event resulting from the 
conversion of a disregarded entity into a section 987 aggregate 
partnership, see Sec.  1.987-12T(h), Example 4.
    The second type of transaction included in the second category is a 
contribution of assets by a related person to a partnership or DE 
through which a section 987 QBU is held, provided that the contributed 
assets are not included on the books and records of an eligible QBU and 
the contribution causes a net transfer from a section 987 QBU owned 
through the partnership or DE. The rules of Sec.  1.987-2 must be 
applied to determine whether the contribution would cause a net 
transfer from any section 987 QBUs held through a partnership. For 
example, if two partners (Partner A and Partner B) each own a 50% 
interest in an existing section 987 aggregate partnership with a single 
section 987 QBU, and Partner A contributes cash that is included on the 
books of the section 987 QBU after the contribution and Partner B 
contributes an equal amount of non-portfolio stock, the contributions 
would not cause either Partner A nor Partner B to have a net transfer 
from the section 987 QBU under Sec.  1.987-2 and there would be no 
section 987 gain or loss to defer. As a result of the broad scope of 
application for Sec.  1.987-12T specified in Sec.  1.987-12T(a)(2), the 
second category includes transactions involving partnerships that are 
not section 987 aggregate partnerships even though QBUs that are held 
through such partnerships generally are not subject to the final 
regulations. Accordingly, Sec.  1.987-12T applies to a disposition of a 
partnership interest or a contribution to a partnership if it otherwise 
would result in recognition of gain or loss under a taxpayer's 
reasonable method of applying section 987.
    The second condition described in Sec.  1.987-12T(b)(2) is that, 
immediately after the transaction or series of transactions, assets of 
the section 987 QBU are reflected on the books and records of a 
successor QBU. For this purpose, a successor QBU with respect to a 
section 987 QBU (original QBU) generally means a section 987 QBU on 
whose books and records assets of the original QBU are reflected 
immediately after the deferral event, provided that, immediately after 
the deferral event, the section 987 QBU is owned by a member of the 
controlled group that includes the person that owned the original QBU 
immediately before the deferral event. This relatedness requirement 
would not be met, for example, if the person that owned the original 
QBU ceased to exist in connection with the deferral event.
    However, if the owner of the original QBU is a U.S. person, then a 
successor QBU does not include a section 987 QBU owned by a foreign 
person, except in the case of a deferral event that is solely described 
in the second category of transactions involving partnership and DE 
interests. This limitation on the definition of a successor QBU in the 
context of outbound transfers serves two purposes. First, consistent 
with the general policy of recognizing foreign currency gains upon an 
outbound transfer, the limitation ensures that section 987 gain is 
recognized to the extent section 987 QBU assets are transferred 
outbound in connection with a termination. Second, the

[[Page 88857]]

limitation coordinates the deferral event rules with the outbound loss 
event rules described in Part 1.D of this Explanation of Provisions, 
which contain different rules for the recognition of section 987 loss 
attributable to assets of a section 987 QBU that are transferred 
outbound in connection with a termination of the section 987 QBU.
ii. Recognition of Section 987 Gain or Loss Under Sec.  1.987-5 in the 
Taxable Year of a Deferral Event
    The temporary regulations provide that, in the taxable year of a 
deferral event, the owner of the deferral QBU generally recognizes 
section 987 gain or loss as determined under Sec.  1.987-5, except 
that, solely for purposes of applying Sec.  1.987-5, all assets and 
liabilities of the deferral QBU that, immediately after the deferral 
event, are properly reflected on the balance sheet of a successor QBU 
are treated as not having been transferred and therefore as remaining 
on the balance sheet of the deferral QBU, notwithstanding the deferral 
event. The effect of these rules is that, in the taxable year of a 
deferral event, only assets and liabilities of the deferral QBU that 
are not reflected on the books and records of a successor QBU 
immediately after the deferral event are taken into account in 
determining the amount of a remittance from the deferral QBU. Section 
987 gain or loss that, as a result of these rules, is not recognized 
under Sec.  1.987-5 in the taxable year of the deferral event is 
referred to as deferred section 987 gain or loss. As discussed in Part 
1.D of this Explanation of Provisions, if the deferral event also 
constitutes an outbound loss event, the amount of loss recognized by 
the owner may be further limited under the rules applicable to outbound 
loss events.
iii. Recognition of Deferred Section 987 Gain or Loss in the Taxable 
Year of a Deferral Event and in Subsequent Taxable Years
    The temporary regulations provide rules for determining when a 
deferral QBU owner recognizes deferred section 987 gain or loss. For 
this purpose, a deferral QBU owner means, with respect to a deferral 
QBU, the owner of the deferral QBU immediately before the deferral 
event with respect to the deferral QBU or the owner's qualified 
successor. The temporary regulations define a qualified successor with 
respect to a corporation (transferor corporation) as another 
corporation (acquiring corporation) that acquires the assets of the 
transferor corporation in a transaction described in section 381(a), 
but only if (A) the acquiring corporation is a domestic corporation and 
the transferor corporation was a domestic corporation, or (B) the 
acquiring corporation is a CFC and the transferor corporation was a 
CFC. A qualified successor of a corporation includes a qualified 
successor of a qualified successor of the corporation.
    As described in the remainder of this Part 1.C.iii, the temporary 
regulations provide that deferred section 987 gain or loss is 
recognized upon subsequent remittances from a successor QBU, or upon a 
deemed remittance that occurs when a successor QBU ceases to be owned 
by a member of the deferral QBU owner's controlled group, subject to an 
exception that applies when a successor QBU terminates in an outbound 
transfer. In general, these rules depend on the continued existence of 
a deferral QBU owner (which includes a qualified successor) and a 
successor QBU and preserve the location of the deferred section 987 
gain or loss as gain or loss of the deferral QBU owner.
a. Subsequent Remittances
    A deferral QBU owner generally recognizes deferred section 987 gain 
or loss in the taxable year of a remittance from a successor QBU to the 
owner of the successor QBU (successor QBU owner). The amount of 
deferred section 987 gain or loss that a deferral QBU owner recognizes 
upon a remittance is the outstanding deferred section 987 gain or loss 
(that is, the deferred section 987 gain or loss not previously 
recognized) multiplied by the remittance proportion of the successor 
QBU owner with respect to the successor QBU for the taxable year as 
determined under Sec.  1.987-5(b) and, to the extent relevant, Sec.  
1.987-12T. For an illustration of this rule, see Sec.  1.987-12T(h), 
Example 5.
    In certain cases, there may be multiple successor QBUs with respect 
to a single deferral QBU. For instance, there may be multiple successor 
QBUs if the owner of a section 987 aggregate partnership interest 
transfers part of its interest or if a successor QBU separates into two 
or more separated QBUs under Sec.  1.987-2T(c)(9)(ii). To ensure that a 
deferral QBU owner recognizes the appropriate amount of deferred 
section 987 gain or loss in connection with a remittance in such cases, 
the temporary regulations provide that multiple successor QBUs of the 
same deferral QBU are treated as a single successor QBU for purposes of 
determining the amount of deferred section 987 gain or loss that is 
recognized.
    For example, if the owner (Corp A) of a section 987 aggregate 
partnership interest transfers part of its interest to another member 
of Corp A's consolidated group (Corp B), the transfer would give rise 
to a deferral event with respect to the section 987 QBU (QBU A) that 
Corp A indirectly owns through the partnership. QBU A would be 
considered a deferral QBU, and Corp A would be considered a deferral 
QBU owner. In addition, QBU A would be considered a successor QBU with 
respect to itself, and the section 987 QBU (QBU B) that Corp B owns 
indirectly through the partnership interest it acquired also would be 
considered a successor QBU with respect to QBU A. In determining the 
amount of deferred section 987 gain or loss recognized upon subsequent 
remittances from successor QBUs, the two successor QBUs are treated as 
a single successor QBU, such that their remittance proportion is 
determined under Sec.  1.987-5 on a combined basis, taking into account 
the assets and remittances of both successor QBUs.
b. Deemed Remittance When a Successor QBU Ceases To Be Owned by a 
Member of the Deferral QBU Owner's Controlled Group
    Solely for purposes of determining a deferral QBU owner's 
recognition of any outstanding deferred section 987 gain or loss, a 
successor QBU owner is treated as having a remittance proportion of 1 
in a taxable year in which its successor QBU ceases to be owned by a 
member of a controlled group that includes the deferral QBU owner, 
including as a result of the deferral QBU owner ceasing to exist 
without having a qualified successor. Accordingly, a deferral QBU owner 
would recognize all outstanding deferred section 987 gain or loss upon 
a successor QBU ceasing to be owned by a member of the deferral QBU 
owner's controlled group if there is only one successor QBU, but would 
recognize only a proportional amount if there are multiple successor 
QBUs, one or more of which remain in the deferral QBU owner's 
controlled group.
c. Recognition of Deferred Section 987 Loss in Certain Outbound 
Successor QBU Terminations
    Notwithstanding that deferred section 987 gain or loss generally is 
recognized upon remittances from a successor QBU, Sec.  1.987-12T(c)(3) 
provides that, if assets of a successor QBU are transferred (or deemed 
transferred) in an exchange that would constitute an outbound loss 
event if the successor QBU had a net accumulated section 987 loss at 
the time of the exchange, the deferral QBU owner recognizes any 
outstanding deferred section 987 loss on a similar basis as it would if 
it originally had transferred the

[[Page 88858]]

deferral QBU in an outbound loss event. Any outstanding deferred 
section 987 loss with respect to the deferral QBU that, as a result of 
this rule, is not recognized is recognized by the deferral QBU owner in 
the first taxable year in which the deferral QBU owner (including any 
qualified successor) and the acquirer of the assets of the successor 
QBU (or any qualified successor) cease to be members of the same 
controlled group. Section 1.987-12T(c)(4) ensures that the policy 
concerns that motivate the treatment of outbound loss events under the 
temporary regulations apply in comparable circumstances involving 
successor QBUs. See Part 1.D of this Explanation of Provisions for an 
explanation of outbound loss events.
d. Special Rules Regarding Successor QBUs
    The temporary regulations include three special rules regarding 
successor QBUs that are relevant to the recognition of deferred section 
987 gain or loss. First, if a section 987 QBU is a successor QBU with 
respect to a deferral QBU that is a successor QBU with respect to 
another deferral QBU, the first-mentioned section 987 QBU is considered 
a successor QBU with respect to the second-mentioned deferral QBU. For 
example, if QBU A is a successor QBU with respect to QBU B, and QBU B 
is a successor QBU with respect to QBU C, then QBU A is a successor QBU 
with respect to QBU C.
    Second, if a successor QBU with respect to a deferral QBU separates 
into two or more separated QBUs (as defined in Sec.  1.987-
2T(c)(9)(iii)), each separated QBU is considered a successor QBU with 
respect to the deferral QBU.
    Third, if a successor QBU with respect to a deferral QBU combines 
with another section 987 QBU of the same owner, resulting in a combined 
QBU (as defined in Sec.  1.987-2T(c)(9)(i)), the combined QBU is 
considered a successor QBU with respect to the deferral QBU.
iv. Source and Character of Deferred Section 987 Gain and Loss
    The temporary regulations provide that the source and character of 
deferred section 987 gain or loss is determined under Sec.  1.987-6 as 
if such gain or loss had been recognized with respect to the deferral 
QBU under Sec.  1.987-5 on the date of the deferral event that gave 
rise to the deferred section 987 gain or loss. Thus, the source and 
character of deferred section 987 gain or loss is determined under 
Sec.  1.987-6 without regard to the timing rules of Sec.  1.987-12T.
D. Outbound Loss Events
    Section 1.987-12T(d) of the temporary regulations contains rules 
that defer section 987 loss to the extent assets of a section 987 QBU 
are transferred outbound to a related foreign person in connection with 
an ``outbound loss event.'' Specifically, the temporary regulations 
provide that, notwithstanding Sec.  1.987-5, the owner of a section 987 
QBU with respect to which an outbound loss event occurs (outbound loss 
QBU) includes in taxable income in the year of the outbound loss event 
section 987 loss with respect to that section 987 QBU only to the 
extent provided in Sec.  1.987-12T(d)(3). Sections 1.987-12T(d)(4) and 
(5) provide rules for the subsequent recognition of losses that are 
deferred under Sec.  1.987-12T(d) that differ from the remittance-based 
rules that generally apply following deferral events.
    Like the definition of deferral event, an outbound loss event 
includes two categories of transactions with respect to a section 987 
QBU with net unrecognized section 987 loss. First, an outbound loss 
event includes any termination of the section 987 QBU in connection 
with a transfer of assets of the section 987 QBU by a U.S. person to a 
foreign person that was a member of the same controlled group as the 
U.S. transferor immediately before the transaction or, if the 
transferee did not exist immediately before the transaction, 
immediately after the transaction (related foreign person). The second 
category of outbound loss events includes any transfer by a U.S. person 
of part of an interest in a section 987 aggregate partnership or DE 
through which the U.S. person owns the section 987 QBU to a related 
foreign person that has the same functional currency as the section 987 
QBU. The second category also includes a contribution of assets by such 
a related foreign person to the partnership or DE if the contribution 
has the effect of reducing the U.S. person's interest in the section 
987 QBU (and therefore causes a deemed transfer of assets and 
liabilities to the U.S. person from the section 987 QBU) and the 
contributed assets are not included on the books and records of an 
eligible QBU of the partnership or DE. The second category would be 
implicated, for example, if a U.S. person transferred part of the 
interest in a DE through which it owned a section 987 QBU to a foreign 
corporation that had the same functional currency as the section 987 
QBU in an outbound section 351 transaction.
    Under these rules, the owner of the outbound loss QBU recognizes 
section 987 loss in the taxable year of the outbound loss event as 
determined under Sec.  1.987-5 and the deferral event rules of Sec.  
1.987-12T(b) and (c), except that, solely for purposes of applying 
Sec.  1.987-5, certain assets and liabilities of the outbound loss QBU 
are treated as not having been transferred and therefore as remaining 
on the balance sheet of the section 987 QBU, notwithstanding the 
outbound loss event. In the first category of outbound loss event 
(involving outbound asset transfers resulting in terminations), assets 
and liabilities that, immediately after the outbound loss event, are 
properly reflected on the books and records of the related foreign 
person or a section 987 QBU of the related foreign person are treated 
as not having been transferred. In the second category of outbound loss 
event (involving certain partnership and DE transactions), assets and 
liabilities that, immediately after the outbound loss event, are 
reflected on the books and records of the eligible QBU from which the 
assets and liabilities of the outbound loss QBU are allocated, and not 
on the books and records of a section 987 QBU, are treated as not 
having been transferred. The difference between the amount that 
otherwise would have been recognized and the amount actually recognized 
under this rule is referred to as outbound section 987 loss.
    Although an outbound loss event in the second category also would 
constitute a deferral event, the rules governing deferral events only 
defer section 987 loss of a deferral QBU to the extent assets and 
liabilities are reflected on the books and records of a successor QBU 
immediately after the deferral event. Assets and liabilities of a 
deferral QBU that are reflected on the books and records of an eligible 
QBU of a partnership and allocated to a partner that has the same 
functional currency as the eligible QBU, as would occur in an outbound 
loss event, are not reflected on the books and records of a successor 
QBU and so would not cause section 987 loss to be deferred under the 
deferral event rules. Thus, there is no overlap in terms of the effect 
of the outbound loss event rules and the deferral event rules.
    If an outbound loss event results from the transfer of assets of 
the outbound loss QBU in a nonrecognition transaction, the basis of the 
stock that is received in the transaction is increased by an amount 
equal to the outbound section 987 loss. In effect, this rule converts a 
section 987 loss into an unrealized stock loss, which may be recognized 
upon a recognition event with respect to the stock. This treatment

[[Page 88859]]

is similar to the treatment under section 367(a) of foreign currency 
losses with respect to foreign-currency denominated property that is 
transferred outbound in a nonrecognition event to a foreign corporation 
that has as its functional currency the currency in which the property 
is denominated. Outbound section 987 loss attributable to an outbound 
loss event that does not occur in connection with a nonrecognition 
transaction is recognized by the owner of the outbound loss QBU in the 
first taxable year in which the owner (or any qualified successor) and 
the related foreign person that participated in the outbound loss event 
(or any qualified successor) cease to be members of the same controlled 
group. In many circumstances this treatment will provide similar 
results as converting section 987 loss into stock basis as in the case 
of outbound loss events that result from a nonrecognition transaction.
    The temporary regulations provide that, if loss is recognized on 
the sale or exchange of stock within two years of an outbound loss 
event that gave rise to an adjustment to the basis of the stock, then, 
to the extent of the outbound section 987 loss, the source and 
character of the loss recognized on the sale or exchange will be 
determined under Sec.  1.987-6 as if such loss were section 987 loss 
recognized pursuant to Sec.  1.987-5 without regard to Sec.  1.987-12T 
on the date of the outbound loss event.
E. Anti-Abuse Rule
    The temporary regulations provide an anti-abuse rule to address 
transactions structured to avoid the deferral rules in Sec.  1.987-12T. 
This rule provides that no section 987 loss is recognized under Sec.  
1.987-5 in connection with a transaction or series of transactions that 
are undertaken with a principal purpose of avoiding the purposes of 
Sec.  1.987-12T. This rule would apply, for example, if, with a 
principal purpose of recognizing a deferred section 987 loss, a 
taxpayer engaged in a transaction that caused a deferral QBU owner to 
cease to exist without a qualified successor or caused a successor QBU 
to cease to exist, such that deferred section 987 loss otherwise would 
be recognized under Sec.  1.987-12T(c).
F. Coordination With Fresh Start Transition Method
    The temporary regulations require adjustments to coordinate the 
application of Sec.  1.987-12T with the fresh start transition method 
described in Sec.  1.987-10(b) for transitioning to the final 
regulations. If a deferral QBU owner is required under Sec.  1.987-
10(a) to apply the fresh start transition method with respect to the 
deferral QBU on the transition date, or if a deferral QBU owner would 
have been so required if it had owned the deferral QBU on the 
transition date, the outstanding deferred section 987 gain or loss of 
the deferral QBU owner with respect to the deferral QBU must be 
adjusted on the transition date to equal the amount of outstanding 
deferred section 987 gain or loss that the deferral QBU owner would 
have had with respect to the deferral QBU on the transition date if, 
immediately before the deferral event, the deferral QBU had 
transitioned to the final regulations pursuant to the fresh start 
transition method. Additionally, if the owner of an outbound loss QBU 
is required under Sec.  1.987-10(a) to apply the fresh start transition 
method with respect to the outbound loss QBU on the transition date, or 
if the owner would have been so required if it had owned the outbound 
loss QBU on the transition date, the basis of any stock that was 
subject to a basis adjustment under Sec.  1.987-12T as a result of the 
outbound loss event must be adjusted to equal the basis that such stock 
would have had on the transition date if, immediately prior to the 
outbound loss event, the outbound loss QBU had transitioned to the 
final regulations pursuant to the fresh start transition method. 
Outbound section 987 loss that is not reflected in stock basis but that 
will be recognized when the owner and the related foreign person that 
participated in the outbound loss event cease to be members of the same 
controlled group must be adjusted in a similar manner. These 
adjustments to coordinate the application of Sec.  1.987-12T with the 
fresh start transition method must be made even if the deferral QBU 
owner or the owner of the outbound loss QBU continues to own the 
deferral QBU or the outbound loss QBU on the transition date, as in the 
case of a deferral event or outbound loss event resulting from a 
transfer of part of an interest in a section 987 aggregate partnership 
that does not result in the termination of the deferral QBU or outbound 
loss QBU.
G. Effective Date
    The temporary regulations under Sec.  1.987-12T generally apply to 
any deferral event or outbound loss event that occurs on or after 
January 6, 2017. However, if the deferral event or outbound loss event 
is undertaken with a principal purpose of recognizing section 987 loss, 
the 30 day delayed effective date does not apply and Sec.  1.987-12T is 
effective immediately on December 7, 2016.

