Exclusion of Foreign Currency Gain or Loss Related to Business Needs From Foreign Personal Holding Company Income; Mark-to-Market Method of Accounting for Section 988 Transactions, 60135-60143 [2017-27320]

Download as PDF Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules deadline for the reasons stated in the Extension Request, the security of our nation’s electric grid will continue to be at risk. However, I understand that Section 403 assigns the Commission the responsibility to take final action on the Proposal within the reasonable time period set forth by me and it is solely within my authority under Section 403 to grant an extension of time for final action. On the assumption that the Commission cannot act on the proposal within the 60-day deadline, I hereby grant the request for an extension of time for the Commission to deliberate and take final action on the Grid Resiliency Pricing Rule for an additional 30 days.1 The new deadline is Wednesday, January 10, 2018. The Commission is nevertheless authorized to act at any time prior to this deadline and I urge the Commission to act expeditiously. During this additional period, the Department will continue to examine all options within my authority under the Department of Energy Organization Act, the Federal Power Act, and any other authorities to take remedial action as necessary to ensure the security of the nation’s electric grid. I continue to believe that urgent action must be taken to ensure the resilience and security of the electric grid, which is so vitally important to the economic and national security of the United States. I look forward to the Commission taking final action in this matter for the benefit of the American people. Sincerely, Rick Perry [FR Doc. 2017–27187 Filed 12–18–17; 8:45 am] BILLING CODE 6450–01–P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [REG–119514–15] RIN 1545–BM80 Exclusion of Foreign Currency Gain or Loss Related to Business Needs From Foreign Personal Holding Company Income; Mark-to-Market Method of Accounting for Section 988 Transactions Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking. AGENCY: This document contains proposed regulations that provide guidance on the treatment of foreign currency gain or loss of a controlled foreign corporation (CFC) under the business needs exclusion from foreign sradovich on DSK3GMQ082PROD with PROPOSALS SUMMARY: 1 This extension is granted pursuant to my authority under section 403 of the Department of Energy Organization Act, among other powers and authorities granted to me by law. VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 personal holding company income (FPHCI). The proposed regulations also provide an election for a taxpayer to use a mark-to-market method of accounting for foreign currency gain or loss attributable to section 988 transactions. In addition, the proposed regulations permit the controlling United States shareholders of a CFC to automatically revoke certain elections concerning the treatment of foreign currency gain or loss. The proposed regulations affect taxpayers and United States shareholders of CFCs that engage in transactions giving rise to foreign currency gain or loss under section 988 of the Internal Revenue Code (Code). DATES: Written or electronic comments and requests for a public hearing must be received by March 19, 2018. ADDRESSES: Send submissions to CC:PA:LPD:PR (REG–119514–15), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–119514– 15), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC, or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG– 119514–15). FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Jeffery G. Mitchell, (202) 317–6934; concerning submissions of comments or requests for a public hearing, Regina Johnson, (202) 317–6901 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collections of information contained in this notice of proposed rulemaking have been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collections of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by February 20, 2018. Comments are specifically requested concerning: Whether the proposed collection of information is necessary for the proper performance of the duties of the IRS, PO 00000 Frm 00010 Fmt 4702 Sfmt 4702 60135 including whether the information will have practical utility; The accuracy of the estimated burden associated with the proposed collection of information; How the quality, utility, and clarity of the information to be collected may be enhanced; How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchases of services to provide information. The collection of information in these proposed regulations is in proposed §§ 1.954–2(g)(3)(iii) and (4)(iii) and 1.988–7. The information is required to be provided by taxpayers and United States shareholders of CFCs that make an election or revoke an election with respect to the treatment of foreign currency gains and losses. The information provided will be used by the IRS for tax compliance purposes. Estimated total annual reporting burden: 5,000 hours. Estimated average annual burden hours per respondent: One hour. Estimated number of respondents: 5,000. Estimated annual frequency of responses: One. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget. Books or 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 proposed amendments to 26 CFR part 1 under sections 446, 954(c)(1)(D), and 988 of the Code. Section 446 requires taxpayers to compute taxable income using accounting methods that clearly reflect income. Section 954(c)(1)(D) provides that FPHCI includes the excess of foreign currency gains over foreign currency losses (as defined in section 988(b)) attributable to section 988 transactions, other than transactions directly related to the business needs of the CFC. Section 988 provides rules for determining the source and character of E:\FR\FM\19DEP1.SGM 19DEP1 60136 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules gain or loss from certain foreign currency transactions. sradovich on DSK3GMQ082PROD with PROPOSALS A. Business Needs Exclusion 1. In General Section 954 defines foreign base company income (FBCI), which generally is income earned by a CFC that is taken into account in computing the amount that a United States shareholder of the CFC must include in income under section 951(a)(1)(A). Under section 954(a)(1), FBCI includes FPHCI, which is defined in section 954(c). The excess of foreign currency gains over foreign currency losses from section 988 transactions is generally included in FPHCI pursuant to section 954(c)(1)(D). Section 988 transactions generally include the following: The