2. Annual Deemed Termination Election

    A comment on the 2006 proposed regulations recommended that 
taxpayers be permitted to make a one-time election under Sec.  1.987-5 
to deem a section 987 QBU as having terminated at the end of each year, 
thereby requiring the owner to recognize all section 987 gains or 
losses with respect to the QBU on an annual basis. The comment 
suggested that such an election would allow taxpayers to reduce the 
complexity and administrative cost of complying with section 987 
because taxpayers would not be required to track transactions between 
an owner and its section 987 QBU or unrecognized section 987 gains and 
losses carried over from previous years.
    The Treasury Department and the IRS have determined that an annual 
deemed termination election would not obviate the need to track 
transactions between an owner and its section 987 QBU, since the net 
transfer would remain relevant to the annual calculation of section 987 
gain or loss. Nonetheless, the Treasury Department and the IRS agree 
that an annual deemed termination election could enhance 
administrability of the final regulations by reducing the recordkeeping 
requirements necessary to apply the final regulations. Additionally, 
when an annual deemed termination election is in effect, taxpayers 
could not strategically time remittances in order to selectively 
recognize section 987 losses but not section 987 gains. Eliminating 
this planning opportunity would obviate the need for the deferral 
provisions of Sec.  1.987-12T. Furthermore, as discussed in Part 3 of 
this Explanation of Provisions, an annual deemed termination election 
would address a policy concern with permitting the hybrid approach to 
section 987 suggested by comments on the 2006 proposed regulations.
    Based on the foregoing considerations, Sec.  1.987-8T(d) provides 
an election for a taxpayer to deem its section 987 QBUs to terminate on 
the last day of each taxable year for which the election is in effect. 
Because the considerations supporting an annual deemed termination 
election generally are relevant regardless of whether a taxpayer is 
subject to the final regulations, the election under Sec.  1.987-8T(d) 
is available to any taxpayer without regard to the applicability of the 
final regulations to that taxpayer or any of its section 987 QBUs. A 
section 987 QBU to which this election applies is treated as having 
made a remittance of all of its gross assets to its owner

[[Page 88860]]

immediately before the section 987 QBU terminates on the last day of 
each taxable year, resulting in the recognition of any net unrecognized 
section 987 gain or loss of the section 987 QBU. See Sec. Sec.  1.987-
5(c)(3) and 1.987-8(e). The owner is then treated as having transferred 
all of the assets and liabilities of the terminated section 987 QBU to 
a new section 987 QBU on the first day of the following taxable year.
    As noted in Part 1 of this Explanation of Provisions, the temporary 
regulations provide that the deferral provisions of Sec.  1.987-12T do 
not apply with respect to section 987 QBUs for which the annual deemed 
termination election is in effect. Consequently, a taxpayer that finds 
the annual deemed termination election preferable to Sec.  1.987-12T 
based on ease of compliance or other reasons may make the annual deemed 
termination election. Moreover, as discussed in Part 3 of this 
Explanation of Provisions, a taxpayer that makes the annual deemed 
termination election with respect to a section 987 QBU may reduce the 
compliance burden associated with computing taxable income or loss 
under the final regulations by electing to translate taxable income or 
loss of the section 987 QBU into the owner's functional currency at the 
yearly average exchange rate without any adjustments.
    The Treasury Department and the IRS have determined that special 
consistency and effective date rules are needed for the annual deemed 
termination election to prevent taxpayers from using the election to 
selectively recognize section 987 losses without recognizing section 
987 gains. Unless the annual deemed termination election is required to 
be made with respect to all section QBUs owned by related persons at 
the time of the election, taxpayers could choose to make the election 
only with respect to section 987 QBUs that have net unrecognized 
section 987 losses at the time of the election. Accordingly, Sec.  
1.987-1T(g)(2)(i)(B)(1) provides that the annual deemed termination 
election generally applies to all section 987 QBUs owned by an electing 
taxpayer, as well as to all section 987 QBUs owned by any person that 
has a relationship to the taxpayer described in section 267(b) or 
section 707(b) (substituting ``and the profits interest'' for ``or the 
profits interest'' in section 707(b)(1)(A) and substituting ``and 
profits interests'' for ``or profits interests'' in section 
707(b)(1)(B)) on the last day of the first taxable year for which the 
election applies to the taxpayer (a related person).
    A taxpayer that is subject to the final regulations and that must 
transition to the final regulations under the fresh start transition 
method of Sec.  1.987-10(b) (fresh start taxpayer) may make the annual 
deemed termination election only if the first taxable year for which 
the election would apply is either (i) the first taxable year beginning 
on or after the transition date (as defined in Sec.  1.987-11(c)) with 
respect to the taxpayer or (ii) a subsequent taxable year in which the 
``taxpayer's controlled group aggregate section 987 loss'' (if any) 
does not exceed $5 million. For this purpose, a ``taxpayer's controlled 
group aggregate section 987 loss'' means the aggregate net amount of 
section 987 gain or loss that would be recognized pursuant to the 
election under Sec.  1.987-8T(d) by the taxpayer and all related 
persons in the first taxable year of each person for which the election 
would apply.
    Taxpayers that used a method based on a reasonable application of 
the 2006 proposed regulations prior to the transition date, and which 
therefore are not subject to the fresh start transition method pursuant 
to Sec.  1.987-10(c), and taxpayers for which the final regulations are 
not applicable, must follow the election rules for fresh start 
taxpayers if any related party is a fresh start taxpayer. If no related 
party is a fresh start taxpayer, the annual deemed termination election 
may be made only if the first taxable year for which the election would 
apply is either (i) the first taxable year beginning on or after 
December 7, 2016, in which the election is relevant in determining 
section 987 taxable income or loss or section 987 gain or loss or (ii) 
a subsequent taxable year in which the ``taxpayer's controlled group 
aggregate section 987 loss'' (if any) does not exceed $5 million.
    If a taxpayer makes the annual deemed termination election, the 
election will apply to the first taxable year of a related person that 
ends with or within a taxable year of the taxpayer to which the 
taxpayer's election applies. Once made, the annual deemed termination 
election may not be revoked.
    As provided in Sec.  1.987-1T(g)(2)(i)(B)(2), the special 
consistency and effective date rules in Sec.  1.987-1T(g)(2)(i)(B)(1) 
do not apply and a taxpayer may make a separate election under Sec.  
1.987-8T(d) with respect to any section 987 QBU owned by the taxpayer 
if the first taxable year for which the election would apply to the 
taxpayer with respect to the section 987 QBU is a taxable year in which 
the deemed termination results in the recognition of section 987 gain 
with respect to the section 987 QBU or the deemed termination results 
in the recognition of $1 million or less of section 987 loss with 
respect to the section 987 QBU.

3. Election To Translate All Items at the Yearly Average Exchange Rate

    As discussed in the preamble to the final regulations, comments on 
the 2006 proposed regulations recommended a hybrid approach that would 
combine the methodology of the regulations proposed under section 987 
in 1991 (INTL-965-86, 56 FR 48457) for computing a section 987 QBU's 
net income with the methodology of the 2006 proposed regulations for 
computing section 987 gain or loss. Under the proposed hybrid approach, 
section 987 gain or loss generally would be determined under the method 
of the 2006 proposed regulations, but taxable income or loss would be 
translated into the owner's functional currency at the yearly average 
exchange rate without any adjustments.
    Although a hybrid approach would simplify the calculation of 
section 987 taxable income or loss, the preamble to the final 
regulations observes that the hybrid approach gives rise to offsetting 
effects in section 987 taxable income or loss and in the foreign 
exchange exposure pool (FEEP) that raise concerns similar to those 
addressed by Congress in enacting section 1092. In particular, under 
the hybrid approach, exchange rate effects with respect to historic 
assets would be reflected in section 987 taxable income or loss to the 
extent of any cost recovery deductions with respect to those assets, 
but equal and offsetting amounts would be reflected in the FEEP and 
would be recognized only upon remittances. Thus, offsetting effects 
arising from a single asset would be taken into account at different 
times. The Treasury Department and the IRS have determined that it 
would be inappropriate for regulations under section 987 to permit 
distortions to section 987 taxable income or loss that have the effect 
of causing potentially large offsetting amounts of loss or gain to be 
reflected in the FEEP with respect to the same asset, since the loss or 
gain in the FEEP would be recognized only upon voluntary remittances 
from the QBU.
    Nonetheless, the Treasury Department and the IRS acknowledge the 
concerns expressed in comments regarding the complexity of the 2006 
proposed regulations that underlie the recommendation to adopt the 
hybrid approach. Concerns about offsetting amounts recognized at 
different times under the hybrid approach would not

[[Page 88861]]

arise for taxpayers that make the annual deemed termination election 
set forth in Sec.  1.987-8T(d). A taxpayer that recognizes all section 
987 gain or loss with respect to its section 987 QBUs annually would 
take into account in recognized section 987 gain or loss the exchange 
rate effects with respect to historic assets that are reflected in the 
FEEP in the same taxable year in which the offsetting effects are taken 
into account in section 987 taxable income or loss. Although the hybrid 
approach could result in differences in character of exchange gain or 
loss relative to the final regulations even for taxpayers that make the 
annual deemed termination election, the Treasury Department and the IRS 
have determined that the administrative convenience of allowing 
taxpayers to translate a section 987 QBU's taxable income at the yearly 
average exchange rate outweighs that consideration.
    Accordingly, the temporary regulations provide that a taxpayer that 
is otherwise generally subject to the final regulations may elect to 
apply the hybrid approach with respect to a section 987 QBU that is 
subject to the annual deemed termination election. In particular, Sec.  
1.987-3T(d) provides that, notwithstanding the rules of Sec.  1.987-
3(c) for translating items determined under Sec.  1.987-3(b) in a 
section 987 QBU's functional currency into the owner's functional 
currency, a taxpayer may elect to translate all items of income, gain, 
deduction, and loss of a section 987 QBU with respect to which the 
annual deemed termination election described in Sec.  1.987-8T(d) is in 
effect into the owner's functional currency, if necessary, at the 
yearly average exchange rate for the taxable year. An owner of multiple 
section 987 QBUs may make the election described in Sec.  1.987-3T(d) 
with respect to all of its section 987 QBUs or only certain designated 
section 987 QBUs.

4. Section 988 Transactions of a Section 987 QBU

A. Background Regarding the Treatment of Section 988 Transactions Under 
the Proposed Regulations
    The 2006 proposed regulations reflected a two-pronged approach to 
the application of section 988 to transactions of a section 987 QBU, 
with different consequences generally depending on whether a 
transaction is denominated in (or determined by reference to) the 
owner's functional currency or a currency that is a nonfunctional 
currency with respect to both the owner and the section 987 QBU (third 
currency). As a general rule, Sec.  1.987-3(e)(1) of the 2006 proposed 
regulations provided that section 988 applies to section 988 
transactions attributable to a section 987 QBU and that the timing of 
any gain or loss is determined under the applicable provisions of the 
Code, but the 2006 proposed regulations did not clearly specify whether 
section 988 gain or loss would be determined with respect to the 
functional currency of the section 987 QBU or the owner's functional 
currency. Assets and liabilities giving rise to section 988 
transactions were defined under proposed Sec.  1.987-1(d) and (e) as 
historic items. Under Sec.  1.987-3(e)(2) of the 2006 proposed 
regulations, transactions of a section 987 QBU described in section 
988(c)(1)(B)(i) (relating to the acquisition of, or becoming an obligor 
under, a debt instrument), section 988(c)(1)(B)(ii) (relating to 
accrual of items of expense or gross income or receipts) or section 
988(c)(1)(C) (relating to the disposition of nonfunctional currency) 
that are denominated in (or determined by reference to) the owner's 
functional currency, however, were not treated as section 988 
transactions of the section 987 QBU, and no gain or loss was recognized 
under section 988 with respect to such transactions. Assets and 
liabilities giving rise to such transactions were required to be 
reflected on the balance sheet of the section 987 QBU in the owner's 
functional currency under Sec.  1.987-2(d)(2) of the 2006 proposed 
regulations.
    Additionally, Sec.  1.987-3(d) of the 2006 proposed regulations 
provided that an item of income, gain, deduction, or loss of a section 
987 QBU denominated in a currency other than the functional currency of 
the owner is translated at the spot rate on date the item is 
appropriately taken into account. Under Sec.  1.987-3(c) of the 2006 
proposed regulations, an item of income, gain, deduction, or loss of a 
section 987 QBU denominated in the owner's functional currency is not 
translated and is taken into account by the section 987 QBU in the 
owner's functional currency.
    One comment indicated that the 2006 proposed regulations were 
unclear regarding the interaction of the rules for the treatment of 
section 988 transactions denominated in a third currency with the 
treatment of assets that give rise to section 988 transactions as 
historic assets. Upon the disposition of a historic asset, the 2006 
proposed regulations required translation of the basis of the historic 
asset at the historic rate and the amount realized with respect to the 
asset at the yearly average exchange rate for the taxable year of the 
disposition or, if properly elected, the appropriate spot rate. Yet, 
Sec.  1.987-3(f), Example 10 of the 2006 proposed regulations 
illustrated the determination of section 988 gain or loss on a third-
currency section 988 transaction in, and by reference to, the section 
987 QBU's functional currency and translation of that amount into the 
owner's functional currency at the yearly average exchange rate. Under 
the approach of the example, historic asset basis is effectively 
translated at the yearly average exchange rate rather than the 
appropriate historic rate.
B. General Rules for Section 988 Transactions in the Temporary 
Regulations
    In light of the comment regarding the uncertain application of 
section 988 to transactions of a section 987 QBU under the 2006 
proposed regulations and further consideration of the appropriate 
rules, the temporary regulations clarify and elaborate upon the 
application of section 988 to transactions attributable to a section 
987 QBU. In this regard, the Treasury Department and the IRS have 
determined that computing section 988 gain or loss by reference to the 
functional currency of the section 987 QBU, rather than the owner's 
functional currency, and translating that amount at the yearly average 
exchange rate would be inconsistent with the treatment of items that 
give rise to section 988 transactions as historic items. Such items 
were treated as historic items under the 2006 proposed regulations 
because they do not economically expose the owner to fluctuations in 
the section 987 QBU's functional currency.
    Taking these considerations into account, the Treasury Department 
and the IRS have determined that it is appropriate to continue to treat 
assets and liabilities giving rise to section 988 transactions of a 
section 987 QBU as historic items under Sec. Sec.  1.987-1(d) and (e) 
of the final regulations. Thus, for example, a note denominated in a 
nonfunctional currency that gives rise to a section 988 transaction 
when acquired is a historic asset. However, the temporary regulations 
generally provide that section 988 gain or loss arising from section 
988 transactions of a section 987 QBU is determined by reference to the 
owner's functional currency, rather than the functional currency of the 
section 987 QBU. See Sec.  1.987-3T(b)(4)(i). Accordingly, in 
determining section 988 gain or loss with respect to a section 988 
transaction of a section 987 QBU, the amounts required under section 
988 to be translated on the applicable booking date or payment date 
with respect to the section 988 transaction are translated from the 
currency in which the amounts are denominated (or by reference to

[[Page 88862]]

which they are determined) into the owner's functional currency at the 
rate required under section 988 and the section 988 regulations, which 
provide for translation at the appropriate spot rate.
    When a section 987 QBU recognizes gain or loss on the disposition 
of a historic asset that gives rise to a section 988 transaction, some 
or all of the total gain or loss that is realized on the disposition 
may be section 988 gain or loss that, under section 988, is ordinary 
income that is sourced by reference to the residence of the section 987 
QBU. For example, on the disposition of a nonfunctional currency note, 
the total gain or loss realized may be comprised of section 988 gain or 
loss that reflects exchange rate changes and other gain or loss that 
reflects other factors, such as changes in prevailing interest rates or 
in the creditworthiness of the note issuer. The total gain or loss on 
the disposition of a historic asset that gives rise to a section 988 
transaction is determined under the general rules of section 987 by 
reference to the functional currency of the section 987 QBU. Section 
988 gain or loss on the note is determined under Sec. Sec.  1.988-
2(b)(5) and (8) and 1.987-3T(b)(4)(i) by comparing the section 987 
QBU's acquisition price for the note in nonfunctional currency 
translated into the owner's functional currency at the spot rates on 
the date of acquisition and the date of disposition, respectively. See 
Sec.  1.987-3T(e), Example 11. To provide for consistent translation 
rates for determining both the total gain or loss on such a historic 
asset and the portion of the total gain or loss that is section 988 
gain or loss, Sec.  1.987-3T(c)(2)(ii) specifies that the spot rate 
also must be used to translate the amount received with respect to a 
historic asset if the acquisition of the historic asset gave rise to a 
section 988 transaction. Additionally, consistent with the regulations 
under Sec.  1.988-1(d) regarding the use of spot rate conventions for 
section 988 transactions, Sec.  1.987-1T(c)(1)(ii)(B) specifies that 
the election in Sec.  1.987-1(c)(1)(ii)(A) to use a spot rate 
convention generally does not apply for purposes of determining section 
987 taxable income or loss with respect to a historic item (as defined 
in Sec.  1.987-1(e)) if acquiring, accruing, or entering into such item 
gave rise to a section 988 transaction or a specified owner functional 
currency transaction (discussed in this Part B).
    Because assets and liabilities that give rise to section 988 
transactions generally are historic items that have a spot rate as the 
historic rate under Sec.  1.987-1T(c)(3)(i)(E), such assets and 
liabilities are translated at historic rates and do not give rise to 
section 987 gain or loss. Thus, when the general rules for section 988 
transactions of a section 987 QBU apply, the owner will take into 
account under subpart J foreign currency exposure with respect to a 
section 988 transaction of a section 987 QBU only to the extent of the 
owner's economic exposure to fluctuations of its functional currency 
relative to the currency in which the section 988 transaction is 
denominated.
    Additionally, consistent with the 2006 proposed regulations, the 
temporary regulations confirm that certain transactions that are 
denominated in (or determined by reference to) the owner's functional 
currency are not subject to section 988. Specifically, Sec.  1.987-
3T(b)(4)(ii) provides that specified owner functional currency 
transactions, which are defined as transactions described in section 
988(c)(1)(B)(i) or (ii) or section 988(c)(1)(C) (including the 
acquisition of nonfunctional currency described in Sec.  1.988-1(a)(1)) 
that are denominated in (or determined by reference to) the owner's 
functional currency, other than certain transactions described in Sec.  
1.987-3T(b)(4)(iii)(A) that are subject to a mark-to-market regime 
(discussed in Part 4.C of this Explanation of Provisions), are not 
treated as section 988 transactions. Although the temporary regulations 
do not follow the 2006 proposed regulations in specifying that assets 
and liabilities that give rise to specified owner functional currency 
transactions must be reflected on the balance sheet of the section 987 
QBU in the owner's functional currency, the temporary regulations treat 
items that give rise to specified owner functional currency 
transactions as historic items that generally have a spot rate as the 
historic rate under Sec.  1.987-1T(c)(3)(i)(E) and provide under Sec.  
1.987-3T(b)(2)(ii) that the basis and amount realized of a historic 
asset that gives rise to a specified owner functional currency 
transactions are not translated if denominated in the owner's 
functional currency. Together, these rules have the same effect as the 
treatment of specified owner functional currency transactions under the 
2006 proposed regulations.
C. Special Rules To Allow Greater Conformity With the Financial 
Accounting Treatment for Certain Section 988 Transactions
    As discussed in the preamble to the final regulations, under the 
financial accounting standard described in Accounting Standards 
Codification, Foreign Currency Matters, section 830 (ASC 830), gains 
and losses from changes in exchange rates with respect to transactions 
that are denominated in a currency other than the entity's functional 
currency are referred to as ``transaction'' gains and losses. The 
category of foreign currency transactions that give rise to transaction 
gains and losses for financial accounting purposes overlaps 
considerably with the definition of a section 988 transaction for tax 
purposes, such that transaction gains and losses under financial 
accounting rules are conceptually similar to section 988 gains and 
losses. The financial accounting rules require the inclusion of 
transaction gains and losses in net income for the period in which the 
exchange rate changes occur. See ASC 830-20-35-1. Moreover, transaction 
gain or loss is always determined by reference to the functional 
currency of the entity that entered into the transaction. Thus, the 
financial accounting rules differ from the general tax rules applicable 
to section 988 transactions entered into by a section 987 QBU in two 
respects. First, the financial accounting rules require transaction 
gain or loss to be determined on a mark-to-market basis, whereas gain 
or loss from a section 988 transaction generally is not recognized 
until there is a realization event under general tax principles and the 
applicable provisions of the Code. Second, the financial accounting 
rules require transaction gain or loss to be determined by reference to 
the entity's functional currency, even when it differs from the 
reporting currency used in the consolidated financial statements and 
the transaction is denominated in the reporting currency.
    As noted in the preamble to the final regulations, comments on the 
2006 proposed regulations expressed a preference for greater 
consistency of the section 987 regulations with financial accounting 
rules. Taking these comments into account, the Treasury Department and 
the IRS have determined that providing treatment similar to the 
financial accounting treatment for certain section 988 transactions of 
section 987 QBUs will enhance administrability of the section 987 
regulations with respect to such transactions and is consistent with 
the policies of sections 987 and 988.
    Accordingly, as discussed in Part 1.C.i of this Explanation of 
Provisions, the temporary regulations permit a taxpayer to elect to 
determine section 987 gain or loss with respect to qualified short-term 
section 988 transactions (described in Part 1.C.i of this Explanation 
of Provisions) of a section 987 QBU under a foreign currency mark-to-
market method of accounting. In addition, as discussed in Part 4.C.ii 
of this

[[Page 88863]]

Explanation of Provisions, the temporary regulations provide that 
section 988 gain or loss with respect to qualified short-term section 
988 transactions that are accounted for under a mark-to-market method 
of accounting for Federal tax purposes (including the elective method 
described in Part 1.C.i of this Explanation of Provisions) is 
determined in, and by reference to, the functional currency of the 
section 987 QBU rather than the functional currency of its owner.
i. Election To Apply a Foreign Currency Mark-to-Market Method of 
Accounting for Certain Section 988 Transactions
    The Treasury Department and the IRS have determined that allowing a 
taxpayer to mark to market foreign currency gain or loss with respect 
to qualified short-term section 988 transactions of a section 987 QBU 
will enhance administrability by aligning the timing for recognizing 
gain or loss with respect to such transactions with the financial 
accounting rules. Accordingly, a taxpayer may elect, on a QBU-by-QBU 
basis, under Sec.  1.987-3T(b)(4)(iii)(C) to apply the foreign currency 
mark-to-market method of accounting to qualified short-term section 988 
transactions. Under this election, the timing of section 988 gain or 
loss is determined for applicable transactions under the principles of 
section 1256(a)(1). Thus, when the election applies, section 988 gain 
or loss with respect to a qualified short-term section 988 transaction 
is recognized on an annual basis, but other gain or loss with respect 
to any property underlying the transaction (e.g., gain or loss on a 
debt instrument due to interest rate fluctuations) is determined under 
the otherwise applicable recognition provisions.
    A qualified short-term section 988 transaction is defined in Sec.  
1.987-3T(b)(4)(iii)(B) as a section 988 transaction, including a 
transaction denominated in the owner's functional currency, that both 
(1) occurs in the ordinary course of the section 987 QBU's business and 
(2) has an original term of one year or less on the day it is entered 
into by the section 987 QBU. The holding of currency that is 
nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) 
to the section 987 QBU in the ordinary course of a section 987 QBU's 
trade or business also is treated as a qualified short-term section 988 
transaction.
ii. Special Rule Requiring Gain or Loss From Certain Section 988 
Transactions That Are Subject to a Mark-to-Market Method of Accounting 
To Be Determined by Reference to the Functional Currency of the Section 
987 QBU
    The temporary regulations include a special rule for determining 
section 988 gain or loss with respect to qualified short-term section 
988 transactions (as described in Part 4.C.i of this Explanation of 
Provisions) of a section 987 QBU that are accounted for under a mark-
to-market method of accounting. Specifically, Sec.  1.987-
3T(b)(4)(iii)(A) provides that section 988 gain or loss with respect to 
qualified short-term section 988 transactions of a section 987 QBU, and 
certain related hedges, that are accounted for under a mark-to-market 
method of accounting under section 475, section 1256, or Sec.  1.987-
3T(b)(4)(iii)(C) (discussed in Part 4.C.i of this Explanation of 
Provisions) is determined in, and by reference to, the functional 
currency of the section 987 QBU rather than the owner's functional 
currency. Items that give rise to qualified short-term section 988 
transactions for which section 988 gain or loss is determined under 
Sec.  1.987-3T(b)(4)(iii)(A) by reference to the section 987 QBU's 
functional currency are treated as marked items under Sec.  1.987-
1T(d)(3), with the result that gain or loss attributable to such items 
is translated at the yearly average exchange rate and that such items 
give rise to net unrecognized section 987 gain or loss.
    Under the rules for qualified short-term section 988 transactions 
accounted for under a mark-to-market method of accounting, a section 
987 QBU owner will take into account the full amount of its economic 
foreign currency exposure arising from such transactions, but the 
effects of such exposure generally will be bifurcated into a component 
reflected in section 987 taxable income or loss and a component 
reflected in the FEEP pool and recognized upon a remittance. These 
components could offset each other if the currency in which the section 
988 transaction is denominated and the owner's functional currency 
moved in opposite directions relative to the section 987 QBU's 
functional currency. Restricting this treatment to qualified short-term 
section 988 transactions accounted for under a mark-to-market method of 
accounting limits the potential for abusive planning. In particular, 
the restriction to transactions accounted for under a mark-to-market 
method of accounting prevents selective realization of section 988 
losses that would be taken into account in section 987 taxable income 
or loss in situations in which an offsetting gain is reflected in the 
FEEP. Additionally, short-term, ordinary-course section 988 
transactions are less likely than other section 988 transactions to 
give rise to substantial offsetting effects in section 987 taxable 
income or loss and in the FEEP.

5. Application of Section 987 to QBUs With the U.S. Dollar as a 
Functional Currency

    Consistent with the opening clause of section 987, which indicates 
that section 987 applies to the determination of the taxable income of 
any taxpayer ``having 1 or more qualified business units with a 
functional currency other than the dollar,'' Sec.  1.987-1T(b)(6)(i) 
sets forth a general rule that section 987 and the regulations 
thereunder do not apply with respect to an eligible QBU (determined 
without regard to the scope limitations of Sec.  1.987-1(b)(3)(ii)) 
that has the U.S. dollar as its functional currency and that would be 
subject to section 987 if it had a functional currency other than the 
U.S. dollar (dollar QBU).
    The Treasury Department and the IRS have determined, however, that 
it is appropriate for a CFC that is the owner of a dollar QBU to 
recognize foreign currency gain or loss with respect to transactions of 
the dollar QBU that would be section 988 transactions if entered into 
directly by the owner. Accordingly, pursuant to the authority granted 
in section 985(a), Sec.  1.987-1T(b)(6)(ii)(A) provides that the CFC 
owner of a dollar QBU will be subject to section 988 with respect to 
any item that is properly reflected on the books and records of the 
dollar QBU and that would give rise to a section 988 transaction if 
such item were acquired, accrued, or entered into directly by the owner 
of the dollar QBU. For purposes of applying section 988 to such items, 
Sec.  1.987-1T(b)(6)(ii)(A) provides that such items are treated as 
properly reflected on the books and records of the dollar QBU's owner. 
Thus, except as provided in the special rule described later in this 
Part 5 of this Explanation of Provisions for computing income that is 
effectively connected with the conduct of a trade or business within 
the United States (ECI), a CFC would determine section 988 gain or loss 
from transactions of a dollar QBU by reference to the CFC's functional 
currency. For example, for purposes of determining its earnings and 
profits, a CFC that has a euro functional currency and that is the 
owner of a dollar QBU with a U.S. dollar-denominated liability

[[Page 88864]]

would apply section 988 with respect to that U.S. dollar-denominated 
liability, measuring section 988 gain or loss on the section 988 
transaction arising from the liability by reference to the euro.
    As a result of treating such items as properly reflected on the 
books and records of the CFC, instead of those of the dollar QBU, the 
CFC's section 988 gain or loss with respect to such items generally 
would be treated as foreign source income because section 988(a)(3) 
generally provides that the source of section 988 gain or loss is 
determined by reference to the residence of the taxpayer or QBU on 
whose books the asset, liability, or other item giving rise to the 
section 988 transaction is properly reflected. Section 1.988-4 then 
would apply to determine whether the section 988 gain or loss would be 
treated as ECI. Because a QBU with ECI must have the U.S. dollar as its 
functional currency (Sec.  1.985-1(b)(1)(v)), section 988 gain or loss 
measured by reference to the owner CFC's functional currency would not 
be ECI. However, the temporary regulations provide a special rule for 
certain section 988 transactions of a dollar QBU (including section 988 
transactions denominated in the owner's functional currency) that arise 
from the conduct of a United States trade or business.
    The special rule applies to a CFC owner of a dollar QBU that would 
have a section 988 transaction that would give rise to section 988 gain 
or loss that would be treated as ECI under Sec.  1.988-4(c) if the item 
that would give rise to the section 988 transaction were treated as 
properly reflected on the books and records of the dollar QBU. Under 
Sec.  1.987-1T(b)(6)(ii)(B), solely for purposes of determining the 
amount of section 988 gain or loss of the CFC that is ECI, any section 
988 gain or loss that would be determined under section 988 as a result 
of the acquisition or accrual of any item and treated as ECI if the 
item were treated as properly reflected on the books and records of the 
dollar QBU is determined by treating such item as properly reflected on 
the books and records of the dollar QBU and, consequently, is 
determined by reference to the U.S. dollar.
    The application of Sec.  1.987-1T(b)(6)(ii) to a section 988 
transaction that is denominated in a third currency (that is, neither 
the CFC's functional currency nor the U.S. dollar) could result in the 
same section 988 transaction generating ECI (determined by reference to 
the U.S. dollar) and generating subpart F income (determined by 
reference to the CFC owner's functional currency), subject to any 
limitation imposed by section 952(b). Under section 952(b), if the 
amount determined under Sec.  1.987-1T(b)(6)(ii)(A) by reference to the 
owner's functional currency and the amount of ECI determined under 
Sec.  1.987-1T(b)(6)(ii)(B) were both gains, only the excess, if any, 
of the gain determined by reference to the owner's functional currency 
over the ECI gain would be taken into account in determining subpart F 
income. If the amount determined under Sec.  1.987-1T(b)(6)(ii)(A) by 
reference to the owner's functional currency and the amount of ECI 
determined under Sec.  1.987-1T(b)(6)(ii)(B) were both losses, the loss 
determined by reference to the owner's functional currency would be 
taken into account in determining subpart F income only to the extent 
it exceeds the ECI loss.
    The Treasury Department and the IRS recognize the potential 
administrative burden associated with applying the foregoing rules to a 
dollar QBU, which may give rise to a large number of section 988 
transactions. Accordingly, Sec.  1.987-1T(b)(6)(iii) provides an 
election for a CFC that directly or indirectly owns a dollar QBU to 
apply section 987 and the regulations thereunder in lieu of applying 
section 988 pursuant to Sec.  1.987-1T(b)(6)(ii). The Treasury 
Department and the IRS have determined that, when this election 
applies, the source of foreign currency gain or loss that is determined 
under section 987 pursuant to the election should be consistent with 
the source that would have been determined under section 988 in the 
absence of the election. Accordingly, consistent with the source rule 
in section 988(a)(3), Sec.  1.987-6T(b)(4) provides that the source of 
section 987 gain or loss determined with respect to a dollar QBU for 
which the owner has elected to apply section 987 is determined by 
reference to the residence of the CFC owner. Thus, such section 987 
gain or loss will have a foreign source.
    As is the case for dollar QBUs of CFCs that do not make the 
election under Sec.  1.987-1T(b)(6)(iii) to apply section 987, CFCs 
that make the election and that have a dollar QBU that engages in a 
U.S. trade or business must apply a special rule to determine the 
amount of ECI that arises from transactions that would give rise to 
section 988 gain or loss if determined by reference to the dollar QBU's 
U.S. dollar functional currency. This special rule for determining the 
amount of ECI applies only to dollar QBUs that generate ECI because, 
under Sec.  1.985-1(b)(1)(v), a QBU that produces income or loss that 
is, or is treated as, ECI must use the dollar as its functional 
currency. The special rule is needed for dollar QBUs that elect to be 
treated as section 987 QBUs because, under the general rules of Sec.  
1.987-3T(b)(4)(i) and (ii), which apply to all section 987 QBUs other 
than with respect to certain short-term transactions described in Sec.  
1.987-3T(b)(4)(iii)(B) that are accounted for under a mark-to-market 
method of accounting, section 988 gain or loss of a section 987 QBU 
with respect to transactions denominated in a third currency is 
determined in, and by reference to, the functional currency of the 
owner of the section 987 QBU, and section 988 gain or loss generally is 
not determined with respect to specified owner functional currency 
transactions described in Part 4.B of this Explanation of Provisions. 
Thus, in order to determine the appropriate amount of ECI from 
transactions of a dollar QBU for which an election to apply section 987 
is in effect, Sec.  1.987-1T(b)(6)(iii)(B) provides that, solely for 
purposes of determining the amount of section 988 gain or loss that is 
ECI, any section 988 gain or loss that would be determined under 
section 988 as a result of the acquisition or accrual of any item and 
treated as ECI under Sec.  1.988-4(c) if the item were treated as 
properly reflected on the books and records of the dollar QBU is 
determined by treating the item as properly reflected on the books and 
records of the dollar QBU. Consequently, solely for that purpose, such 
section 988 gain or loss is determined by reference to the U.S. dollar. 
For purposes of determining the amount of section 988 gain or loss for 
other purposes, including to determine the earnings and profits of the 
CFC, the rules in Sec.  1.987-3T(b)(4)(i) and (ii) continue to apply. 
As is the case for a CFC that has not made the election to apply 
section 987 in lieu of section 988, a transaction to which the special 
rule applies could generate both ECI and subpart F income.

6. Combinations and Separations of QBUs

A. Combinations and Separations Do Not Give Rise to Transfers
    Under Sec.  1.987-2(c), an asset or liability is treated as 
transferred to a section 987 QBU from its owner if, as a result of a 
disregarded transaction, the asset or liability is reflected on the 
books and records of the section 987 QBU. Similarly, an asset or 
liability is treated as transferred from a section 987 QBU to its owner 
if, as a result of a disregarded transaction, the asset or liability is 
no longer reflected on the books and records of the section 987 QBU. 
For this purpose, a disregarded transaction generally means a

[[Page 88865]]

transaction that is not regarded for Federal income tax purposes. 
Absent a special rule, the combination of multiple section 987 QBUs 
that have the same owner, or the separation of a section 987 QBU into 
two or more section 987 QBUs that have the same owner, would give rise 
to a transfer between an owner and one or more section 987 QBUs under 
the final regulations.
    Consistent with the policy of deferring section 987 gain or loss 
under Sec.  1.987-12T when assets of a section 987 QBU are reflected on 
the books and records of another section 987 QBU in the same controlled 
group as a result of certain transactions that result in deemed 
transfers, the Treasury Department and the IRS have determined that it 
would not be appropriate for combinations or separations of section 987 
QBUs of the same owner to give rise to transfers to or from the section 
987 QBUs. Accordingly, under the temporary regulations, section 987 
gain or loss generally is not recognized when two or more section 987 
QBUs (combining QBUs) with the same owner combine into a single section 
987 QBU (combined QBU) or when a section 987 QBU (separating QBU) 
separates into multiple section 987 QBUs (each, a separated QBU).
    Specifically, notwithstanding the general rule of the final 
regulations, Sec.  1.987-2T(c)(9)(i) provides that the combination of 
two or more combining QBUs that have the same owner into a combined QBU 
does not give rise to a transfer of any combining QBU's assets or 
liabilities to the owner. In addition, Sec.  1.987-2T(c)(9)(i) provides 
that transactions between the combining QBUs occurring in the taxable 
year of the combination, which otherwise would give rise to transfers, 
do not result in a transfer of the combining QBUs' assets or 
liabilities to the owner under Sec.  1.987-2(c). For this purpose, a 
combination occurs when the assets and liabilities that are properly 
reflected on the books and records of two or more combining QBUs begin 
to be properly reflected on the books and records of a combined QBU and 
the separate existence of the combining QBUs ceases. A combination may 
result from any transaction or series of transactions in which 
combining QBUs become a combined QBU.
    Similarly, Sec.  1.987-2T(c)(9)(iii) provides that the separation 
of a separating QBU into two or more separated QBUs that have the same 
owner after the separation does not give rise to a transfer of any of 
the separating QBU's assets or liabilities to the owner. For this 
purpose, a separation occurs when assets and liabilities that are 
properly reflected on the books and records of a separating QBU begin 
to be properly reflected on the books and records of two or more 
separated QBUs. A separation may result from any transaction or series 
of transactions in which the separating QBU becomes two or more 
separated QBUs.
B. Determination of Net Unrecognized Section 987 Gain or Loss of 
Combined QBUs and Separated QBUs
    The temporary regulations generally require combining the aggregate 
net unrecognized section 987 gain or loss of combining QBUs for 
purposes of determining net unrecognized section 987 gain or loss of 
the combined QBU and require apportioning the net unrecognized section 
987 gain or loss of a separating QBU among separated QBUs in proportion 
to their respective shares of the aggregate adjusted basis of the 
separating QBU's gross assets. Specifically, Sec.  1.987-4T(f)(1) 
provides that the net unrecognized section 987 gain or loss of a 
combined QBU for a taxable year is determined by taking into account 
the net accumulated unrecognized section 987 gain or loss of each 
combining QBU for all prior taxable years for which the final 
regulations apply and treating the combining QBUs as having combined 
immediately prior to the beginning of the taxable year of combination. 
Additionally, Sec.  1.987-4T(f)(2) provides that the net unrecognized 
section 987 gain or loss of a separated QBU for a taxable year is 
determined by taking into account the separated QBU's share of the net 
accumulated unrecognized section 987 gain or loss of the separating QBU 
for all prior taxable years for which the final regulations apply and 
treating the separating QBU as having separated immediately prior to 
the beginning of the taxable year of separation. No transactions are 
deemed to occur between the separating QBUs in the taxable year of 
separation prior to the completion of the separation. A separated QBU's 
share of the separating QBU's net accumulated unrecognized section 987 
gain or loss for all prior taxable years is determined by apportioning 
the separating QBU's net accumulated unrecognized section 987 gain or 
loss for all prior taxable years to each separated QBU in proportion to 
the aggregate adjusted basis of the gross assets properly reflected on 
the books and records of each separated QBU immediately after the 
separation.
    The temporary regulations also clarify at Sec.  1.987-2T(c)(9)(ii) 
that, if a combining section 987 QBU has a different functional 
currency than the combined QBU, the combining section 987 QBU will be 
deemed to have automatically changed its functional currency to the 
functional currency of the combined section 987 QBU immediately prior 
to the combination. A combining section 987 QBU that is deemed to 
change its functional currency under this paragraph must make the 
adjustments described in Sec.  1.985-5.