accrual of any item of income or expense that is to be paid or received in a nonfunctional currency after the date of accrual; lending or borrowing in a nonfunctional currency; entering into or acquiring a forward, future, option, or similar contract denominated in a nonfunctional currency; and the disposition of nonfunctional currency. See section 988(c). Thus, accruals in connection with ordinary business transactions, such as purchases and sales of inventory or the provision of services, are section 988 transactions if the receivable or payable is denominated in, or determined by reference to, a currency other than the taxpayer’s functional currency, as determined under § 1.985–1. Notwithstanding the general rule that includes the excess of foreign currency gains over foreign currency losses from section 988 transactions in FPHCI, section 954(c)(1)(D) excludes from FPHCI any foreign currency gain or loss attributable to a transaction directly related to the business needs of the CFC (business needs exclusion). To qualify for the business needs exclusion, a foreign currency gain or loss must, in addition to satisfying other requirements, arise from a transaction entered into, or property used, in the normal course of the CFC’s business that does not itself (and could not reasonably be expected to) give rise to subpart F income (as defined in section 952) other than foreign currency gain or loss. See § 1.954–2(g)(2)(ii)(B)(1). Foreign currency gain or loss attributable to a bona fide hedging transaction (as defined in § 1.954– 2(a)(4)(ii)) with respect to a transaction or property that qualifies for the business needs exclusion also qualifies for the business needs exclusion, provided that any gain or loss with VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 respect to such transaction or property that is attributable to changes in exchange rates is clearly determinable from the records of the CFC as being derived from such property or transaction. See § 1.954–2(g)(2)(ii)(B)(2). Generally, bona fide hedging transactions are transactions that meet the requirements for a hedging transaction under § 1.1221–2(a) through (d), except that a bona fide hedging transaction also includes a transaction entered into in the normal course of business primarily to manage risk with respect to section 1231 property or a section 988 transaction. Under § 1.1221– 2(b), a hedging transaction is defined as a transaction that a taxpayer enters into in the normal course of its trade or business primarily to manage the risk of price changes or currency fluctuations with respect to ordinary property that is held or to be held by the taxpayer, or to manage the risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, by the taxpayer. Transactions that manage risks related to assets that would produce capital gain or loss on disposition (capital assets), or assets owned or liabilities owed by a related party, do not qualify as hedging transactions under § 1.1221– 2(b). To qualify as a bona fide hedging transaction, the transaction must be clearly identified as a hedging transaction before the end of the day on which the CFC acquired, originated, or entered into the transaction. See §§ 1.1221–2(f) and 1.954–2(a)(4)(ii)(A) and (B). Section 1.954–2(g)(2)(ii)(C) provides special rules for applying the business needs exclusion to CFCs that are regular dealers as defined in § 1.954–2(a)(4)(iv). Transactions in dealer property (as defined in § 1.954–2(a)(4)(v)) that are entered into by a CFC that is a regular dealer in such property in its capacity as a dealer are treated as directly related to the business needs of the CFC. See § 1.954–2(g)(2)(ii)(C)(1). In addition, an interest-bearing liability denominated in a nonfunctional currency and incurred by a regular dealer is treated as dealer property if it reduces the CFC’s currency risk with respect to dealer property and is identified on the CFC’s records as a liability treated as dealer property. See § 1.954–2(g)(2)(ii)(C)(2). A regular dealer is a CFC that regularly and actively offers to, and in fact does, purchase property from and sell property to unrelated customers in the ordinary course of business, or that regularly and actively offers to, and in fact does, enter into, assume, offset, assign or otherwise PO 00000 Frm 00011 Fmt 4702 Sfmt 4702 terminate positions in property with unrelated customers in the ordinary course of business. See § 1.954– 2(a)(4)(iv). 2. Use of Net Foreign Currency Losses Under section 954(c)(1)(D), although a foreign currency loss that does not qualify for the business needs exclusion reduces the amount of foreign currency gain that is included in FPHCI, an excess of foreign currency losses over foreign currency gains from section 988 transactions generally does not reduce FPHCI. Such a net foreign currency loss does, however, reduce earnings and profits for purposes of the current earnings and profits limitation on subpart F income in section 952(c)(1). Additionally, as described in Part D of this Background section, when an election under § 1.954–2(g)(3) or (4) is in effect, a foreign currency loss can reduce FPHCI or, in the case of an election under § 1.954–2(g)(3), another category of subpart F income. 3. Inapplicability of Business Needs Exclusion to Transactions and Property That Give Rise to Both Subpart F Income and Non-Subpart F Income In order for the business needs exclusion to apply to exclude foreign currency gain and loss from the computation of FPHCI, the foreign currency gain or loss must arise from a transaction or property that does not itself (and could not reasonably be expected to) give rise to any subpart F income other than foreign currency gain or loss. For example, foreign currency gains and losses related to the purchase and sale of inventory are excluded from the computation of FPHCI if none of the income from the purchase and sale is subpart F income under section 952. However, if the transaction or property gives rise to, or could reasonably be expected to give rise to, any amount of subpart F income (other than foreign currency gain or loss), none of the foreign currency gain or loss attributable to the transaction or property would qualify for the business needs exclusion. Thus, there is a cliff effect: If even a de minimis amount of income or gain from the transaction or property is subpart F income, the entire amount of the foreign currency gain or loss from the transaction or property, or from a bona fide hedging transaction with respect to the transaction or property, is included in the FPHCI computation. 