7. Translation of Foreign Taxes Claimed as a Foreign Tax Credit and 
Related Income

    Under the general rule of Sec.  1.987-3(c)(1), the owner of a 
section 987 QBU uses the yearly average exchange rate (as defined in 
Sec.  1.987-1(c)(2)) to translate an item of income, gain, deduction, 
or loss of a section 987 QBU into the owner's functional currency. 
Alternatively, the owner of a section 987 QBU may elect to use the spot 
rate (as defined in Sec.  1.987-1(c)(1)) for the day each item is taken 
into account.
    Under section 986(a)(1)(A), for purposes of determining the amount 
of its foreign tax credit, a taxpayer that takes foreign income taxes 
into account when accrued generally translates the amount of any 
foreign income taxes (and any adjustments thereto) into dollars using 
the average exchange rate for the taxable year to which such taxes 
relate. However, sections 986(a)(1)(B) and (C) contain exceptions to 
this general rule, including for taxes that are not paid within two 
years of the close of the taxable year to which the taxes relate (two-
year rule). In addition, section 986(a)(1)(D) provides that a taxpayer 
may elect to translate foreign income taxes denominated in a functional 
currency other than the taxpayer's functional currency using a spot 
rate in lieu of using the yearly average exchange rate. Section 
986(a)(2)(A) generally provides that, for purposes of determining the 
amount of the foreign tax credit with respect to any foreign income 
taxes not subject to section 986(a)(1)(A) (or section 986(a)(1)(E), 
which provides a special rule for regulated investment companies), 
including by reason of the two-year rule or an election under section 
986(a)(1)(D), the taxes are translated into dollars using the spot rate 
on the date such taxes were paid. Adjustments to such taxes are subject 
to the same rule, except that any refund or credit is translated into 
dollars using the exchange rate that applied to the original payment of 
such foreign income taxes.
    Taking into account the translation rules of Sec.  1.987-3(c) and 
section 986(a),

[[Page 88866]]

a mismatch could arise between the owner functional currency value of 
income used to pay foreign income taxes and the owner functional 
currency value of the foreign income taxes claimed as a credit. In the 
case of foreign income taxes deemed paid under section 902, section 78 
generally prevents such a mismatch at the level of the domestic 
shareholder claiming the credit by requiring the domestic shareholder 
to include in income an amount equal to the taxes deemed paid, but 
where a U.S. person claims a credit under section 901 that is not for 
taxes deemed paid under section 902 or section 960, foreign income 
taxes and the income used to pay those taxes could be translated at 
different translation rates. To address this potential mismatch, Notice 
89-74, 1989-1 C.B. 739, provides that when a U.S. taxpayer with a 
foreign branch that has a functional currency other than the dollar 
claims a foreign tax credit with respect to a foreign tax, the taxpayer 
is required to translate a functional currency amount equal to the 
foreign taxes paid on branch income using the exchange rate at the time 
of payment of such taxes.
    Consistent with Notice 89-74, Sec.  1.987-3T(c)(2)(v) includes a 
special translation rule providing that income in an amount equal to 
the functional currency amount of the section 987 QBU's foreign income 
taxes claimed as a credit must be translated at the same rate used to 
translate the taxes. This translation rule applies to the owner of a 
section 987 QBU claiming a credit under section 901 for foreign income 
taxes, other than income taxes deemed paid under section 902 or section 
960, that are properly reflected on the books of the section 987 QBU. 
Mechanically, this rule requires the owner to reduce the amount of 
section 987 taxable income or loss that otherwise would be determined 
under Sec.  1.987-3 by an amount equal to the creditable tax amount, 
translated into U.S. dollars at the yearly average exchange rate for 
the taxable year in which the creditable tax is accrued, and then to 
increase the resulting amount by an amount equal to the creditable tax 
amount translated into U.S. dollars at the same exchange rate used to 
translate the creditable taxes into U.S. dollars under section 986(a). 
If the foreign taxes and the income are both translated at the same 
rate (that is, the same yearly average exchange rate), no adjustment is 
necessary under Sec.  1.987-3T(c)(2)(v).

8. Determination of a Partner's Share of Assets and Liabilities of a 
Section 987 Aggregate Partnership

    As discussed in the preamble to the final regulations, the final 
regulations apply an aggregate approach with respect to section 987 
aggregate partnerships, which are defined in Sec.  1.987-1(b)(5) as 
partnerships for which all of the capital and profits interests are 
owned, directly or indirectly, by persons that are related within the 
meaning of section 267(b) or section 707(b). This approach is 
consistent with the aggregate approach to partnerships reflected in the 
2006 proposed regulations, but the 2006 proposed regulations would have 
applied to all partnerships. Under the aggregate approach, assets and 
liabilities reflected on the books and records of an eligible QBU of a 
partnership are allocated to each partner, which is considered an 
indirect owner of the eligible QBU. If the eligible QBU has a different 
functional currency than its indirect owner, then the assets and 
liabilities of the eligible QBU that are allocated to the partner are 
treated as a section 987 QBU of the indirect owner.
    The 2006 proposed regulations provided a rule for determining a 
partner's share of the assets and liabilities of an eligible QBU that 
is owned indirectly through a section 987 aggregate partnership. 
Specifically, proposed Sec.  1.987-7(b) provided that a partner's share 
of assets and liabilities reflected on the books and records of an 
eligible QBU owned through a section 987 aggregate partnership must be 
determined in a manner consistent with how the partners have agreed to 
share the economic benefits and burdens corresponding to partnership 
assets and liabilities, taking into account the rules and principles of 
subchapter K. One comment noted that this rule for allocating assets 
and liabilities to a partner's indirectly owned section 987 QBU was 
ambiguous and that the rules and principles of subchapter K do not 
provide sufficient guidance in this regard.
    The Treasury Department and the IRS acknowledge the ambiguity in 
the 2006 proposed regulations regarding the manner in which assets and 
liabilities of a partnership are allocated to a partner's indirectly 
owned section 987 QBU under the aggregate approach. Accordingly, the 
temporary regulations provide more specific rules for determining a 
partner's share of the assets and liabilities reflected on the books 
and records of an eligible QBU owned indirectly through a section 987 
aggregate partnership. Specifically, Sec.  1.987-7T(b) provides that, 
in any taxable year, a partner's share of each asset and liability of a 
section 987 aggregate partnership is proportional to the partner's 
liquidation value percentage with respect to the aggregate partnership. 
A partner's liquidation value percentage is defined as the ratio of the 
liquidation value of the partner's interest in the partnership to the 
aggregate liquidation value of all the partners' interests in the 
partnership. The liquidation value of the partner's interest in the 
partnership is the amount of cash the partner would receive with 
respect to its interest if, immediately following the applicable 
determination date, the partnership sold all of its assets for cash 
equal to the fair market value of such assets (taking into account 
section 7701(g)), satisfied all of its liabilities (other than those 
described in Sec.  1.752-7), paid an unrelated third party to assume 
all of its Sec.  1.752-7 liabilities in a fully taxable transaction, 
and then liquidated.
    In general, the temporary regulations provide that the 
determination date for determining a partner's liquidation value 
percentage is the date of the most recent event described in Sec.  
1.704-1(b)(2)(iv)(f)(5) or Sec.  1.704-1(b)(2)(iv)(s)(1) (a revaluation 
event), irrespective of whether the capital accounts of the partners 
are adjusted under Sec.  1.704-1(b)(2)(iv)(f), or, if there has been no 
revaluation event, the date of the formation of the partnership. 
However, if a partnership agreement provides for the allocation of any 
item of income, gain, deduction, or loss from partnership property to a 
partner other than in accordance with the partner's liquidation value 
percentage in a particular taxable year, the determination date is the 
last day of the partner's taxable year, or, if the partner's section 
987 QBU owned indirectly through a section 987 aggregate partnership 
terminates during the partner's taxable year, the date such section 987 
QBU is terminated. Without this requirement to redetermine liquidation 
value percentages at year-end when such an allocation is in effect, the 
allocation could result in section 987 taxable income or loss, which 
necessarily would reflect the allocation, being taken into account in 
determining section 987 gain or loss under Sec.  1.987-4 even though 
the allocation was not taken into account in computing the owner 
functional currency value of the section 987 QBU, such that distortions 
would arise in the computation of section 987 gain or loss.
    The Treasury Department and the IRS have determined that the 
liquidation value percentage methodology reflected

[[Page 88867]]

in Sec.  1.987-7T(b) reflects an administrable approach to allocating 
assets and liabilities of a section 987 aggregate partnership to 
eligible QBUs of its partners in a manner consistent with the partners' 
economic interests in the assets and liabilities of the partnership. 
The Treasury Department and the IRS request comments on the application 
of the liquidation value percentage approach reflected in the temporary 
regulations, including whether any alternative measure could better 
satisfy the criteria of administrability and consistency with the 
economics of the partners' arrangement.

9. Deferral of Certain Section 988 Loss Realized by a Debtor With 
Respect to a Related-Party Loan

    Section 267(a)(1) provides that no deduction is allowed in respect 
of any loss from the sale or exchange of property, directly or 
indirectly, between persons who have a relationship described in 
section 267(b). Section 267(f)(2) modifies the general rule of section 
267(a)(1) in the case of a sale or exchange of property between 
corporations that are members of the same controlled group (as defined 
in section 267(f)(1)), generally providing that a loss realized upon 
such a sale or exchange is deferred until the property is transferred 
outside the group such that there would be recognition of loss under 
consolidated return principles. Section 267(f)(3)(C) provides that, to 
the extent provided in regulations, section 267(a)(1) does not apply to 
any loss sustained by a member of a controlled group on the repayment 
of a loan made to another member of such controlled group if such loan 
is payable or denominated in a foreign currency and attributable to a 
reduction in the value of that foreign currency. Section 1.267(f)-1(e) 
provides that section 267(a) generally does not apply to an exchange 
loss realized with respect to a loan of nonfunctional currency to 
another controlled group member if the transaction that causes the 
realization of the loss does not have as a significant purpose the 
avoidance of Federal income tax. Additionally, Sec.  1.267(f)-1(h) 
provides that if a transaction is engaged in with a principal purpose 
to avoid the purposes of Sec.  1.267(f)-1, including by distorting the 
timing of losses, adjustments may be made to carry out such purposes. 
Section 1.988-2(b)(16)(i) cross-references the regulations under 
section 267 regarding the coordination of sections 267 and 988 with 
respect to the treatment of a creditor under a debt instrument, but 
Sec.  1.988-2(b)(16)(ii) is reserved with respect to the treatment of a 
debtor. The temporary regulations correct the cross-reference in Sec.  
1.988-2(b)(16)(i) to refer to Sec.  1.267(f)-1(e) rather than Sec.  
1.267(f)-1(h).
    The Treasury Department and the IRS have determined that the policy 
considerations underlying section 267(f)(3)(C) and Sec.  1.267(f)-1(e) 
with respect to creditors on loans to related persons also apply with 
respect to debtors on such loans and that there is no reason to 
distinguish between a creditor and debtor with regard to the 
application of an anti-avoidance rule to the same transaction. 
Accordingly, pursuant to the authority granted to the Secretary in 
section 989(c)(5) to prescribe regulations providing for the 
appropriate treatment of related-party transactions, Sec.  1.988-
2T(b)(16)(ii) provides that exchange loss of a debtor with respect to a 
loan (original loan) from a person with whom the debtor has a 
relationship described in section 267(b) or section 707(b) is deferred 
if the transaction resulting in realization of the loss has a principal 
purpose of avoiding Federal income tax. Such deferred loss will be 
recognized at the end of the term of the original loan.

Special Analyses

    Certain IRS regulations, including these, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory assessment is not 
required. For applicability of the Regulatory Flexibility Act (5 U.S.C. 
chapter 6), please refer to the Special Analyses section in the 
preamble to the cross-referenced notice of proposed rulemaking in the 
Proposed Rules section of this issue of the Federal Register. Pursuant 
to section 7805(f) of the Internal Revenue Code, these regulations have 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Mark E. Erwin of the 
Office of Associate Chief Counsel (International). However, other 
personnel from the IRS and the Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendment to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 985, 987, 989(c) and 7805 * * *

0
Par. 2. Section 1.987-0 is amended by adding entries for Sec. Sec.  
1.987-6(b)(4) and 1.987-12(a) through (h) to read as follows:


Sec.  1.987-0  Section 987; table of contents.

* * * * *


Sec.  1.987-6   Character and source of section 987 gain or loss.

* * * * *
    (b) * * *
    (4) [Reserved].
* * * * *


Sec.  1.987-12   Deferral of section 987 gain or loss.

    (a) through (h) [Reserved].

0
Par. 3. Section 1.987-1 is amended by adding paragraphs (b)(1)(iii), 
(b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(B) and (C), 
and (g)(3)(i)(E) through (H) to read as follows:


Sec.  1.987-1   Scope, definitions, and special rules.

* * * * *
    (b) * * *
    (1) * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.987-
1T(b)(1)(iii).
* * * * *
    (b) * * *
    (6) [Reserved]. For further guidance, see Sec.  1.987-1T(b)(6).
* * * * *
    (c) * * *
    (1) * * *
    (ii) * * *
    (B) [Reserved]. For further guidance, see Sec.  1.987-
1T(c)(1)(ii)(B).
* * * * *
    (c) * * *
    (3) * * *
    (i) * * *
    (E) [Reserved]. For further guidance, see Sec.  1.987-
1T(c)(3)(i)(E).
* * * * *
    (d) * * *
    (3) [Reserved]. For further guidance, see Sec.  1.987-1T(d)(3).
* * * * *
    (f) [Reserved]. For further guidance, see Sec.  1.987-1T(f).
* * * * *
    (g) * * *
    (2) * * *
    (i) * * *
    (B) through (C) [Reserved]. For further guidance, see Sec.  1.987-
1T(g)(2)(i)(B) through (C).
* * * * *

[[Page 88868]]

    (g) * * *
    (3) * * *
    (i) * * *
    (E) through (H) [Reserved]. For further guidance, see Sec.  1.987-
1T(g)(3)(i)(E) through (H).
* * * * *

0
Par. 4. Section 1.987-1T is added to read as follows:


Sec.  1.987-1T   Scope, definitions, and special rules (temporary).

    (a) through (b)(1)(ii) [Reserved]. For further guidance, see Sec.  
1.987-1(a) through (b)(1)(ii).
    (iii) Certain provisions applicable to all taxpayers. 
Notwithstanding Sec.  1.987-1(b)(1)(ii), paragraphs (b)(6) and 
(g)(3)(i)(E) of this section and Sec.  1.987-6T(b)(4) apply to any 
taxpayer that is an owner of a dollar QBU (as defined in paragraph 
(b)(6) of this section), and paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) 
of this section and Sec. Sec.  1.987-8T(d) and 1.987-12T apply to any 
taxpayer that is an owner of an eligible QBU (determined without regard 
to Sec.  1.987-1(b)(3)(ii)) that is subject to section 987.
    (b)(2) through (b)(5) [Reserved]. For further guidance, see Sec.  
1.987-1(b)(2) through (b)(5).
    (6) Dollar QBUs--(i) In general. Except as provided in paragraphs 
(b)(1)(iii) and (b)(6)(iii) of this section, section 987 and the 
regulations thereunder do not apply with respect to an eligible QBU 
(determined without regard to Sec.  1.987-1(b)(3)(ii)) that has the 
U.S. dollar as its functional currency and that would be subject to 
section 987 if it had a functional currency other than the dollar 
(dollar QBU). This paragraph (b)(6) applies to all taxpayers, including 
entities described in Sec.  1.987-1(b)(1)(ii).
    (ii) Application of section 988 to a dollar QBU--(A) In general. 
Except as provided in paragraphs (b)(6)(ii)(B) and (b)(6)(iii) of this 
section, a controlled foreign corporation (as defined in section 
957(a)) (CFC) that is the owner of a dollar QBU applies section 988 
with respect to any item that is properly reflected on the books and 
records of the dollar QBU and that would give rise to a section 988 
transaction if such item were acquired, accrued, or entered into 
directly by the owner of the dollar QBU. Except as provided in 
paragraph (b)(6)(ii)(B) of this section, for purposes of determining 
the amount of section 988 gain or loss of the CFC, any item that is 
properly reflected on the books and records of the dollar QBU and that 
would give rise to a section 988 transaction if such item were 
acquired, accrued, or entered into directly by the owner of the dollar 
QBU is treated as properly reflected on the books and records of the 
owner of the dollar QBU, such that the amount of section 988 gain or 
loss with respect to such item is determined by reference to the 
owner's functional currency.
    (B) Section 988 gain or loss characterized as effectively connected 
income. Solely for the purpose of determining the amount of section 988 
gain or loss of a CFC described in paragraph (b)(6)(ii)(A) of this 
section that is effectively connected with the conduct of a trade or 
business within the United States (ECI), any section 988 gain or loss 
that would be determined under section 988 as a result of the 
acquisition or accrual of any item and treated as ECI under Sec.  
1.988-4(c) if the item were treated as properly reflected on the books 
and records of the dollar QBU is determined by treating such item as 
properly reflected on the books and records of the dollar QBU. 
Consequently, solely for that purpose, such section 988 gain or loss is 
determined by reference to the U.S. dollar.
    (iii) Election for a CFC to apply section 987 to a dollar QBU--(A) 
In general. A CFC that is the owner of a dollar QBU may elect to apply 
section 987 and the regulations thereunder with respect to the dollar 
QBU in lieu of applying section 988 pursuant to paragraph (b)(6)(ii) of 
this section. If the dollar QBU or CFC is described in Sec.  1.987-
1(b)(1)(ii), however, the CFC must apply section 987 to the dollar QBU 
using the method it applied to the dollar QBU immediately prior to the 
effective date of this paragraph (b)(6) as provided in paragraph (h) of 
this section, provided such method was a reasonable interpretation of 
section 987, or, if no such method exists, a reasonable method.
    (B) Section 988 gain or loss characterized as effectively connected 
income. Solely for the purpose of determining the amount of section 988 
gain or loss of a dollar QBU that is the subject of an election 
described in paragraph (b)(6)(iii)(A) of this section that is ECI, 
Sec.  1.987-3T(b)(4)(i) and (ii) do not apply, and any section 988 gain 
or loss that would be determined under section 988 as a result of the 
acquisition or accrual of any item and treated as ECI under Sec.  
1.988-4(c) if the item were treated as properly reflected on the books 
and records of the dollar QBU is determined by treating such item as 
properly reflected on the books and records of the dollar QBU. 
Consequently, solely for that purpose, such section 988 gain or loss is 
determined by reference to the U.S. dollar. See Sec.  1.987-6T(b)(4) 
for rules regarding the source of section 987 gain or loss with respect 
to a dollar QBU for which the CFC owner has made the election described 
in this paragraph.
    (b)(7) through (c)(1)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.987-1(b)(7) through (c)(1)(ii)(A).
    (B) Election inapplicable with respect to certain amounts. Except 
as provided in this paragraph (c)(1)(ii)(B), the election provided in 
Sec.  1.987-1(c)(1)(ii)(A) does not apply for purposes of determining 
section 987 taxable income or loss (as defined in Sec.  1.987-3(a)) 
with respect to a historic item (as defined in Sec.  1.987-1(e)) if 
acquiring, accruing, or entering into such item gives rise to a section 
988 transaction or specified owner functional currency transaction. 
However, the election provided in Sec.  1.987-1(c)(1)(ii)(A) does apply 
for purposes of determining section 987 taxable income or loss with 
respect to a payable or receivable described in Sec.  1.988-1(d)(3) 
under the circumstances described in Sec.  1.988-1(d)(3).
    (c)(2) through (c)(3)(i)(D) [Reserved]. For further guidance, see 
Sec.  1.987-1(c)(2) through (c)(3)(i)(D).
    (E) Section 988 transactions and specified owner functional 
currency transactions. If acquiring, accruing, or entering into a 
historic item gives rise to a section 988 transaction of a section 987 
QBU or a specified owner functional currency transaction described in 
Sec.  1.987-3T(b)(4)(ii), the historic rate is the spot rate (as 
defined in paragraph (c)(1) of this section) on the date such item is 
acquired, accrued, or entered into. For this purpose, use of a spot 
rate convention under Sec.  1.987-1(c)(1)(ii) is permitted only with 
respect to a payable or receivable described in Sec.  1.988-1(d)(3) and 
only to the extent provided therein.
    (c)(3)(ii) through (d)(2) [Reserved]. For further guidance, see 
Sec.  1.987-1(c)(3)(ii) through (d)(2).
    (3) Gives rise to a qualified short-term section 988 transaction 
(as defined in Sec.  1.987-3T(b)(4)(iii)(B)) of the section 987 QBU, 
whether denominated in the functional currency of the owner or other 
nonfunctional currency with respect to the section 987 QBU, for which 
section 988 gain or loss is determined under Sec.  1.987-
3T(b)(4)(iii)(A) in, and by reference to, the functional currency of 
the section 987 QBU.
    (e) [Reserved]. For further guidance, see Sec.  1.987-1(e).
    (f) Examples. The following examples illustrate the application of 
Sec.  1.987-1(d) and (e).