4. Transactions That Manage the Risk of Currency Fluctuation in a Qualified Business Unit A CFC may conduct business through a qualified business unit (as defined in E:\FR\FM\19DEP1.SGM 19DEP1 sradovich on DSK3GMQ082PROD with PROPOSALS Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules § 1.989(a)–1) (QBU) that is not treated as a separate entity for federal income tax purposes, either because it is a branch or division of the CFC or because it is a business entity that is disregarded as separate from its owner. Although the QBU is not treated as a separate entity, it may have a functional currency under § 1.985–1 that is different from that of the CFC owner, with consequences for the determination of foreign currency gain and loss under sections 987 and 988. The QBU’s transactions in its own functional currency are not section 988 transactions of the CFC, and accordingly the CFC does not realize foreign currency gain or loss on such transactions. The CFC generally must, however, take into account under section 987 foreign currency gain or loss with respect to the QBU upon remittances from the QBU. For business and financial accounting reasons, a CFC may enter into transactions to manage the exchange rate risk associated with its net investment in its QBU. Under generally accepted accounting principles in the United States (U.S. GAAP), a majority owner of a business entity (parent corporation) must consolidate the accounts of the majority-owned entity, including a foreign entity, with its own accounts for purposes of financial reporting. Under U.S. GAAP, the income, assets, liabilities, and other financial results of foreign operations that are conducted in a functional currency that differs from the consolidated parent’s functional currency must be translated into the functional currency of the consolidated parent. Foreign currency gains or losses arising from the translation are recorded in a ‘‘cumulative translation adjustment’’ account and reported as a component of shareholders’ equity on the balance sheet. See generally Accounting Standards Codification (ASC) 830–30–45. Foreign currency gain or loss from transactions that effectively hedge the risk of currency fluctuations in the net equity investment in foreign operations also are recorded in the cumulative translation adjustment account. See ASC 815–35–35. A cumulative translation adjustment is not taken into account in computing the income of the consolidated group until the relevant operations are disposed of or liquidated. The transactions that a CFC uses to manage its exchange rate risk with respect to its net investment in a QBU are typically section 988 transactions. Thus, foreign currency gains or losses attributable to those transactions are taken into account in computing FPHCI, unless the transactions qualify as bona VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 fide hedging transactions that satisfy the requirements of the business needs exclusion. See § 1.954–2(g)(2)(ii)(B)(2). Neither the Code nor the section 954 regulations provide specific guidance on whether a transaction entered into to manage exchange rate risk arising from a CFC’s net investment in a QBU can qualify as a bona fide hedging transaction eligible for the business needs exclusion. This issue can be consequential because foreign currency gain, but not loss, from a transaction erroneously identified as a bona fide hedging transaction is included in the computation of FPHCI, unless the CFC qualifies for the inadvertent identification exception. See § 1.954– 2(a)(4)(ii)(C) and (g)(2)(ii)(B)(2). Additionally, even if a transaction entered into to manage exchange rate risk arising from a CFC’s net investment in a QBU is eligible for treatment as a bona fide hedging transaction, the transaction would not qualify for the business needs exclusion unless the hedged property did not, and could not reasonably be expected to, give rise to any subpart F income. Also for business and financial accounting reasons, a CFC may enter into transactions to manage the exchange rate risk with respect to its net investment in a subsidiary CFC. A transaction that manages the risk of price or currency fluctuation with respect to a CFC’s net investment in a subsidiary CFC is not considered a hedging transaction for federal income tax purposes. In Hoover Co. v. Commissioner, 72 T.C. 706 (1979), the Tax Court held that transactions entered into to manage the risk of a decline in value of a taxpayer’s net investment in a foreign subsidiary that might occur if the value of the subsidiary’s functional currency declined relative to the U.S. dollar were not hedging transactions for federal income tax purposes. See also § 1.1221–2(b) (providing that a hedging transaction must manage risk with respect to ‘‘ordinary property . . . that is held or to be held by the taxpayer’’). Thus, foreign currency gains and losses on transactions that manage the risk of currency fluctuation on a CFC’s net investment in a subsidiary CFC are taken into account in computing FPHCI. B. Timing of Foreign Currency Gains and Losses 1. Hedge Timing Rules of § 1.446–4 Section 1.446–4 generally requires gain or loss from a hedging transaction, as defined in § 1.1221–2(b), to be taken into account at the same time as the gain or loss from the item being hedged. As noted in Part A.1 of this Background PO 00000 Frm 00012 Fmt 4702 Sfmt 4702 60137 section, bona fide hedging transactions under § 1.954–2(a)(4)(ii) include both hedging transactions as defined in § 1.1221–2(b) and transactions that manage the risk of price or currency fluctuation with respect to section 1231 property and section 988 transactions. Thus, § 1.446–4 does not explicitly apply to all bona fide hedging transactions, which has led to some uncertainty about whether gain or loss from a bona fide hedging transaction that is not described in § 1.1221–2(b) is properly taken into account in the same taxable year as gain or loss on the hedged item. The Department of the Treasury (Treasury Department) and the IRS understand that some taxpayers have applied the hedge timing rules of § 1.446–4 to all bona fide hedging transactions, irrespective of whether those transactions are hedging transactions as defined in § 1.1221–2(b). 2. Treasury Center CFCs It is common for a U.S.