    Example 1. U.S. Corp is a domestic corporation with the U.S. 
dollar as its

[[Page 88869]]

functional currency and is the owner of Business A, a section 987 
QBU that has the pound as its functional currency. Assume all 
transactions of Business A are entered into in the ordinary course 
of its business. U.S. Corp has not made an election under Sec.  
1.987-3T(b)(4)(iii)(C) to adopt a foreign currency mark-to-market 
method of accounting for qualified short-term section 988 
transactions. Items reflected on Business A's balance sheet include 
[pound]10,000, $1,000, a building with a basis of [pound]100,000, a 
light general purpose truck with a basis of [pound]30,000, a 
computer with a basis of [pound]1,000, a 60-day receivable for 
[yen]15,000, an account payable of [pound]5,000, and a foreign 
currency contract within the meaning of section 1256(g)(2) that 
requires Business A to exchange [pound]100 for $125 in 90 days. 
Under paragraph (d) of this section, the [pound]10,000, the 
[pound]5,000 account payable and the [pound]/$ section 1256 foreign 
currency contract are marked items. The other items are historic 
items under this paragraph (e) of this section.
    Example 2. The facts are the same as Example 1 except that U.S. 
Corp has elected under Sec.  1.987-3T(b)(4)(iii)(C) to adopt the 
foreign currency mark-to-market method of accounting for qualified 
short-term section 988 transactions of Business A. Under paragraphs 
(d) and (e) of this section, the [pound]10,000, the $1,000, the 
[yen]15,000 receivable, the [pound]5,000 account payable, and the 
[pound]/$ section 1256 foreign currency contract are marked items.

    (g)(1) through (g)(2)(i)(A) [Reserved]. For further guidance, see 
Sec.  1.987-1(g)(1) through (g)(2)(i)(A).
    (B) Annual deemed termination election--(1) In general. Except as 
provided in paragraph (g)(2)(i)(B)(2) of this section, an election 
under Sec.  1.987-8T(d) (annual deemed termination election) applies to 
all section 987 QBUs owned by the taxpayer, as well as to all section 
987 QBUs owned by any person that has a relationship to the taxpayer 
described in section 267(b) or section 707(b) (substituting ``and the 
profits interest'' for ``or the profits interest'' in section 
707(b)(1)(A) and substituting ``and profits interests'' for ``or 
profits interests'' in section 707(b)(1)(B)) on the last day of the 
first taxable year for which the election applies (a related person). 
If a taxpayer makes the election under Sec.  1.987-8T(d), the first 
taxable year of a related person for which the election applies is the 
first taxable year that ends with or within a taxable year of the 
taxpayer for which the taxpayer's election applies. An election under 
Sec.  1.987-8T(d) may not be revoked.
    (i) Fresh start taxpayers. A taxpayer to which Sec.  1.987-10 
applies that is required under Sec.  1.987-10(a) to apply the fresh 
start transition method described in Sec.  1.987-10(b) (fresh start 
taxpayer) may make the election under Sec.  1.987-8T(d) only if the 
first taxable year for which the election would apply to the taxpayer 
is either the first taxable year beginning on or after the transition 
date (as defined in Sec.  1.987-11(c)) in which the election is 
relevant or a subsequent taxable year in which the taxpayer's 
controlled group aggregate section 987 loss, if any, does not exceed $5 
million. For purposes of this paragraph (g)(2)(i)(B), a taxpayer's 
controlled group aggregate section 987 loss means the aggregate net 
amount of section 987 loss that would be recognized pursuant to the 
election by the taxpayer and all other persons to whom the taxpayer's 
election would apply in the first taxable year of each person for which 
the election would apply.
    (ii) Other taxpayers. Other taxpayers, including taxpayers 
described in Sec.  1.987-1(b)(1)(ii) and taxpayers described in Sec.  
1.987-10(c), must follow the election rules provided in paragraph 
(g)(2)(i)(B)(1)(i) of this section if any related party is a fresh 
start taxpayer. If no related party is a fresh start taxpayer, the 
election under Sec.  1.987-8T(d) may be made only if the first taxable 
year for which the election would apply to the taxpayer is either the 
first taxable year beginning on or after December 7, 2016, in which the 
election is relevant or a subsequent taxable year in which the 
taxpayer's controlled group aggregate section 987 loss, if any, does 
not exceed $5 million.
    (2) QBU-by-QBU elections in certain circumstances. Notwithstanding 
paragraph (g)(2)(i)(B)(1) of this section, a taxpayer may make a 
separate election under Sec.  1.987-8T(d) with respect to any section 
987 QBU owned by the taxpayer if the first taxable year for which the 
election would apply to the taxpayer with respect to the section 987 
QBU is a taxable year in which there is a section 987 gain recognized 
with respect to the section 987 QBU pursuant to the election, or is a 
taxable year in which there is a section 987 loss of $1 million or less 
that would be recognized with respect to the section 987 QBU pursuant 
to the election
    (C) Election to translate all items at the yearly average exchange 
rate. An election under Sec.  1.987-3T(d) (election to translate all 
items at the yearly average exchange rate) may be made with respect to 
a section 987 QBU only if the first taxable year for which the election 
would apply is the first taxable year for which an election under Sec.  
1.987-8T(d) (annual deemed termination election) applies with respect 
to the section 987 QBU.
    (g)(2)(ii) through (g)(3)(i)(D) [Reserved]. For further guidance, 
see Sec.  1.987-1(g)(2)(ii) through (g)(3)(i)(D).
    (E) Election for a CFC to apply section 987 to a dollar QBU. An 
election under Sec.  1.987-1T(b)(6)(iii) for a CFC to apply section 987 
to a dollar QBU must be titled ``Section 987 Election for a CFC to 
Apply Section 987 to a Dollar QBU Under Sec.  1.987-1T(b)(6)(iii)'' and 
must provide the name and address of each QBU for which the election is 
being made.
    (F) Election to apply the foreign currency mark-to-market method of 
accounting for qualified short-term section 988 transactions. An 
election under Sec.  1.987-3T(b)(4)(iii)(C) to apply the foreign 
currency mark-to-market method of accounting for qualified short-term 
section 988 transactions must be titled ``Section 987 Election to Use 
Foreign Currency Mark-to-Market Method of Accounting for Qualified 
Short-Term Section 988 Transactions Under Sec.  1.987-
3(b)T(4)(iii)(C)'' and must provide the name and address of each 
section 987 QBU for which the election is being made.
    (G) Election to translate all items at the yearly average exchange 
rate. An election under Sec.  1.987-3T(d) to translate all items at the 
yearly average exchange rate must be titled ``Section 987 Election to 
Translate All Items at the Yearly Average Exchange Rate Under Sec.  
1.987-3T(d)'' and must provide the name and address of each section 987 
QBU for which the election is being made.
    (H) Annual deemed termination election. An election under Sec.  
1.987-8T(d) for an owner to deem all of its section 987 QBUs to 
terminate on the last day of each taxable year must be titled ``Section 
987 Annual Deemed Termination Election Under Sec.  1.987-8T(d)'' and 
must provide the name and address of each section 987 QBU to which the 
election applies, including a section 987 QBU owned by a related person 
(within the meaning of paragraph (g)(2)(i)(B)(1) of this section).
    (g)(4) through (6) [Reserved]. For further guidance, see Sec.  
1.987-1(g)(4) through (6).
    (h) Effective/applicability date. Paragraphs (g)(2)(i)(B) and 
(g)(3)(i)(H) of this section apply to the first taxable year beginning 
on or after December 7, 2016. Paragraphs (b)(1)(iii), (b)(6), 
(c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and 
(g)(3)(i)(E) through (G) of this section apply to taxable years 
beginning 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 Sec.  1.987-11(b), then paragraphs 
(b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), 
(g)(2)(i)(C), and (g)(3)(i)(E) through (G) of this section apply to 
taxable years to which Sec. Sec.  1.987-1 through 1.987-10 apply as a 
result of such election.

[[Page 88870]]

    (i) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 5. Section 1.987-2 is amended by adding paragraph (c)(9) to read 
as follows:


Sec.  1.987-2   Attribution of items to eligible QBUs; definition of a 
transfer and related rules.

* * * * *
    (c) * * *
    (9) [Reserved]. For further guidance, see Sec.  1.987-2T(c)(9).
* * * * *

0
Par. 6. Section 1.987-2T is added to read as follows:


Sec.  1.987-2T  Attribution of items to eligible QBUs; definition of a 
transfer and related rules (temporary).

    (a) through (c)(8) [Reserved]. For further guidance, see Sec.  
1.987-2(a) through (c)(8).
    (9) Certain disregarded transactions not treated as transfers--(i) 
Combinations of section 987 QBUs. The combination of two or more 
separate section 987 QBUs (combining QBUs) that are directly owned by 
the same owner, or that are indirectly owned by the same partner 
through a single section 987 aggregate partnership, into one section 
987 QBU (combined QBU) does not give rise to a transfer of any 
combining QBU's assets or liabilities to the owner under Sec.  1.987-
2(c). In addition, transactions between the combining QBUs occurring in 
the taxable year of the combination do not result in a transfer of the 
combining QBUs' assets or liabilities to the owner under Sec.  1.987-
2(c). For this purpose, a combination occurs when the assets and 
liabilities that are properly reflected on the books and records of two 
or more combining QBUs begin to be properly reflected on the books and 
records of a combined QBU and the separate existence of the combining 
QBUs ceases. A combination may result from any transaction or series of 
transactions in which the combining QBUs become a combined QBU. For 
rules regarding the determination of net unrecognized section 987 gain 
or loss of a combined QBU, see Sec.  1.987-4T(f)(1).
    (ii) Change in functional currency from a combination. If, 
following a combination of section 987 QBUs described in paragraph 
(c)(9)(i) of this section, the combined section 987 QBU has a different 
functional currency than one or more of the combining section 987 QBUs, 
any such combining section 987 QBU is treated as changing its 
functional currency and the owner of the combined section 987 QBU must 
comply with the regulations under section 985 regarding the change in 
functional currency. See Sec. Sec.  1.985-1(c)(6) and 1.985-5.
    (iii) Separation of section 987 QBUs. The separation of a section 
987 QBU (separating QBU) into two or more section 987 QBUs (separated 
QBUs) that, after the separation, are directly owned by the same owner, 
or that are indirectly owned by the same partner through a single 
section 987 aggregate partnership, does not give rise to a transfer of 
the separating QBU's assets or liabilities to the owner under Sec.  
1.987-2(c). Additionally, transactions that occurred between the 
separating QBUs in the taxable year of the separation prior to the 
completion of the separation do not give rise to transfers for purposes 
of section 987. For this purpose, a separation occurs when the assets 
and liabilities that are properly reflected on the books and records of 
a separating QBU begin to be properly reflected on the books and 
records of two or more separated QBUs. A separation may result from any 
transaction or series of transactions in which a separating QBU becomes 
two or more separated QBUs. A separation may also result when a section 
987 QBU that is subject to a grouping election under Sec.  1.987-
1(b)(2)(ii)(A) changes its functional currency. For rules regarding the 
determination of net unrecognized section 987 gain or loss of a 
separated QBU, see Sec.  1.987-4T(f)(2).
    (c)(10) through (d) [Reserved]. For further guidance see Sec.  
1.987-2(c)(10) through (d).
    (e) 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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (f) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 7. Section 1.987-3 is amended by adding paragraphs (b)(2)(ii), 
(b)(4), (c)(2)(ii) and (v), and (d), and Example 9 through Example 14 
at the end of paragraph (e) to read as follows:


Sec.  1.987-3   Determination of section 987 taxable income or loss of 
an owner of a section 987 QBU.

* * * * *
    (b) * * *
    (2) * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.987-
3T(b)(2)(ii).
* * * * *
    (b) * * *
    (4) [Reserved]. For further guidance, see Sec.  1.987-3T(b)(4).
* * * * *
    (c) * * *
    (2) * * *
    (ii) [Reserved]. For further guidance, see Sec.  1.987-
3T(c)(2)(ii).
* * * * *
    (c) * * *
    (2) * * *
    (v) through (d) [Reserved]. For further guidance, see Sec.  1.987-
3T(c)(2)(v) through (d).
    (e) Examples. * * *
    Example 9 through Example 14 [Reserved]. For further guidance, see 
Sec.  1.987-3T(e), Example 9 through Example 14.

0
Par. 8. Section 1.987-3T is added to read as follows:


Sec.  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 Sec.  
1.987-3(a) through (b)(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 paragraph (b)(4)(ii) 
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 Sec.  1.987-3(b)(3).
    (4) Special rule for section 988 transactions--(i) In general. 
Section 988 and the regulations thereunder apply to section 988 
transactions of a section 987 QBU. For this purpose, whether a 
transaction is a section 988 transaction is determined by reference to 
the functional currency of the section 987 QBU. (But see paragraph 
(b)(4)(ii) of this section, providing that specified owner functional 
currency transactions are not treated as section 988 transactions.) 
However, except as provided in paragraph (b)(4)(iii)(A) of this 
section, section 988 gain or loss is determined in, and by reference 
to, the functional currency of the owner of the section 987 QBU rather 
than the functional currency of the section 987 QBU. Accordingly, in 
determining section 988 gain or loss of a section 987 QBU with respect 
to a section 988 transaction of the section 987 QBU, the amounts 
required under section 988 and the regulations thereunder to be 
translated on the

[[Page 88871]]

applicable booking date or payment date with respect to the section 988 
transaction are translated into the owner's functional currency at the 
rate required under section 988 and the regulations thereunder.
    (ii) Specified owner functional currency transactions not treated 
as section 988 transactions. Transactions of a section 987 QBU 
described in sections 988(c)(1)(B)(i), 988(c)(1)(B)(ii), and 
988(c)(1)(C) (including the acquisition of nonfunctional currency as 
described in Sec.  1.988-1(a)(1)), other than transactions described in 
paragraph (b)(4)(iii)(A) 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 988 
transactions. Thus, no currency gain or loss is recognized by a section 
987 QBU under section 988 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 988 gain or 
loss with respect to section 988 transactions described in paragraph 
(b)(4)(iii)(B) 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 
paragraph (b)(4)(iii)(C) of this section, and any hedges entered into 
to manage risk with respect to such transactions within the meaning of 
Sec.  1.1221-2(c)(4) (related hedges), must be determined in, and by 
reference to, the functional currency of the section 987 QBU (rather 
than the functional currency of its owner).
    (B) Qualified short-term section 988 transaction. A qualified 
short-term section 988 transaction is a section 988 transaction that 
occurs in the ordinary course of a section 987 QBU's business and has 
an original term of one year or less on the date the transaction is 
entered into by the section 987 QBU. The holding of currency that is 
nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) 
to the section 987 QBU in the ordinary course of a section 987 QBU's 
trade or business also is treated as a qualified short-term section 988 
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 988 transaction. See Sec. Sec.  1.988-2(b)(15), 1.988-2(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 paragraph (b)(4)(iii)(C) to 
apply the foreign currency mark-to-market method of accounting 
described in this paragraph for all qualified short-term section 988 
transactions described in paragraph (b)(4)(iii)(B) of this section, and 
any related hedges, that are properly attributable to a section 987 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 475 or section 1256. Under the foreign currency mark-to-
market method of accounting, the timing of section 988 gain or loss on 
section 988 transactions is determined under the principles of section 
1256(a)(1). Thus, only section 988 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 988 gain or 
loss from being taken into account again under section 988 or another 
provision of the Code or regulations. A section 988 transaction subject 
to this election is not subject to the ``netting rule'' of section 
988(b) and Sec.  1.988-2(b)(8), 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 988 gain or loss would 
be recognized with respect to such section 988 transaction but for this 
election.
    (iv) Examples. Examples 10 through 13 of paragraph (e) of this 
section illustrate the application of this paragraph (b)(4).
    (c)(1) through (c)(2)(i) [Reserved]. For further guidance, see 
Sec.  1.987-3(c)(1) through (c)(2)(i).
    (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 988 transaction described in paragraph (b)(4)(i) 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 988 gain or loss described in section 988(b) and paragraph 
(b)(4)(i) of this section), the amount realized (determined, if 
necessary, under Sec.  1.987-3(b)(2)(i)) 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 Sec.  
1.987-1T(c)(1)(ii)(B) regarding the use of a spot rate convention.
    (iii) through (iv) [Reserved]. For further guidance, see Sec.  
1.987-3(c)(2)(iii) through (iv).
    (v) Translation of income to account for certain foreign income tax 
claimed as a credit. The owner of a section 987 QBU claiming a credit 
under section 901 for foreign income taxes, other than foreign income 
taxes deemed paid under section 902 or section 960, that are properly 
reflected on the books and records of the section 987 QBU (the 
creditable tax amount) must determine section 987 taxable income or 
loss attributable to the section 987 QBU by reducing the amount of 
section 987 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 986(a). 
See Example 14 of paragraph (e) of this section,, for an illustration 
of this rule.
    (d) Election to translate all items at the yearly average exchange 
rate. Notwithstanding Sec.  1.987-3(c), a taxpayer that has made the 
annual deemed termination election described in Sec.  1.987-8T(d) may 
elect under this paragraph (d) to translate all items of income, gain, 
deduction, and loss with respect to a section 987 QBU determined under 
Sec.  1.987-3(b) in the functional currency of the section 987 QBU into 
the owner's functional currency, if necessary, at the yearly average 
exchange rate for the taxable year. Example 9 of paragraph (e) of this 
section illustrates the application of this election.
    (e) Example 1 through Example 8 [Reserved]. For further guidance, 
see Sec.  1.987-3(e), Example 1 through Example 8.

    Example 9. The facts are the same as in Example 7, except that 
U.S. Corp properly elects under paragraph (d) 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 [euro]2,000 gain on the sale of the land 
is translated at the yearly average exchange rate for 2021 of 
[euro]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 [pound]100 on August 27, 2021, 
for [euro]120 and sells the pounds on November 17, 2021, for 
[euro]125. The dollar-pound spot rate (without the use of a spot 
rate convention) is [pound]1 = $1 on August

[[Page 88872]]

27, 2021, and [pound]1 = $1.10 on November 17, 2021. The disposition 
of the pounds is a section 988 transaction of Business A under 
paragraph (b)(4)(i) of this section, and the pounds are a historic 
asset under Sec.  1.987-1(e). Section 988 gain or loss with respect 
to the disposition of the pounds is determined under paragraph 
(b)(4)(i) of this section and Sec.  1.988-2(a)(2) by reference to 
the dollar functional currency of Business A's owner. The dollar 
amount realized for the pounds is determined under paragraph 
(c)(2)(ii) of this section by translating [pound]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 Sec.  1.987-3(c)(2)(i) by translating [pound]100 into $100 
using the historic rate described in Sec.  1.987-1T(c)(3)(i)(E), 
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 988 gain with respect to Business A's disposition of 
[pound]100.
    Example 11. (i) Business A purchases a [pound]100 2-year note 
for [euro]75 on October 1, 2021, and receives a [pound]100 repayment 
of principal with respect to the note on December 31, 2021. At the 
spot rates on October 1, 2021 (as defined in Sec.  1.987-1(c)(1)), 
without the use of a spot rate convention, Business A's [euro]75 
purchase price translates into [pound]80 and $95. At the spot rates 
on December 31, 2021, without the use of a spot rate convention, the 
[pound]100 principal amount on the note translates into [euro]90 and 
$130, and [pound]80 translates into $104.
    (ii) The acquisition of the note is a section 988 transaction of 
Business A under paragraph (b)(4)(i) of this section, and the note 
is a historic asset under Sec.  1.987-1(e). To determine its section 
987 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 
Sec.  1.988-2(b)(8), U.S. Corp also must determine whether some or 
all of that gain or loss constitutes section 987 gain or loss 
described in section 988(b).
    (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 Sec.  1.987-3(b), if 
necessary, and translated into dollars under Sec.  1.987-3(c). 
Business A has a [euro]75 basis in the note that is translated into 
$95 under Sec.  1.987-3(c)(2)(i) at the historic rate described in 
Sec.  1.987-1T(c)(3)(i)(E), which is the spot rate on the date the 
note was acquired without the use of a spot rate convention. 
Business A's [pound]100 amount realized on the note is translated 
into [euro]90 under Sec.  1.987-3(b)(2)(i) using the spot rate on 
December 31, 2021, without the use of a spot rate convention. That 
[euro]90 amount realized is then translated into $130 under 
paragraph (c)(2)(ii) 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 987 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 988 gain. 
The amount of section 988 gain realized with respect to the note is 
determined under Sec.  1.988-2(b)(5), 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 [pound]80. Under 
paragraph (b)(4)(i) of this section, section 988 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 
988 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 [pound]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 987 taxable income with respect to the note is 
section 988 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 
988.
    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 paragraph (b)(4)(ii) of this section, the 
acquisition of the [pound]100 2-year note is a specified owner 
functional currency transaction that is not treated as a section 988 
transaction of Business A. Because the note is a historic asset 
under Sec.  1.987-1(e), Business A's [euro]75 basis in the note 
translates into [pound]80 at the historic rate described in Sec.  
1.987-1T(c)(3)(i)(E), 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 [pound]80 rather than [euro]75, then pursuant to 
paragraph (b)(2)(ii) of this section, Business A's basis in the note 
would have been determined without translating the [pound]80 
purchase price because it is denominated in the owner's functional 
currency.) Under paragraph (b)(2)(ii) of this section, the 
[pound]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 [pound]20 ([pound]100 
less [pound]80) of section 987 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 
paragraph (b)(4)(iii)(C) of this section to use the foreign currency 
mark-to-market method of accounting for qualified short-term section 
988 transactions entered into by Business A. The euro-dollar spot 
rate without the use of a spot rate convention is [euro]1 = $1 on 
January 1, 2021, and [euro]1 = $2 on December 31, 2021, and the 
yearly average exchange rate for 2021 is [euro]1 = $1.50.
    (ii) Under Sec.  1.987-3(b)(2)(i), the $100 earned by Business A 
is translated into [euro]100 at the spot rate on January 1, 2021, as 
defined in Sec.  1.987-1(c)(1) without the use of a spot rate 
convention. In determining U.S. Corp's taxable income, the [euro]100 
of service income is translated into $150 at the yearly average 
exchange rate for 2021, as provided in Sec.  1.987-3(c)(1).
    (iii) The $100 demand deposit constitutes a qualified short-term 
section 988 transaction under paragraph (b)(4)(iii)(B) of this 
section because the demand deposit is treated as nonfunctional 
currency within the meaning of section 988(c)(1)(C)(ii). Because 
Business A uses the foreign currency mark-to-market method of 
accounting for qualified short-term section 988 transactions, under 
paragraph (b)(4)(iii)(A) of this section, section 988 gain or loss 
for such transactions is determined in, and by reference to, euros, 
the functional currency of Business A. Accordingly, section 988 gain 
or loss must be determined on Business A's holding of the $100 
demand deposit in, and by reference to, the euro. Under Sec.  1.988-
2(a)(2), Business A is treated as having an amount realized of 
[euro]50 when the $100 is marked to market at the end of 2021 under 
paragraph (b)(4)(iii)(C) of this section. Marking the dollars to 
market gives rise to a section 988 loss of [euro]50 ([euro]50 amount 
realized, less Business A's [euro]100 basis in the $100). In 
determining U.S. Corp's taxable income, that [euro]50 loss is 
translated into a $75 loss at the yearly average exchange rate for 
2021, as provided in Sec.  1.987-3(c)(1).
    Example 14. (i) Facts. Business A earns [euro]100 of revenue 
from the provision of services and incurs [euro]30 of general 
expenses and [euro]10 of depreciation expense during 2021. Except as 
otherwise provided, U.S. Corp uses the yearly average exchange rate 
described in Sec.  1.987-1(c)(2) 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 986(a)(1)(D) 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 [euro]1 = $1.50. The historic rate used to 
translate the depreciation expense is [euro]1 = $1.00. The spot rate 
on the date that Business A paid its foreign income taxes was 
[euro]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 paragraph (c)(2)(v) of this 
section. Accordingly, U.S. Corp determines its section 987 taxable 
income by reducing the section 987 taxable income or loss that 
otherwise would be determined under this section by [euro]15, 
translated into U.S. dollars at the yearly average exchange rate 
([euro]1 = $1.50), and increasing the resulting amount by [euro]15, 
translated using the same exchange rate that is used to translate 
the creditable taxes into U.S. dollars under section 986(a) ([euro]1 
= $1.60). Following these adjustments, Business A's section 987 
taxable income for 2021 is $96.50, computed as follows:

[[Page 88873]]



----------------------------------------------------------------------------------------------------------------
                                                                     Amount in      Translation
                                                                      [euro]           rate         Amount in $
----------------------------------------------------------------------------------------------------------------
Revenue.........................................................       [euro]100       [euro]1 =         $150.00
                                                                                           $1.50
General Expenses................................................            (30)       [euro]1 =         (45.00)
                                                                                           $1.50
Depreciation....................................................            (10)       [euro]1 =         (10.00)
                                                                                           $1.00
                                                                 -----------------------------------------------
Tentative section 987 taxable income............................        [euro]60  ..............          $95.00
Adjustments under paragraph (c)(2)(v) of this section:
    Decrease by [euro]15 tax translated at yearly average         ..............  ..............        ($22.50)
     exchange rate ([euro]1 = $1.50)............................
    Increase by [euro]15 tax translated at spot rate on payment   ..............  ..............           24.00
     date ([euro]1 = $1.60).....................................
                                                                 -----------------------------------------------
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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (g) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 9. Section 1.987-4 is amended by adding paragraphs (c)(2) and (f) 
to read as follows:


Sec.  1.987-4   Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU.

* * * * *
    (c) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.987-4T(c)(2).
* * * * *
    (f) [Reserved]. For further guidance, see Sec.  1.987-4T(f).
* * * * *

0
Par. 10. Section 1.987-4T is added to read as follows:


Sec.  1.987-4T   Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU (temporary).

    (a) through (c)(1) [Reserved]. For further guidance, see Sec.  
1.987-4(a) through (c)(1).
    (2) Coordination with Sec.  1.987-12T. For purposes of paragraph 
(c)(1) of this section, amounts taken into account under Sec.  1.987-5 
are determined without regard to Sec.  1.987-12T.
    (d) through (e) [Reserved]. For further guidance, see Sec.  1.987-
4(d) through (e).
    (f) Combinations and separations--(1) Combinations. The net 
unrecognized section 987 gain or loss of a combined QBU (as defined in 
Sec.  1.987-2T(c)(9)(i)) for a taxable year is determined under Sec.  
1.987-4(b) by taking into account the net accumulated unrecognized 
section 987 gain or loss of each combining QBU (as defined in Sec.  
1.987-2T(c)(9)(i)) for all prior taxable years to which the regulations 
under section 987 apply, as determined under Sec.  1.987-4(c), and by 
treating the combining QBUs as having combined immediately prior to the 
beginning of the taxable year of combination.
    (2) Separations. The net unrecognized section 987 gain or loss of a 
separated QBU (as defined in Sec.  1.987-2T(c)(9)(iii)) for a taxable 
year is determined under Sec.  1.987-4(b) by taking into account the 
separated QBU's share of the net accumulated unrecognized section 987 
gain or loss of the separating QBU (as defined in Sec.  1.987-
2T(c)(9)(iii)) for all prior taxable years to which the regulations 
under section 987 apply, as determined under Sec.  1.987-4(c), and by 
treating the separating QBU as having separated immediately prior to 
the beginning of the taxable year of separation. A separated QBU's 
share of the separating QBU's net accumulated unrecognized section 987 
gain or loss for all such prior taxable years is determined by 
apportioning the separating QBU's net accumulated unrecognized section 
987 gain or loss for all such prior taxable years to each separated QBU 
in proportion to the aggregate adjusted basis of the gross assets 
properly reflected on the books and records of each separated QBU 
immediately after the separation. For purposes of determining the owner 
functional currency net value of the separated QBUs on the last day of 
the taxable year preceding the taxable year of separation under Sec.  
1.987-5(d)(1)(B) and (e), the balance sheets of the separated QBUs on 
that day will be deemed to reflect the assets and liabilities reflected 
on the balance sheet of the separating QBU on that day, apportioned 
between the separated QBUs in a reasonable manner that takes into 
account the assets and liabilities reflected on the balance sheets of 
the separated QBUs immediately after the separation.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (f)(1) and (2) of this section.

    Example 1. Combination of two section 987 QBUs that have the 
same owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a 
DE. Entity A conducts a business in France that constitutes a 
section 987 QBU (French QBU) that has the euro as its functional 
currency. French QBU has a net accumulated unrecognized section 987 
loss from all prior taxable years to which the regulations under 
section 987 apply of $100. DC1 also owns Entity B, a DE. Entity B 
conducts a business in Germany that constitutes a section 987 QBU 
(German QBU) that has the euro as its functional currency. German 
QBU has a net accumulated unrecognized section 987 gain from all 
prior taxable years to which the regulations under section 987 apply 
of $110. During the taxable year, Entity A and Entity B merge under 
local law. As a result, the books and records of French QBU and 
German QBU are combined into a new single set of books and records. 
The combined entity has the euro as its functional currency.
    (ii) Analysis. Pursuant to Sec.  1.987-2T(c)(9)(i), French QBU 
and German 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 Sec.  1.987-5(c)). For 
purposes of computing net unrecognized section 987 gain or loss 
under Sec.  1.987-4 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 987 QBU at the end of that taxable year 
described under Sec.  1.987-4(d)(1)(B) takes into account items 
reflected on the balance sheets of both French QBU and German QBU at 
that time. Additionally, any transactions between French QBU and 
German QBU occurring during the year of the merger will not result 
in transfers to or from a section 987 QBU. Pursuant to paragraph 
(f)(1) of this section, the combined QBU will have a net accumulated 
unrecognized section 987 gain from all prior taxable years of $10 
(the $100 loss from French QBU plus the $110 gain from German QBU).
    Example 2. Separation of two section 987 QBUs that have the same 
owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a DE. 
Entity A conducts a business in the Netherlands that constitutes a 
section 987 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 [euro]1,000. In Year 2, the

[[Page 88874]]

net accumulated unrecognized section 987 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 
987 QBU under Sec.  1.987-1(b)(2) (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 [euro]600 and the aggregate 
adjusted basis of scooter QBU's assets is [euro]400. Each section 
987 QBU continues to have the euro as its functional currency.
    (ii) Analysis. Pursuant to Sec.  1.987-2T(c)(9)(iii), 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 (as defined in 
Sec.  1.987-5(c)). For purposes of computing net unrecognized 
section 987 gain or loss under Sec.  1.987-4 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 paragraph (f)(2) of 
this section, bicycle QBU will have a net accumulated unrecognized 
section 987 loss of $120 ([euro]600/[euro]1,000 x $200), and scooter 
QBU will have a net accumulated unrecognized section 987 loss of $80 
([euro]400/[euro]1,000 x $200).

    (g) [Reserved]. For further guidance, see Sec.  1.987-4(g).
    (h) 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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (i) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 11. Section 1.987-6 is amended by adding paragraph (b)(4) to read 
as follows:


Sec.  1.987-6   Character and source of section 987 gain or loss.

* * * * *
    (b) * * *
    (4) [Reserved]. For further guidance, see Sec.  1.987-6T(b)(4).
* * * * *

0
Par. 12. Section 1.987-6T is added to read as follows:


Sec.  1.987-6T   Character and source of section 987 gain or loss 
(temporary)

    (a) through (b)(3) [Reserved]. For further guidance, see Sec.  
1.987-6(a) through (b)(3).
    (4) Source of section 987 gain or loss with respect to a dollar 
QBU. The source of section 987 gain or loss with respect to a dollar 
QBU (as defined in Sec.  1.987-1T(b)(6)(i)) for which the CFC owner has 
elected under Sec.  1.987-1T(b)(6)(iii) to apply section 987 is 
determined by reference to the residence of the CFC owner. This 
paragraph (b)(4) applies to any CFC that has made the election under 
Sec.  1.987-1T(b)(6)(iii), including a CFC described in Sec.  1.987-
1(b)(1)(ii).
    (c) [Reserved]. For further guidance, see Sec.  1.987-6(c).
    (d) 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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (e) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 13. Section 1.987-7 is amended by adding paragraph (b) to read as 
follows:


Sec.  1.987-7   Section 987 aggregate partnerships.

* * * * *
    (b) [Reserved]. For further guidance, see Sec.  1.987-7T(b).
* * * * *

0
Par. 14. Section 1.987-7T is added to read as follows:


Sec.  1.987-7T   Section 987 aggregate partnerships (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.987-7(a).
    (b) Liquidation value percentage methodology--(1) In general. In 
any taxable year, a partner's share of each asset, including its basis 
in each asset, and the amount of each liability reflected under Sec.  
1.987-2(b) on the books and records of an eligible QBU owned indirectly 
through a section 987 aggregate partnership is proportional to the 
partner's liquidation value percentage with respect to the aggregate 
partnership for that taxable year, as determined under paragraph (b)(2) 
of this section.
    (2) Liquidation value percentage--(i) In general. For purposes of 
this paragraph (b), a partner's liquidation value percentage is the 
ratio (expressed as a percentage) of the liquidation value of the 
partner's interest in the partnership to the aggregate liquidation 
value of all of the partners' interests in the partnership. The 
liquidation value of a partner's interest in a partnership is the 
amount of cash the partner would receive with respect to the interest 
if, immediately following the applicable determination date, the 
partnership sold all of its assets for cash equal to the fair market 
value of such assets (taking into account section 7701(g)), satisfied 
all of its liabilities (other than those described in Sec.  1.752-7), 
paid an unrelated third party to assume all of its Sec.  1.752-7 
liabilities in a fully taxable transaction, and then liquidated.
    (ii) Determination date.--(A) In general. Except as provided in 
paragraph (b)(2)(ii)(B) of this section, the determination date is the 
date of the most recent event described in Sec.  1.704-
1(b)(2)(iv)(f)(5) or Sec.  1.704-1(b)(2)(iv)(s)(1) (a revaluation 
event), irrespective of whether the capital accounts of the partners 
are adjusted under Sec.  1.704-1(b)(2)(iv)(f), or, if there has been no 
revaluation event, the date of the formation of the partnership.
    (B) Allocations not in accordance with liquidation value 
percentage. If a partnership agreement provides for the allocation of 
any item of income, gain, deduction, or loss from partnership property 
to a partner other than in accordance with the partner's liquidation 
value percentage, the determination date is the last day of the 
partner's taxable year, or, if the partner's section 987 QBU owned 
indirectly through a section 987 aggregate partnership terminates 
during the partner's taxable year, the date such section 987 QBU is 
terminated.
    (3) Example. The following example illustrates the rule of this 
paragraph (b).

    Example. (i) Facts. DC, a domestic corporation, owns all of the 
stock of FS, a controlled foreign corporation (as defined in section 
957(a)) with the U.S. dollar as its functional currency. FS owns a 
capital and profits interest in FPRS, a foreign partnership. The 
remaining capital and profits interest in FPRS is owned by DC. FPRS 
is a section 987 aggregate partnership with the euro as its 
functional currency. The balance sheet of FPRS reflects one asset 
(Asset A) with a basis of [euro]60x and a fair market value of 
[euro]100x, another asset (Asset B) with a basis of [euro]100x and a 
fair market value of [euro]200x, and a liability (Liability) of 
[euro]50x. At the end of year 1, the liquidation value percentage, 
as determined under paragraph (b)(2) of this section, of DC with 
respect to FPRS is 75 percent, and the liquidation value percentage 
of FS with respect to FPRS is 25 percent.
    (ii) Result. Under Sec.  1.987-1(b)(4), DC and FS are each 
treated as indirectly owning an eligible QBU with a balance sheet 
that reflects their respective shares of any assets and liabilities 
of FPRS. Under paragraph (b)(1) of this section, DC and FS's shares 
of FPRS's assets and liabilities are determined in accordance with 
DC and FS's respective liquidation value percentages. Accordingly, 
because DC has a liquidation value percentage of 75 percent with 
respect to FPRS, [euro]75x of Asset A (with a [euro]45x basis), 
[euro]150x of Asset B (with a [euro]75x basis), and

[[Page 88875]]

[euro]37.50x of Liability will be attributed to the DC-FPRS QBU. 
Additionally, because FS has a liquidation value percentage of 25 
percent with respect to FPRS, [euro]25x of Asset A (with a [euro]15x 
basis), [euro]50x of Asset B (with a [euro]25x basis), and 
[euro]12.50x of Liability will be attributed to the FS-FPRS QBU.