-parented multinational group to own one or more CFCs that serve as financing entities for other group members. Such CFCs (treasury center CFCs) may borrow in various currencies from third party lenders or from other members of the group and lend the proceeds to other members of the group. Treasury center CFCs also may be used to centralize the management of currency and other risks of other CFCs within the multinational group. Treasury center CFCs typically qualify as securities dealers under section 475, but if a treasury center CFC transacts primarily or exclusively with related persons, as is often the case, it would not qualify as a regular dealer under § 1.954–2(a)(4)(iv) and thus would not be eligible for the special rules applying the business needs exclusion to certain transactions of regular dealers under § 1.954– 2(g)(2)(ii)(C). When a treasury center CFC borrows nonfunctional currency from related or unrelated parties and makes loans denominated in that nonfunctional currency to a related CFC, the foreign currency gain or loss attributable to the principal amount borrowed by the treasury center CFC will economically offset all or a portion of the foreign currency loss or gain, respectively, attributable to the lending activity. Similarly, the foreign currency gain or loss attributable to the treasury center CFC’s accrual of interest income and expense with respect to its lending and borrowing activities, respectively, will offset each other, in whole or in part. Thus, by borrowing and lending in the same nonfunctional currency, a treasury E:\FR\FM\19DEP1.SGM 19DEP1 sradovich on DSK3GMQ082PROD with PROPOSALS 60138 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules center CFC is said to be ‘‘naturally hedged.’’ Although foreign currency gain and loss attributable to lending and borrowing transactions that are denominated in the same nonfunctional currency will typically partially or fully economically offset, the applicable tax accounting methods may cause the treasury center CFC to recognize a gain and an offsetting loss in different taxable years. If a treasury center CFC qualifies as a dealer under section 475, for example because it regularly purchases debt from related CFCs in the ordinary course of a trade or business, the treasury center CFC generally must use a mark-to-market method of accounting for its securities. See section 475 and § 1.475(c)–1(a)(3)(i). However, § 1.475(c)–2(a)(2) provides that a dealer’s own issued debt liabilities are not securities for purposes of section 475. Thus, a treasury center CFC that funds its nonfunctional currency lending activities in whole or in part by issuing matching nonfunctional currency debt must mark to market its loan receivables and generally will include any foreign currency gain or loss recognized as a result of the mark to market in the computation of FPHCI each year, but, pursuant to § 1.475(c)– 2(a)(2), offsetting foreign currency loss or gain, respectively, on its borrowing transactions generally is not taken into account until principal and interest is paid. Moreover, the rule in § 1.1221– 2(d)(5) prohibits taxpayers from treating the purchase or sale of a debt instrument as a hedging transaction, which will generally prevent a treasury center CFC from relying on the § 1.446– 4 hedge timing rules to match foreign currency gains and losses on borrowing transactions and loan receivables. The resulting mismatch in the timing of offsetting foreign currency gains and losses may have significant adverse consequences on the computation of the treasury center CFC’s subpart F income because, as discussed in Part A.2 of this Background section, a foreign currency loss generally will not reduce the CFC’s subpart F income except to the extent there are other foreign currency gains in the year the loss is recognized. Treasury and the IRS understand that some taxpayers have taken the position that the offsetting foreign currency gains and losses on the naturally hedged nonfunctional currency loans and borrowings may be taken into account in the same taxable years. VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 C. Foreign Currency Gain or Loss on Interest-Bearing Liabilities and Related Hedging Transactions As explained in Part A.3 of this Background section, the business needs exclusion does not apply to foreign currency gain or loss with respect to a transaction or property if any subpart F income arises, or could reasonably be expected to arise, from the transaction or property. § 1.954–2(g)(2)(ii)(B)(2). However, § 1.954–2(g)(2)(iii) provides a special rule for foreign currency gain or loss arising from an interest-bearing liability. Under § 1.954–2(g)(2)(iii), such foreign currency gain or loss generally is characterized as subpart F income and non-subpart F income in the same manner that interest expense associated with the liability would be allocated and apportioned between subpart F income and non-subpart F income under §§ 1.861–9T and 1.861–12T. Section 1.954–2(g) does not provide a corresponding rule for a bona fide hedging transaction with respect to an interest-bearing liability. However, § 1.861–9T(b)(2) and (b)(6) provide rules that allocate foreign currency gain or loss on certain hedging transactions in the same manner as interest expense. A foreign currency gain or loss arising from a transaction that hedges an interest-bearing liability and that is not governed by § 1.861–9T is subject to the general rule of § 1.954–2(g)(2)(ii)(B)(2) and its ‘‘cliff effect.’’ Consequently, although the foreign currency gain or loss on the hedge of an interest-bearing liability economically offsets the foreign currency loss or gain on that liability, the interaction of the regulations under sections 861 and 954 could result in different allocations of foreign currency gains and losses between subpart F income and non-subpart F income. foreign base company sales income category for purposes of determining subpart F income. This election associates foreign currency gain or loss that otherwise would be included in the computation of FPHCI with the categories of subpart F income and foreign base company income to which it relates and allows net foreign currency losses with respect to a category to reduce the income in that category. For this treatment to apply, however, the relationship between the foreign currency gain or loss and the category of income must be clearly determinable from the CFC’s records. See § 1.954–2(g)(3)(i)(A). Under the second election, the controlling United States shareholders of a CFC may elect to include in the computation of FPHCI all foreign currency gain or loss attributable to any section 988 transaction (except a transaction in which gain or loss is treated as capital gain or loss under section 988(a)(1)(B)) and to certain section 1256 contracts. See § 1.954– 2(g)(4). When this election is in effect, net foreign currency loss reduces gross income in other categories of FPHCI. Controlling United States shareholders typically make the § 1.954–2(g)(4) election if a CFC has relatively little net foreign currency gain or loss. In those circumstances, the administrative burden of tracing foreign currency gain and loss to specific transactions or property, as is required under the business needs exclusion and the § 1.954–2(g)(3) election, may outweigh the benefit of those provisions. As the CFC’s foreign currency gain or loss becomes more significant, the net benefit of the business needs exclusion or the § 1.954–2(g)(3) election may increase and the relative benefit of the § 1.954–2(g)(4) election may decrease. D. Elections To Treat Foreign Currency Gain or Loss as a Specific Category of Subpart F Income or FBCI or FPHCI Section 1.954–2 provides two elections with respect to foreign currency gains or losses. Under the first election, the controlling United States shareholders of a CFC may elect to include foreign currency gain or loss that relates to a specific category of subpart F income or, in the case of FBCI, a specific subcategory of FBCI described in § 1.954–1(c)(1)(iii)(A)(1) or (2), in that category of subpart F income or FBCI, rather than in FPHCI. See § 1.954– 2(g)(3). Thus, for example, under this election, foreign currency gain or loss on a transaction that hedges currency risk with respect to transactions that result in foreign base company sales income would be included in the Explanation of Provisions PO 00000 Frm 00013 Fmt 4702 Sfmt 4702 A. Business Needs Exclusion 1. Transactions and Property That Give Rise to Both Subpart F Income and NonSubpart F Income The Treasury Department and the IRS believe that foreign currency gain or loss arising from a transaction or property, or from a bona hedging transaction with respect to such a transaction or property, should be eligible for the business needs exclusion to the extent the transaction or property generates non-subpart F income. Accordingly, proposed § 1.954–2(g)(2)(ii)(C)(1) provides that foreign currency gain or loss attributable to a transaction or property that gives rise to both subpart F income and non-subpart F income, and that otherwise satisfies the E:\FR\FM\19DEP1.SGM 19DEP1 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules requirements of the business needs exclusion, is allocated between subpart F income and non-subpart F income in the same proportion as the income from the underlying transaction or property. As a result, the amount of foreign currency gain or loss allocable to nonsubpart F income qualifies for the business needs exclusion, and the amount allocable to subpart F income is taken into account in computing FPHCI. Under proposed § 1.954–2(g)(2)(ii)(C)(1), the entire foreign currency gain or loss arising from property that does not give rise to income (as defined in § 1.954– 2(e)(3)), or from a bona fide hedging transaction with respect to such property, is attributable to subpart F income because any gain upon a disposition of such property would be subpart F income. sradovich on DSK3GMQ082PROD with PROPOSALS 2. Hedges of Net Investment in a QBU The Treasury Department and the IRS believe that a transaction that manages exchange rate risk with respect to a CFC’s net investment in a QBU that is not treated as a separate entity for federal income tax purposes should qualify for the business needs exclusion to the extent the underlying property of the QBU does not give rise to subpart F income. Accordingly, proposed § 1.954– 2(g)(2)(ii)(C)(2) provides that the qualifying portion of any foreign currency gain or loss that arises from a ‘‘financial statement hedging transaction’’ with respect to a QBU and that is allocable to non-subpart F income is directly related to the business needs of a CFC. A financial statement hedging transaction is defined as a transaction that is entered into by a CFC for the purpose of managing exchange rate risk with respect to part or all of that CFC’s net investment in a QBU that is included in the consolidated financial statements of a United States shareholder of the CFC or a corporation that directly or indirectly owns such United States shareholder. The qualifying portion is defined as the amount of foreign currency gain or loss arising from a financial statement hedging transaction that is properly accounted for under U.S. GAAP as a cumulative foreign currency translation adjustment to shareholders’ equity. The qualifying portion of any foreign currency gain or loss arising from a financial statement hedging transaction must be allocated between subpart F income and non-subpart F income using the principles of § 1.987–6(b). The amount of the qualifying portion allocated to non-subpart F income qualifies for the business needs exclusion. VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 The proposed amendment to § 1.446– 4(a), discussed in Part B.1 of this Explanation of Provisions section, provides that a bona fide hedging transaction (as defined in § 1.954– 2(a)(4)(ii)) is subject to the hedge timing rules of § 1.446–4. Additionally, as noted earlier, proposed § 1.954– 2(g)(2)(ii)(C)(2) provides that part or all of the qualifying portion of any foreign currency gain or loss arising from a financial statement hedging transaction is eligible for the business needs exclusion. However, financial statement hedging transactions are not included in the definition of bona fide hedging transaction under § 1.954–2(a)(4)(ii), as proposed to be amended pursuant to these proposed regulations. Thus, foreign currency gain or loss arising from a financial statement hedging transaction is not subject to the hedge timing rules of § 1.446–4 and is taken into account in accordance with the taxpayer’s method of accounting. Generally, a taxpayer’s financial statement hedging transaction is a section 988 transaction with respect to the taxpayer. Accordingly, to the extent that the taxpayer elects to use a markto-market method of accounting for section 988 gain or loss under proposed § 1.988–7, and also makes the annual deemed termination election described in § 1.987–8T(d), the taxpayer generally would recognize annually foreign currency gain or loss from both the financial statement hedging transaction and the QBU with respect to which exchange rate risk is managed. The Treasury Department and the IRS request comments regarding whether the hedge timing rules of § 1.446–4 should apply to a financial statement hedging transaction (as defined in proposed § 1.954–2(g)(2)(ii)(C)(2)) with respect to section 987 QBUs with respect to which no annual deemed termination election is in effect, and, if so, how the appropriate matching should be achieved. The Treasury Department and the IRS also request comments regarding whether the business needs exclusion should apply to a transaction that