    (c) [Reserved]. For further guidance, see Sec.  1.987-7(c).
    (d) 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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (e) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 15. Section 1.987-8 is amended by adding paragraph (d) to read as 
follows:


Sec.  1.987-8  Termination of a section 987 QBU.

* * * * *
    (d) [Reserved]. For further guidance, see Sec.  1.987-8T(d).
* * * * *

0
Par. 16. Section 1.987-8T is added to read as follows


Sec.  1.987-8T   Termination of a section 987 QBU (temporary).

    (a) through (c) [Reserved]. For further guidance, see Sec.  1.987-
8(a) through (c).
    (d) Annual deemed termination election. A taxpayer, including a 
taxpayer described in Sec.  1.987-1(b)(1)(ii) to which Sec. Sec.  
1.987-1 through 1.987-11 generally do not apply, may elect under this 
paragraph (d) to deem all of the section 987 QBUs of which it is an 
owner to terminate on the last day of each taxable year for which the 
election is in effect. See Sec.  1.987-8(e) regarding the effect of 
such a deemed termination. The owner of a section 987 QBU that is 
deemed to terminate under this paragraph is treated as having 
transferred all of the assets and liabilities attributable to such 
section 987 QBU to a new section 987 QBU on the first day of the 
following taxable year.
    (e) through (f) [Reserved]. For further guidance, see Sec.  1.987-
8(e) through (f).
    (g) Effective/applicability date. This section applies to taxable 
years beginning on or after December 7, 2016.
    (h) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 17. Section 1.987-12 is added to read as follows:


Sec.  1.987-12   Deferral of section 987 gain or loss.

    (a) through (h) [Reserved]. For further guidance, see Sec.  1.987-
12T(a) through (h).

0
Par. 18. Section 1.987-12T is added to read as follows:


Sec.  1.987-12T   Deferral of section 987 gain or loss (temporary).

    (a) In general--(1) Overview. This section provides rules that 
defer the recognition of section 987 gain or loss that, but for this 
section, would be recognized in connection with certain QBU 
terminations and certain other transactions involving partnerships. 
This paragraph (a) provides an overview of this section and describes 
the section's scope of application, including with respect to QBUs 
subject to section 987 but to which Sec. Sec.  1.987-1 through 1.987-11 
generally do not apply. Paragraph (b) of this section describes the 
extent to which section 987 gain or loss is recognized under Sec.  
1.987-5 or similar principles in the taxable year of a deferral event 
(as defined in paragraph (b)(2) of this section) with respect to a QBU. 
Paragraph (c) of this section describes the extent to which section 987 
gain or loss that, as a result of paragraph (b), is not recognized 
under Sec.  1.987-5 or similar principles is recognized upon the 
occurrence of subsequent events. Paragraph (d) of this section 
describes the extent to which section 987 loss is recognized under 
Sec.  1.987-5 or similar principles in the taxable year of an outbound 
loss event (as defined in paragraph (d)(2) of this section) with 
respect to a QBU. Paragraph (e) of this section provides rules for 
determining the source and character of gains and losses that, as a 
result of this section, are not recognized under Sec.  1.987-5 or 
similar principles in the taxable year of a deferral event or outbound 
loss event. Paragraph (f) of this section defines controlled group and 
qualified successor for purposes of this section. Paragraph (g) of this 
section provides an anti-abuse rule. Paragraph (h) of this section 
provides examples illustrating the rules described in this section.
    (2) Scope. This section applies to any foreign currency gain or 
loss realized under section 987(3), including foreign currency gain or 
loss of an entity described in Sec.  1.987-1(b)(1)(ii). References in 
this section to section 987 gain or loss refer to any foreign currency 
gain or loss realized under section 987(3), references to a section 987 
QBU refer to any eligible QBU (as defined in Sec.  1.987-1(b)(3)(i), 
but without regard to Sec.  1.987-1(b)(3)(ii)) that is subject to 
section 987, and references to a section 987 aggregate partnership 
refer to any partnership for which the acquisition or disposition of a 
partnership interest could give rise to foreign currency gain or loss 
realized under section 987(3). Additionally, references to recognition 
of section 987 gain or loss under Sec.  1.987-5 encompass any 
determination and recognition of gain or loss under section 987(3) that 
would occur but for this section. Accordingly, the principles of this 
section apply to a QBU subject to section 987 regardless of whether the 
QBU otherwise is subject to Sec. Sec.  1.987-1 through 1.987-11. An 
owner of a QBU that is not subject to Sec.  1.987-5 must adapt the 
rules set forth in this section as necessary to recognize section 987 
gains or losses that are subject to this section consistent with the 
principles of this section.
    (3) Exceptions--(i) Annual deemed termination elections. This 
section does not apply to section 987 gain or loss of a section 987 QBU 
with respect to which the annual deemed termination election described 
in Sec.  1.987-8T(d) is in effect.
    (ii) De minimis exception. This section does not apply to a section 
987 QBU for a taxable year if the net unrecognized section 987 gain or 
loss of the section 987 QBU that, as a result of this section, would 
not be recognized under Sec.  1.987-5 in the taxable year does not 
exceed $5 million.
    (b) Gain and loss recognition in connection with a deferral event--
(1) In general. Notwithstanding Sec.  1.987-5, the owner of a section 
987 QBU with respect to which a deferral event occurs (a deferral QBU) 
includes in taxable income section 987 gain or loss in connection with 
the deferral event only to the extent provided in paragraphs (b)(3) and 
(c) of this section. However, if the deferral event also constitutes an 
outbound loss event described in paragraph (d) of this section, the 
amount of loss recognized by the owner may be further limited under 
that paragraph.
    (2) Deferral event--(i) In general. A deferral event with respect 
to a section 987 QBU means any transaction or series of transactions 
that satisfy the conditions described in paragraphs (b)(2)(ii) and 
(b)(2)(iii) of this section.
    (ii) Transactions. The transaction or series of transactions 
include either:
    (A) A termination of the section 987 QBU other than any of the 
following terminations: a termination described in Sec.  1.987-8(b)(3), 
a termination described in Sec.  1.987-8(c), or a termination described 
solely in Sec.  1.987-8(b)(1); or
    (B) A disposition of part of an interest in a section 987 aggregate 
partnership or DE through which the section 987 QBU is owned or any 
contribution by another

[[Page 88876]]

person to such a partnership or DE of assets that, immediately after 
the contribution, are not considered to be included on the books and 
records of an eligible QBU, provided that the contribution gives rise 
to a deemed transfer from the section 987 QBU to the owner.
    (iii) Assets on books of successor QBU. Immediately after the 
transaction or series of transactions, assets of the section 987 QBU 
are reflected on the books and records of a successor QBU (as defined 
in paragraph (b)(4) of this section).
    (3) Gain or loss recognized under Sec.  1.987-5 in the taxable year 
of a deferral event. In the taxable year of a deferral event with 
respect to a deferral QBU, the owner of the deferral QBU recognizes 
section 987 gain or loss as determined under Sec.  1.987-5, except 
that, solely for purposes of applying Sec.  1.987-5, all assets and 
liabilities of the deferral QBU that, immediately after the deferral 
event, are reflected on the books and records of a successor QBU are 
treated as not having been transferred and therefore as remaining on 
the books and records of the deferral QBU notwithstanding the deferral 
event.
    (4) Successor QBU. For purposes of this section, a section 987 QBU 
(potential successor QBU) is a successor QBU with respect to a section 
987 QBU referred to in paragraph (b)(2)(ii) of this section if, 
immediately after the transaction or series of transactions described 
in that paragraph, the potential successor QBU satisfies all of the 
conditions described in paragraphs (b)(4)(i) through (b)(4)(iii) of 
this section.
    (i) The books and records of the potential successor QBU reflect 
assets that, immediately before the transaction or series of 
transactions described in paragraph (b)(2)(ii) of this section, were 
reflected on the books and records of the section 987 QBU referred to 
in that paragraph.
    (ii) The owner of the potential successor QBU and the owner of the 
section 987 QBU referred to in paragraph (b)(2)(ii) of this section 
immediately before the transaction or series of transactions described 
in that paragraph are members of the same controlled group.
    (iii) In the case of a section 987 QBU referred to in paragraph 
(b)(2)(ii)(A) of this section, if the owner of the section 987 QBU 
immediately before the transaction or series of transactions described 
in that paragraph was a U.S. person, the potential successor QBU is 
owned by a U.S. person.
    (c) Recognition of deferred section 987 gain or loss in the taxable 
year of a deferral event and in subsequent taxable years--(1) In 
general--(i) Deferred section 987 gain or loss. A deferral QBU owner 
(as defined in paragraph (c)(1)(ii) of this section) recognizes section 
987 gain or loss attributable to the deferral QBU that, as a result of 
paragraph (b) of this section, is not recognized in the taxable year of 
the deferral event under Sec.  1.987-5 (deferred section 987 gain or 
loss) in the taxable year of the deferral event and in subsequent 
taxable years as provided in paragraphs (c)(2) through (4) of this 
section.
    (ii) Deferral QBU owner. For purposes of this paragraph (c), a 
deferral QBU owner means, with respect to a deferral QBU, the owner of 
the deferral QBU immediately before the deferral event, or the owner's 
qualified successor.
    (2) Recognition upon a subsequent remittance--(i) In general. 
Except as provided in paragraph (c)(3) of this section, a deferral QBU 
owner recognizes deferred section 987 gain or loss in the taxable year 
of the deferral event and in subsequent taxable years upon a remittance 
from a successor QBU to the owner of the successor QBU (successor QBU 
owner) in the amount described in paragraph (c)(2)(ii) of this section.
    (ii) Amount. The amount of deferred section 987 gain or loss that 
is recognized pursuant to this paragraph (c)(2) in a taxable year of 
the deferral QBU owner is the outstanding deferred section 987 gain or 
loss (that is, the amount of deferred section 987 gain or loss not 
previously recognized) multiplied by the remittance proportion of the 
successor QBU owner with respect to the successor QBU for the taxable 
year ending with or within the taxable year of the deferral QBU owner, 
as determined under Sec.  1.987-5(b) (and, to the extent relevant, 
paragraphs (b) and (c)(2)(iii) of this section) without regard to any 
election under Sec.  1.987-8T(d). For purposes of computing this 
remittance proportion, multiple successor QBUs of the same deferral QBU 
are treated as a single successor QBU.
    (iii) Deemed remittance when a successor QBU ceases to be owned by 
a member of the deferral QBU owner's controlled group. For purposes of 
this paragraph (c)(2), in a taxable year of the deferral QBU owner in 
which a successor QBU ceases to be owned by a member of a controlled 
group that includes the deferral QBU owner, the successor QBU owner is 
treated as having a remittance proportion of 1. Accordingly, if there 
is only one successor QBU with respect to a deferral QBU and that 
successor QBU ceases to be owned by a member of the controlled group 
that includes the deferral QBU owner, all outstanding deferred section 
987 gain or loss with respect to that deferral QBU will be recognized. 
This paragraph (c)(2)(iii) does not affect the application of 
Sec. Sec.  1.987-1 through 1.987-11 to the successor QBU owner with 
respect to its ownership of the successor QBU.
    (3) Recognition of deferred section 987 loss in certain outbound 
successor QBU terminations. Notwithstanding paragraph (c)(2) of this 
section, if assets of the successor QBU (transferred assets) are 
transferred (or deemed transferred) in a transaction that would 
constitute an outbound loss event if the successor QBU had a net 
accumulated section 987 loss at the time of the exchange, then the 
deferral QBU owner recognizes outstanding deferred section 987 loss, if 
any, to the extent it would recognize loss under paragraph (d)(1) of 
this section if (i) the deferral QBU owner owned the successor QBU, 
(ii) the deferral QBU owner had net unrecognized section 987 loss with 
respect to the successor QBU equal to its outstanding deferred section 
987 loss with respect to the deferral QBU, and (iii) the transferred 
assets were transferred (or deemed transferred) in an outbound loss 
event. Any outstanding deferred section 987 loss with respect to the 
deferral QBU that is not recognized as a result of the preceding 
sentence is recognized by the deferral QBU owner in the first taxable 
year in which the deferral QBU owner (including any qualified 
successor) ceases to be a member of a controlled group that includes 
the acquirer of the transferred assets or any qualified successor of 
such acquirer.
    (4) Special rules regarding successor QBUs--(i) Successor QBU with 
respect to a deferral QBU that is a successor QBU. If a section 987 QBU 
is a successor QBU with respect to a deferral QBU that is a successor 
QBU with respect to another deferral QBU, the first-mentioned section 
987 QBU is considered a successor QBU with respect to the second-
mentioned deferral QBU. For example, if QBU A is a successor QBU with 
respect to QBU B, and QBU B is a successor QBU with respect to QBU C, 
then QBU A is a successor QBU with respect to QBU C.
    (ii) Separation of a successor QBU. If a successor QBU with respect 
to a deferral QBU separates into two or more separated QBUs (as defined 
in Sec.  1.987-2T(c)(9)(iii)), each separated QBU is considered a 
successor QBU with respect to the deferral QBU.
    (iii) Combination of a successor QBU. If a successor QBU with 
respect to a deferral QBU combines with another

[[Page 88877]]

section 987 QBU of the same owner, resulting in a combined QBU (as 
defined in Sec.  1.987-2T(c)(9)(i)), the combined QBU is considered a 
successor QBU with respect to the deferral QBU.
    (d) Loss recognition upon an outbound loss event--(1) In general. 
Notwithstanding Sec.  1.987-5, the owner of a section 987 QBU with 
respect to which an outbound loss event occurs (an outbound loss QBU) 
includes in taxable income in the taxable year of an outbound loss 
event section 987 loss with respect to that section 987 QBU only to the 
extent provided in paragraph (d)(3) of this section.
    (2) Outbound loss event. An outbound loss event means, with respect 
to a section 987 QBU:
    (i) Any termination of the section 987 QBU in connection with a 
transfer by a U.S. person of assets of the section 987 QBU to a foreign 
person that is a member of the same controlled group as the U.S. 
transferor immediately before the transaction or, if the transferee did 
not exist immediately before the transaction, immediately after the 
transaction (related foreign person), provided that the termination 
would result in the recognition of section 987 loss with respect to the 
section 987 QBU under Sec.  1.987-5 and paragraph (b) of this section 
but for this paragraph (d);
    (ii) Any transfer by a U.S. person of part of an interest in a 
section 987 aggregate partnership or DE through which the U.S. person 
owns the section 987 QBU to a related foreign person that has the same 
functional currency as the section 987 QBU, or any contribution by such 
a related foreign person to such a partnership or DE of assets that, 
immediately after the contribution, are not considered to be included 
on the books and records of an eligible QBU, provided that the transfer 
would result in the recognition of section 987 loss with respect to the 
section 987 QBU under Sec.  1.987-5 and paragraph (b) of this section 
but for this paragraph (d).
    (3) Loss recognized upon an outbound loss event. In the taxable 
year of an outbound loss event with respect to an outbound loss QBU, 
the owner of the outbound loss QBU recognizes section 987 loss as 
determined under Sec.  1.987-5 and paragraphs (b) and (c) of this 
section, except that, solely for purposes of applying Sec.  1.987-5, 
the following assets and liabilities of the outbound loss QBU are 
treated as not having been transferred and therefore as remaining on 
the books and records of the outbound loss QBU notwithstanding the 
outbound loss event:
    (i) In the case of an outbound loss event described in paragraph 
(d)(2)(i) of this section, assets and liabilities that, immediately 
after the outbound loss event, are reflected on the books and records 
of the related foreign person described in that paragraph or of a 
section 987 QBU owned by such related foreign person; and
    (ii) In the case of an outbound loss event described in paragraph 
(d)(2)(ii) of this section, assets and liabilities that, immediately 
after the outbound loss event, are reflected on the books and records 
of the eligible QBU from which the assets and liabilities of the 
outbound loss QBU are allocated and not on the books and records of a 
section 987 QBU.
    (4) Adjustment of basis of stock received in certain nonrecognition 
transactions. If an outbound loss event results from the transfer of 
assets of the outbound loss QBU in a transaction described in section 
351 or section 361, the basis of the stock that is received in the 
transaction is increased by an amount equal to the section 987 loss 
that, as a result of this paragraph (d), is not recognized with respect 
to the outbound loss QBU in the taxable year of the outbound loss event 
(outbound section 987 loss).
    (5) Recognition of outbound section 987 loss that is not converted 
into stock basis. Outbound section 987 loss attributable to an outbound 
loss event that is not described in paragraph (d)(4) of this section is 
recognized by the owner of the outbound loss QBU in the first taxable 
year in which the owner or any qualified successor of the owner ceases 
to be a member of a controlled group that includes the related foreign 
person referred to in paragraph (d)(2)(i) or (ii) of this section, or 
any qualified successor of such person.
    (e) Source and character--(1) Deferred section 987 gain or loss and 
certain outbound section 987 loss. The source and character of deferred 
section 987 gain or loss recognized pursuant to paragraph (c) of this 
section, and of outbound section 987 loss recognized pursuant to 
paragraph (d)(5) of this section, is determined under Sec.  1.987-6 as 
if such deferred section 987 gain or loss were recognized pursuant to 
Sec.  1.987-5 without regard to this section on the date of the related 
deferral event or outbound loss event.
    (2) Outbound section 987 loss reflected in stock basis. If loss is 
recognized on the sale or exchange of stock described in paragraph 
(d)(4) of this section within two years of the outbound loss event 
described in that paragraph, then, to the extent of the outbound 
section 987 loss, the source and character of the loss recognized on 
the sale or exchange is determined under Sec.  1.987-6 as if such loss 
were section 987 loss recognized pursuant to Sec.  1.987-5 without 
regard to this section on the date of the outbound loss event.
    (f) Definitions--(1) Controlled group. For purposes of this 
section, a controlled group means all persons with the relationships to 
each other specified in sections 267(b) or 707(b).
    (2) Qualified successor. For purposes of this section, a qualified 
successor with respect to a corporation (transferor corporation) means 
another corporation (acquiring corporation) that acquires the assets of 
the transferor corporation in a transaction described in section 
381(a), but only if (A) the acquiring corporation is a domestic 
corporation and the transferor corporation was a domestic corporation, 
or (B) the acquiring corporation is a controlled foreign corporation 
(as defined in section 957(a)) (CFC) and the transferor corporation was 
a CFC. A qualified successor of a corporation includes the qualified 
successor of a qualified successor of the corporation.
    (g) Anti-abuse. No section 987 loss is recognized under Sec.  
1.987-5 or this section in connection with a transaction or series of 
transactions that are undertaken with a principal purpose of avoiding 
the purposes of this section.
    (h) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, DC1 is a domestic 
corporation that owns all of the stock of DC2, which is also a domestic 
corporation, and CFC1 and CFC2 are CFCs. In addition, DC1, DC2, CFC1, 
and CFC2 are members of a controlled group as defined in paragraph 
(f)(1) of this section, and the de minimis rule of paragraph (a)(3)(ii) 
of this section is not applicable. Finally, except as otherwise 
provided, Business A is a section 987 QBU with the euro as its 
functional currency, there are no transfers between Business A and its 
owner, and Business A's assets are not depreciable or amortizable.