is entered into for the purpose of managing the risk of foreign currency fluctuation with respect to a CFC’s net investment in a subsidiary CFC. Comments are requested regarding how the gain or loss on such a transaction could or should be allocated between subpart F and non-subpart F income and whether and how the gain or loss could or should be matched with the foreign currency gain or loss on the ‘‘hedged’’ item. The Treasury Department and the IRS are aware that a CFC may enter into a PO 00000 Frm 00014 Fmt 4702 Sfmt 4702 60139 transaction that manages exchange rate risk arising from a disregarded loan to a QBU. The Treasury Department and the IRS understand that, for U.S. GAAP purposes, exchange gain or loss with respect to a transaction that manages exchange rate risk with respect to the disregarded loan generally would not be reflected as a cumulative foreign currency translation adjustment. For federal income tax purposes, the loan would be disregarded, and exchange gain or loss on the hedging transaction potentially could be subpart F income. The Treasury Department and the IRS request comments regarding whether, taking into account the amendments in the proposed regulations, additional amendments to the business needs exclusion are appropriate to account for foreign currency gain or loss arising from a transaction that is entered into for the purpose of managing the risk of foreign currency fluctuation with respect to disregarded transactions, including disregarded loans, between a CFC and its QBU. Specifically, comments are requested regarding how the foreign currency gain or loss on such a hedging transaction could or should be allocated between subpart F and nonsubpart F income and when such foreign currency gain or should be recognized. B. Timing of Foreign Currency Gains and Losses 1. Extension of § 1.446–4 Hedge Timing Rules to Bona Fide Hedging Transactions The proposed amendment to § 1.446– 4(a) extends the hedge timing rules of § 1.446–4 to all bona fide hedging transactions as defined in § 1.954– 2(a)(4)(ii). Although this amendment will be particularly useful in connection with foreign currency gains and losses from bona fide hedging transactions of treasury center CFCs, the amendment will eliminate timing mismatches for gains and losses arising from all bona fide hedging transactions and from the hedged property or transaction. In addition, proposed § 1.954– 2(a)(4)(ii) revises the definition of a bona fide hedging transaction to permit the acquisition of a debt instrument by a CFC to be treated as a bona fide hedging transaction with respect to an interest-bearing liability of the CFC, provided that the acquisition of the debt instrument has the effect of managing the CFC’s exchange rate risk with respect to the liability within the meaning of § 1.1221–2(c)(4) and (d), determined without regard to § 1.1221– 2(d)(5), and otherwise meets the requirements of a bona fide hedging E:\FR\FM\19DEP1.SGM 19DEP1 60140 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules sradovich on DSK3GMQ082PROD with PROPOSALS transaction. If a CFC, including a treasury center CFC, identifies a debt instrument that manages exchange rate risk as a hedge of an interest-bearing liability, the foreign currency gain or loss arising from that debt instrument will be taken into account under § 1.446–4 at the same time as the foreign currency gain or loss arising from the hedged interest-bearing liability. Treating a debt instrument as a hedge of an interest-bearing liability, rather than treating the interest-bearing liability as a hedge of the debt instrument, is consistent with the principles underlying § 1.861–9T(b)(2), which allocates and apportions foreign currency gain or losses on a transaction that hedges an interest-bearing liability in the same manner as interest expense with respect to the liability is allocated and apportioned. See part C of this Explanation of Provisions section for further discussion of the impact of this rule on the allocation of foreign currency gain or loss on a debt instrument between subpart F income and non-subpart F income. 2. Elective Mark-to-Market Method of Accounting for Foreign Currency Gain and Loss Proposed § 1.988–7 permits a taxpayer, including a CFC, to elect to use a mark-to-market method of accounting for section 988 gain or loss with respect to section 988 transactions, including becoming an obligor under an interest-bearing liability. This elective mark-to-market method of accounting takes into account only changes in the value of the section 988 transaction attributable to exchange rate fluctuations and does not take into account changes in value due to other factors, such as changes in market interest rates or the creditworthiness of the borrower. The proposed regulations require appropriate adjustments to be made to prevent section 988 gain or loss taken into account under the mark-tomarket method of accounting from being taken into account again under section 988 or another provision of the Code. This election is available to any taxpayer but is expected to be particularly relevant in the case of a treasury center CFC. A treasury center CFC that uses a mark-to-market method for securities under section 475 and that makes the election under proposed § 1.988–7 will be able to match the timing of foreign currency gain or loss with respect to an interest-bearing liability (such as a loan from a related or unrelated party) with economically offsetting foreign currency loss or gain arising from its nonfunctional currencydenominated assets (such as a VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 receivable from a related party). Whether the corresponding foreign currency gains and losses qualify for the business needs exclusion is determined under the rules of § 1.954–2(g)(2), as proposed to be amended pursuant to these proposed regulations. Thus, if the foreign currency gains or losses do not fully offset each other, the difference may increase or decrease the CFC’s FPHCI. However, the election under proposed § 1.988–7 does not apply to the following: (1) Any securities that are marked to market under any other provision; (2) any securities that, pursuant to an election or an identification made by the taxpayer, are excepted from mark-to-market treatment under any other provision; (3) any transactions of a QBU that is subject to section 987; or (4) any section 988 transactions denominated in, or determined by reference to, a hyperinflationary currency. The election applies for the year in which the election is made and all subsequent taxable years unless it is revoked by the Commissioner or the taxpayer or, in the case