    Example 1. Contribution of a section 987 QBU to a member of the 
controlled group. (i) Facts. DC1 owns all of the interests in 
Business A. The balance sheet of Business A reflects assets with an 
aggregate adjusted basis of [euro]1,000x and no liabilities. DC1 
contributes [euro]900x of Business A's assets to DC2 in an exchange 
to which section 351 applies. Immediately after the contribution, 
the remaining [euro]100x of Business A's assets are no longer 
reflected on the books and records of a section 987 QBU. DC2, which 
has the U.S. dollar as its functional currency, uses the former 
Business A assets in a business (Business B) that constitutes a 
section 987 QBU. At the time of the contribution, Business A has net 
accumulated unrecognized section 987 gain of $100x.
    (ii) Analysis. (A) Under Sec.  1.987-2(c)(2)(ii), DC1's 
contribution of [euro]900x of Business A's

[[Page 88878]]

assets to DC2 is treated as a transfer of all of the assets of 
Business A to DC1, immediately followed by DC1's contribution of 
[euro]900x of Business A's assets to DC2. The contribution of 
Business A's assets is a deferral event within the meaning of 
paragraph (b)(2) of this section because: (1) The transfer from 
Business A to DC1 is a transfer of substantially all of Business A's 
assets to DC1, resulting in a termination of Business A under Sec.  
1.987-8(b)(2); and (2) immediately after the transaction, assets of 
Business A are reflected on the books and records of Business B, a 
section 987 QBU owned by a member of DC1's controlled group and a 
successor QBU within the meaning of paragraph (b)(4) of this 
section. Accordingly, Business A is a deferral QBU within the 
meaning of paragraph (b)(1) of this section, and DC1 is a deferral 
QBU owner of Business A within the meaning of paragraph (c)(1)(ii) 
of this section.
    (B) Under paragraph (b)(3) of this section, DC1's taxable income 
in the taxable year of the deferral event includes DC1's section 987 
gain or loss determined with respect to Business A under Sec.  
1.987-5, except that, for purposes of applying Sec.  1.987-5, all 
assets and liabilities of Business A that are reflected on the books 
and records of Business B immediately after Business A's termination 
are treated as not having been transferred and therefore as though 
they remained on Business A's books and records (notwithstanding the 
deemed transfer of those assets under Sec.  1.987-8(e)). 
Accordingly, in the taxable year of the deferral event, DC1 is 
treated as making a remittance of [euro]100x, corresponding to the 
assets of Business A that are no longer reflected on the books and 
records of a section 987 QBU, and is treated as having a remittance 
proportion with respect to Business A of 0.1, determined by dividing 
the [euro]100x remittance by the sum of the remittance and the 
[euro]900x aggregate adjusted basis of the gross assets deemed to 
remain on Business A's books at the end of the year. Thus, DC1 
recognizes $10x of section 987 gain in the taxable year of the 
deferral event. DC1's deferred section 987 gain equals $90x, which 
is the amount of section 987 gain that, but for the application of 
paragraph (b) of this section, DC1 would have recognized under Sec.  
1.987-5 ($100x), less the amount of section 987 gain recognized by 
DC1 under Sec.  1.987-5 and this section ($10x).
    Example 2. Election to be classified as a corporation. (i) 
Facts. DC1 owns all of the interests in Entity A, a DE. Entity A 
conducts Business A, which has net accumulated unrecognized section 
987 gain of $500x. Entity A elects to be classified as a corporation 
under Sec.  301.7701-3(a). As a result of the election and pursuant 
to Sec.  301.7701-3(g)(1)(iv), DC1 is treated as contributing all of 
the assets and liabilities of Business A to newly-formed CFC1, which 
has the euro as its functional currency. Immediately after the 
contribution, the assets and liabilities of Business A are reflected 
on CFC1's balance sheet.
    (ii) Analysis. Under Sec.  1.987-2(c)(2)(ii), DC1's contribution 
of all of the assets and liabilities of Business A to CFC1 is 
treated as a transfer of all of the assets and liabilities of 
Business A to DC1, followed immediately by DC1's contribution of 
those assets and liabilities to CFC1. Because the deemed transfer 
from Business A to DC1 is a transfer of substantially all of 
Business A's assets to DC1, the Business A QBU terminates under 
Sec.  1.987-8(b)(2). The contribution of Business A's assets is not 
a deferral event within the meaning of paragraph (b)(2) of this 
section because, immediately after the transaction, no assets of 
Business A are reflected on the books and records of a successor QBU 
within the meaning of paragraph (b)(4) of this section due to the 
fact that the assets of Business A are not reflected on a section 
987 QBU immediately after the termination as well as the fact that 
the requirement of paragraph (b)(4)(iii) of this section is not met. 
Accordingly, DC1 recognizes section 987 gain with respect to 
Business A under Sec.  1.987-5 without regard to this section. 
Because the requirement of paragraph (b)(4)(iii) of this section is 
not met, the result would be the same even if the assets of Business 
A were transferred in a section 351 exchange to an existing foreign 
corporation that had a different functional currency than Business 
A.
    Example 3. Outbound loss event. (i) Facts. The facts are the 
same as in Example 2, except that Business A has net accumulated 
unrecognized section 987 loss of $500x rather than net accumulated 
unrecognized section 987 gain of $500x.
    (ii) Analysis. (A) The analysis of the transactions under 
Sec. Sec.  1.987-2(c)(2)(ii), 1.987-8(b)(2), and paragraph (b) of 
this section is the same as in Example 2. However, the termination 
of Business A as a result of the transfer of the assets of Business 
A by a U.S. person (DC1) to a foreign person (CFC1) that is a member 
of DC1's controlled group is an outbound loss event described in 
paragraph (d)(2) of this section.
    (B) Under paragraphs (d)(1) and (d)(3) of this section, in the 
taxable year of the outbound loss event, DC1 includes in taxable 
income section 987 loss recognized with respect to Business A as 
determined under Sec.  1.987-5, except that, for purposes of 
applying Sec.  1.987-5, all assets and liabilities of Business A 
that are reflected on the books and records of CFC1, a related 
foreign person described in paragraph (d)(2) of this section, are 
treated as not having been transferred. Accordingly, DC1's 
remittance proportion with respect to Business A is 0, and DC1 
recognizes no section 987 loss with respect to Business A. DC1's 
outbound section 987 loss is $500x, which is the amount of section 
987 loss that DC1 would have recognized under Sec.  1.987-5 ($500x) 
without regard to paragraph (d) of this section, less the amount of 
section 987 loss recognized by DC1 under paragraph (d)(3) of this 
section ($0). Under paragraph (d)(4) of this section, DC1 must 
increase its basis in its CFC1 shares by the amount of the outbound 
section 987 loss ($500x).
    Example 4. Conversion of a DE to a partnership. (i) Facts. DC1 
owns all of the interests in Entity A, a DE that conducts Business 
A. On the last day of Year 1, DC1 sells 50 percent of its interest 
in Entity A to DC2 (the Entity A sale).
    (ii) Analysis. (A) For Federal income tax purposes, Entity A is 
converted to a partnership when DC2 purchases the 50 percent 
interest in Entity A. DC2's purchase is treated as the purchase of 
50 percent of the assets of Entity A (that is, the assets of 
Business A), which, prior to the purchase, were treated as held 
directly by DC1 for Federal income tax purposes. Immediately after 
DC2's deemed purchase of 50 percent of Business A assets, DC1 and 
DC2 are treated as contributing their respective interests in 
Business A assets to a partnership. See Rev. Rul. 99-5 (1999-1 CB 
434) (situation 1). These deemed transactions are not taken into 
account for purposes of this section, but the Entity A sale and 
resulting existence of a partnership have consequences under section 
987 and this section, as described in paragraphs (ii)(B) through (D) 
of this Example 4.
    (B) Immediately after the Entity A sale, Entity A is a section 
987 aggregate partnership within the meaning of Sec.  1.987-1(b)(5) 
because DC1 and DC2 own all the interests in partnership capital and 
profits, DC1 and DC2 are related within the meaning of section 
267(b), and the partnership has an eligible QBU (Business A) that 
would be a section 987 QBU with respect to a partner if owned by the 
partner directly. As a result of the Entity A sale, 50 percent of 
the assets and liabilities of Business A ceased to be reflected on 
the books and records of DC1's Business A section 987 QBU. As a 
result, such assets and liabilities are treated as if they were 
transferred from DC1's Business A section 987 QBU to DC1. 
Additionally, following DC2's acquisition of 50 percent of the 
interest in Entity A, DC2 is allocated 50 percent of the assets and 
liabilities of Business A under Sec. Sec.  1.987-2(b), 1.987-7(a), 
and 1.987-7T(b). Because DC2 and Business A have different 
functional currencies, DC2's portion of the Business A assets and 
liabilities constitutes a section 987 QBU. Accordingly, 50 percent 
of the assets and liabilities of Business A are treated as 
transferred by DC2 to DC2's Business A section 987 QBU.
    (C) The Entity A sale is a deferral event described in paragraph 
(b)(2) of this section because: (1) The sale constitutes the 
disposition of part of an interest in a DE; and (2) immediately 
after the transaction, assets of DC1's Business A section 987 QBU 
are reflected on the books and records of DC1's Business A section 
987 QBU and DC2's Business A section 987 QBU, each of which is a 
successor QBU with respect to DC1's Business A section 987 QBU 
within the meaning of paragraph (b)(4) of this section. Accordingly, 
DC1's Business A section 987 QBU is a deferral QBU within the 
meaning of paragraph (b)(1) of this section, and DC1 is a deferral 
QBU owner within the meaning of paragraph (c)(1)(ii) of this 
section. Under paragraph (b)(1) of this section, DC1 includes in 
taxable income section 987 gain or loss with respect to Business A 
in connection with the deferral event to the extent provided in 
paragraphs (b)(3) and (c) of this section.
    (D) Under paragraph (b) of this section, in the taxable year of 
the Entity A sale, DC1 includes in taxable income section 987 gain 
or loss with respect to Business A as determined under Sec.  1.987-
5, except that, for purposes of applying Sec.  1.987-5, all assets 
and liabilities of Business A that, immediately

[[Page 88879]]

after the Entity A sale, are reflected on the books and records of 
successor QBUs are treated as though they were not transferred and 
therefore as remaining on the books and records of DC1's Business A 
section 987 QBU notwithstanding the Entity A sale. Accordingly, 
DC1's remittance amount under Sec.  1.987-5 is $0, and DC1 
recognizes no section 987 gain or loss with respect to Business A.
    Example 5. Partial recognition of deferred gain or loss. (i) 
Facts. DC1 owns all of the interests in Entity A, a DE that conducts 
Business A in Country X. During Year 1, DC1 contributes all of its 
interests in Entity A to DC2 in an exchange to which section 351 
applies. At the time of the contribution, Business A has net 
accumulated unrecognized section 987 gain of $100x. After the 
contribution, Entity A continues to conduct business in Country X 
(Business B). In Year 3, as a result of a net transfer of property 
from Business B to DC2, DC2's remittance proportion with respect to 
Business B, as determined under Sec.  1.987-5, is 0.25.
    (ii) Analysis. (A) For the reasons described in Example 1, the 
contribution of Entity A by DC1 to DC2 results in a termination of 
Business A and a deferral event with respect to Business A, a 
deferral QBU; DC1 is a deferral QBU owner within the meaning of 
paragraph (c)(1)(ii) of this section; Business B is a successor QBU 
with respect to Business A; DC2 is a successor QBU owner; and the 
$100x of net accumulated unrecognized section 987 gain with respect 
to Business A becomes deferred section 987 gain as a result of the 
deferral event.
    (B) Under paragraph (c)(1) of this section, DC1 recognizes 
deferred section 987 gain with respect to Business A in accordance 
with paragraphs (c)(2) through (4) of this section. Under paragraph 
(c)(2)(i) of this section, DC1 recognizes deferred section 987 gain 
in Year 3 as a result of the remittance from Business B to DC2. 
Under paragraph (c)(2)(ii) of this section, the amount of deferred 
section 987 gain that DC1 recognizes is $25x, which is DC1's 
outstanding deferred section 987 gain or loss ($100x) with respect 
to Business A multiplied by the remittance proportion (0.25) of DC2 
with respect to Business B for the taxable year as determined under 
Sec.  1.987-5(b).

    (i) Coordination with fresh start transition method--(1) In 
general. If a taxpayer is a deferral QBU owner, or is or was the owner 
of an outbound loss QBU, and the taxpayer is required under Sec.  
1.987-10(a) to apply the fresh start transition method described in 
Sec.  1.987-10(b) to the deferral QBU or outbound loss QBU, or would 
have been so required if the taxpayer had owned the deferral QBU or 
outbound loss QBU on the transition date (as defined in Sec.  1.987-
11(c)), the adjustments described in paragraphs (i)(2) and (i)(3) of 
this section, as applicable, must be made on the transition date.
    (2) Adjustment to deferred section 987 gain or loss. The amount of 
any outstanding deferred section 987 gain or loss of a deferral QBU 
owner with respect to a deferral QBU described in paragraph (i)(1) of 
this section must be adjusted to equal the amount of outstanding 
deferred section 987 gain or loss that the deferral QBU owner would 
have had with respect to the deferral QBU on the transition date if, 
immediately before the deferral event, the deferral QBU had 
transitioned to the method prescribed by Sec. Sec.  1.987-1 through 
1.987-10 pursuant to the fresh start transition method.
    (3) Adjustments in the case of an outbound loss event. The basis of 
any stock described in paragraph (d)(4) of this section that was 
received in connection with the transfer (or deemed transfer) of assets 
of an outbound loss QBU described in paragraph (i)(1) of this section 
and that is held on the transition date must be adjusted to equal the 
basis that such stock would have had on the transition date if, 
immediately prior to the outbound loss event, the outbound loss QBU had 
transitioned to the method prescribed by Sec. Sec.  1.987-1 through 
1.987-10 pursuant to the fresh start transition method. If no such 
stock was received, the amount of any outbound section 987 loss with 
respect to the outbound loss QBU that may be recognized on or after the 
transition date pursuant to paragraph (d)(5) of this section must be 
adjusted to equal the amount of such loss that would be outstanding and 
that may be recognized pursuant to that paragraph if, immediately 
before the outbound loss event, the outbound loss QBU had transitioned 
to the method prescribed by Sec. Sec.  1.987-1 through 1.987-10 
pursuant to the fresh start transition method.
    (j) Effective/applicability date--(1) In general. Except as 
described in paragraph (j)(2) of this section, this section applies to 
any deferral event or outbound loss event that occurs on or after 
January 6, 2017.
    (2) Exception. This section applies to any deferral event or 
outbound loss event that occurs on or after December 7, 2016, if such 
deferral event or outbound loss event is undertaken with a principal 
purpose of recognizing section 987 loss.
    (k) Expiration date. The applicability of this section expires 
December 6, 2019.

0
Par. 19. Section 1.988-0 is amended by revising the entry for Sec.  
1.988-2(b)(16) and adding an entry for Sec.  1.988-2(i) to read as 
follows:


Sec.  1.988-0   Taxation of gain or loss from a section 988 
transaction; Table of contents.

* * * * *


Sec.  1.988-2  Recognition and computation of exchange gain or loss.

* * * * *
    (b) * * *
    (16) [Reserved].
* * * * *
    (i) [Reserved].

0
Par. 20. Section 1.988-1 is amended by adding paragraph (a)(3) to read 
as follows:


Sec.  1.988-1   Certain definitions and special rules.

* * * * *
    (a) * * *
    (3) [Reserved]. For further guidance, see Sec.  1.988-1T(a)(3).
* * * * *

0
Par. 21. Section 1.988-1T is added to read as follows:


Sec.  1.988-1T  Certain definitions and special rules (temporary).

    (a)(1) through (a)(2) [Reserved]. For further guidance, see Sec.  
1.988-1(a)(1) through (2).
    (3) Specified owner functional currency transactions of a section 
987 QBU not treated as section 988 transactions. Specified owner 
functional currency transactions, as defined in Sec.  1.987-
3T(b)(4)(ii), held by a section 987 QBU are not treated as section 988 
transactions. Thus, no currency gain or loss shall be recognized by a 
section 987 QBU under section 988 with respect to such transactions.
    (4) through (i) [Reserved]. For further guidance, see Sec.  1.988-
1(a)(4) through (i).
    (j) 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 Sec.  1.987-11(b), then 
this section applies to taxable years to which Sec. Sec.  1.987-1 
through 1.987-10 apply as a result of such election.
    (k) Expiration date. The applicability of this section expires on 
December 6, 2019.

0
Par. 22. Section 1.988-2 is amended by revising paragraph (b)(16) and 
adding paragraph (i) to read as follows:


Sec.  1.988-2   Recognition and computation of exchange gain or loss.

* * * * *
    (b) * * *
    (16) [Reserved]. For further guidance, see Sec.  1.988-2T(b)(16).
* * * * *
    (i) [Reserved]. For further guidance, see Sec.  1.988-2T(i).

0
Par. 23. Section 1.988-2T is added to read as follows:

[[Page 88880]]

Sec.  1.988-2T   Recognition and computation of exchange gain or loss 
(temporary).

    (a) through (b)(15) [Reserved]. For further guidance, see Sec.  
1.988-2(a) through (b)(15).
    (16) Deferral of loss on certain related-party debt instruments.--
(i) Treatment of creditor. For rules applicable to a corporation 
included in a controlled group that is a creditor under a debt 
instrument see Sec.  1.267(f)-1(e).
    (ii) Treatment of debtor--(A) In general. Exchange loss realized 
under Sec.  1.988-2(b)(4) or (b)(6) is deferred if--
    (1) The loss is realized by a debtor with respect to a loan from a 
person that has a relationship to the debtor described in section 
267(b) or section 707(b); and
    (2) The transaction resulting in the realization of exchange loss 
has as a principal purpose the avoidance of Federal income tax.
    (B) Recognition of deferred loss. Any exchange loss that is 
deferred under paragraph (b)(16)(ii)(A) of this section is deferred 
until the end of the term of the loan, determined immediately prior to 
the transaction.
    (17) through (h) [Reserved]. For further guidance, see Sec.  1.988-
2(b)(17) through (h).
    (i) Special rules for section 988 transactions of a section 987 
QBU. For rules regarding section 988 transactions of a section 987 QBU, 
see Sec.  1.987-3T(b)(4) for section 987 QBUs in general and Sec.  
1.987-1T(b)(6) for dollar QBUs.
    (j) Effective/applicability date. Paragraph (b)(16) of this section 
applies to any exchange loss realized on or after December 7, 2016. 
Paragraph (i) of 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 Sec.  1.987-11(b), then paragraph (i) of this 
section applies to taxable years to which Sec. Sec.  1.987-1 through 
1.987-10 apply as a result of such election.
    (k) Expiration date. The applicability of this section expires on 
December 6, 2019.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: November 14, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-28380 Filed 12-7-16; 8:45 am]
BILLING CODE 4830-01-P