of a CFC, the controlling domestic shareholders of the CFC. Proposed § 1.988–7(d) permits a taxpayer or CFC to revoke the election to use a mark-to-market method of accounting for foreign currency gains or losses on section 988 transactions at any time. A subsequent election cannot be made until the sixth taxable year following the year of revocation and cannot be revoked until the sixth taxable year following the year of such subsequent election. C. Hedges of Exchange Rate Risk Arising From an Interest-Bearing Liability The Treasury Department and the IRS believe that it is appropriate to require foreign currency gain or loss from transactions that have the effect of managing exchange rate risk arising from an interest-bearing liability to be allocated between subpart F income and non-subpart F income in the same manner as the foreign currency gain or loss on the hedged liability. Accordingly, the proposed amendments to § 1.954–2(g)(2)(iii) require foreign currency gains and losses arising from a transaction or property (including debt instruments) that manages exchange rate risk with respect to an interest-bearing liability to be allocated and apportioned between subpart F income and nonsubpart F income in the same manner that foreign currency gain or loss from the interest-bearing liability would be allocated and apportioned. As noted in Part B.1 of this Explanation of Provisions, the proposed amendment to § 1.954–2(a)(4)(ii) revises the definition PO 00000 Frm 00015 Fmt 4702 Sfmt 4702 of a bona fide hedging transaction to permit the acquisition of a debt instrument by a CFC to be treated as a bona fide hedging transaction with respect to an interest-bearing liability of the CFC under certain circumstances. As a result of that proposed amendment and the amendment described in this Part C, if a CFC identifies a debt instrument that manages exchange rate risk as a hedge of an interest-bearing liability, the foreign currency gain or loss arising from that debt instrument will be allocated between subpart F income and non-subpart F income in the same manner as the foreign currency gain or loss arising from the hedged interest-bearing liability. Thus, the proposed amendments to the regulations permit a CFC that timely and properly identifies a debt instrument as a hedge of an interestbearing liability to alleviate the character mismatch that may occur under the existing regulations, as described in Part C of the Background section of this preamble. The proposed amendments to § 1.954–2(g)(2)(iii) also clarify that the special rules in that paragraph apply to foreign currency gain or loss arising from an interestbearing liability, or from a bona fide hedging transaction with respect to the liability, in lieu of the general rule of the business needs exclusion in § 1.954– 2(g)(2)(ii). D. Revocation of Election To Treat Foreign Currency Gain or Loss as a Specific Category of Subpart F Income or as FPHCI Proposed § 1.954–2(g)(3)(iii) permits a CFC to revoke its election under § 1.954–2(g)(3) (to characterize foreign currency gain or loss that arises from a specific category of subpart F income as gain or loss in that category) at any time without securing the prior consent of the Commissioner. Similarly, proposed § 1.954–2(g)(4)(iii) permits a CFC to revoke its election under § 1.954–2(g)(4) (to treat all foreign currency gain or loss as FPHCI) at any time without securing the prior consent of the Commissioner. The Treasury Department and the IRS remain concerned about CFCs frequently changing these elections without a substantial business reason but also believe that the ability of a taxpayer to automatically revoke these elections would promote sound tax administration. Therefore, the proposed regulations provide that, if an election has been revoked under proposed § 1.954–2(g)(3)(iii) or proposed § 1.954– 2(g)(4)(iii), a subsequent election cannot be made until the sixth taxable year following the year of revocation and any subsequent election cannot be revoked E:\FR\FM\19DEP1.SGM 19DEP1 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules until the sixth year following the year of such subsequent election. sradovich on DSK3GMQ082PROD with PROPOSALS E. Applicability Dates The proposed amendments generally are proposed to apply to taxable years ending on or after the date the proposed regulations are published as final regulations in the Federal Register. However, the proposed amendments to §§ 1.446–4(a), 1.954–2(a)(4)(ii)(A), 1.954–2(g)(2)(ii)(C)(1), and 1.954– 2(g)(2)(iii) are proposed to apply to bona fide hedging transactions entered into on or after the date the proposed regulations are published as final regulations in the Federal Register. A taxpayer may rely on any of the proposed amendments, other than the amendments to §§ 1.446–4(a), 1.954– 2(a)(4)(ii)(A), 1.954–2(g)(2)(ii)(C)(1), and 1.954–2(g)(2)(iii), insofar as each applies to a bona fide hedging transaction, for taxable years ending on or after December 19, 2017, provided the taxpayer consistently applies the proposed amendment for all such taxable years that end before the first taxable year ending on or after the date the proposed regulations are published as final regulations in the Federal Register. A taxpayer may rely on any of the proposed amendments to §§ 1.446– 4(a), 1.954–2(a)(4)(ii)(A), 1.954– 2(g)(2)(ii)(C)(1), and 1.954–2(g)(2)(iii) with respect to a bona fide hedging transaction entered into on or after December 19, 2017 and prior to the applicability date, provided the taxpayer consistently applies the proposed amendment to all bona fide hedging transactions entered into on or after December 19, 2017 and prior to the date that these regulations are published as final regulations in the Federal Register. 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 impact assessment is not required. It is hereby certified that the collection of information requirement will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations primarily will affect domestic corporations that have foreign operations, which tend to be larger businesses, and that the average burden is minimal. Accordingly, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f), this notice of proposed rulemaking has been submitted to the Chief Counsel for VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 Advocacy of the Small Business Administration for comment on its impact on small business. Comments and Requests for Public Hearing Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under ADDRESSES. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request. A public hearing will be scheduled if requested in writing by any person that timely submits comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register. Drafting Information The principal author of these regulations is Jeffery G. Mitchell 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. Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is proposed to be amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 continues to read in part as follows: ■ Authority: 26 U.S.C. 7805 * * * Section 1.954–2 also issued under 26 U.S.C. 954(b) and (c). * * * Section 1.988–7 also issued under 26 U.S.C. 446, 988(d), and 989(c). * * * Par. 2. Section 1.446–4 is amended by: ■ 1. Revising the first sentence of paragraph (a). ■ 2. Revising the heading of paragraph (g) and adding a sentence at the end of paragraph (g). ■ 3. Removing paragraph (h). The revisions and addition read as follows: ■ § 1.446–4 Hedging transactions. (a) In general. Except as provided in this paragraph (a), a hedging transaction as defined in § 1.1221–2(b) (whether or not the character of gain or loss from the transaction is determined under § 1.1221–2) and a bona fide hedging PO 00000 Frm 00016 Fmt 4702 Sfmt 4702 60141 transaction as defined in § 1.954– 2(a)(4)(ii) must be accounted for under the rules of this section. * * * * * * * * (g) Applicability date. * * * This section applies to a bona fide hedging transaction (as defined in § 1.954– 2(a)(4)(ii)) entered into on or after the date that these regulations are published as final regulations in the Federal Register. ■ Par. 3. Section 1.954–0(b) is amended by: ■ 1. Redesignating the entry for § 1.954– 2(g)(2)(ii)(D) as the entry for § 1.954– 2(g)(2)(ii)(E). ■ 2. Redesignating the entries for § 1.954–2(g)(2)(ii)(C), (g)(2)(ii)(C)(1), (g)(2)(ii)(C)(2), (g)(2)(ii)(C)(2)(i), (g)(2)(ii)(C)(2)(ii), and (g)(2)(ii)(C)(2)t(iii) as the entries for § 1.954–2(g)(2)(ii)(D), (g)(2)(ii)(D)(1), (g)(2)(ii)(D)(2), (g)(2)(ii)(D)(2)(i), (g)(2)(ii)(D)(2)(ii), and (g)(2)(ii)(D)(2)(iii), respectively. ■ 3. Adding new entries for § 1.954– 2(g)(2)(ii)(C), (g)(2)(ii)(C)(1), and (g)(2)(ii)(C)(2). ■ 4. Revising the entry for § 1.954– 2(g)(2)(iii). The additions and revision read as follows: § 1.954–0 * Introduction. * * (b) * * * * * § 1.954–2 Foreign personal holding company income. * * * * * (g) * * * (2) * * * (ii) * * * (C) Foreign currency gains and losses arising from a transaction or property that gives rise to both non-subpart F income and subpart F income or from a bona fide hedging transaction with respect to such a transaction or property. (1) In general. (2) Financial statement hedging transaction with respect to the net investment in a qualified business unit. * * * * * (iii) Special rule for foreign currency gain or loss from an interest-bearing liability and bona fide hedges of an interest-bearing liability. * * * * * ■ Par. 4. Section 1.954–2 is amended by: ■ 1. Adding a sentence after the first sentence in paragraph (a)(4)(ii)(A). ■ 2. Redesignating paragraph (g)(2)(ii)(D) as paragraph (g)(2)(ii)(E). ■ 3. Redesignating paragraph (g)(2)(ii)(C) as paragraph (g)(2)(ii)(D). ■ 4. In newly redesignated paragraph (g)(2)(ii)(D)(2)(i), removing ‘‘paragraph E:\FR\FM\19DEP1.SGM 19DEP1 60142 Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules (g)(2)(ii)(C)’’ and adding ‘‘paragraph (g)(2)(ii)(D)’’ in its place and removing ‘‘paragraph (g)(2)(ii)(C)(1)’’ and adding ‘‘paragraph (g)(2)(ii)(D)(1)’’ in its place. ■ 5. In newly redesignated paragraph (g)(2)(ii)(D)(2)(ii), removing ‘‘paragraph (g)(2)(ii)(C)(2)(i)’’ and adding ‘‘paragraph (g)(2)(ii)(D)(2)(i)’’ each place it appears. ■ 6. In newly redesignated paragraph (g)(2)(ii)(D)(2)(iii), removing ‘‘paragraph (g)(2)(ii)(C)(2)’’ and adding ‘‘paragraph (g)(2)(ii)(D)(2)’’ in its place. ■ 7. Adding new paragraph (g)(2)(ii)(C). ■ 8. Revising paragraph (g)(2)(iii). ■ 9. Revising paragraph (g)(3)(iii). ■ 10. Revising paragraph (g)(4)(iii). ■ 11. Adding two sentences after the third sentence in paragraph (i)(2). The additions and revisions read as follows: sradovich on DSK3GMQ082PROD with PROPOSALS § 1.954–2 Foreign personal holding company income. (a) * * * (4) * * * (ii) * * * (A) * * * Additionally, the acquisition of a debt instrument by a controlled foreign corporation may be treated as a bona fide hedging transaction with respect to an interestbearing liability of the controlled foreign corporation, provided that the acquisition of the debt instrument has the effect of managing the controlled foreign corporation’s exchange rate risk with respect to the liability within the meaning of § 1.1221–2(c)(4) and (d), determined without regard to § 1.1221– 2(d)(5), and otherwise meets the requirements of paragraph (a)(4)(ii) of this section. * * * * * * * * (g) * * * (2) * * * (ii) * * * (C) Foreign currency gains and losses arising from a transaction or property that gives rise to both non-subpart F income and subpart F income or from a bona fide hedging transaction with respect to such a transaction or property—(1) In general. If a foreign currency gain or loss would be directly related to the business needs of the controlled foreign corporation pursuant to paragraph (g)(2)(ii)(B)(1) or (2) of this section except that it arises from a transaction or property that gives rise, or is reasonably expected to give rise, to both non-subpart F income and subpart F income (other than foreign currency gain or loss), or from a bona fide hedging transaction with respect to such a transaction or property, the amount of foreign currency gain or loss that is allocable to non-subpart F income under this paragraph (g)(2)(ii)(C)(1) is directly VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 related to the business needs of the controlled foreign corporation. The amount of foreign currency gain or loss arising from a transaction or property described in this paragraph (g)(2)(ii)(C)(1), or from a bona fide hedging transaction with respect to such a transaction or property, that is allocable to non-subpart F income equals the product of the total amount of foreign currency gain or loss arising from the transaction or property and the ratio of non-subpart F income (other than foreign currency gain or loss) that the transaction or property gives rise to, or is reasonably expected to give rise to, to the total income that the transaction or property gives rise to, or is reasonably expected to give rise to. However, none of the foreign currency gain or loss arising from property that does not give rise to income (as defined in paragraph (e)(3) of this section), or from a bona fide hedging transaction with respect to such property, is allocable to nonsubpart F income. (2) Financial statement hedging transaction with respect to a qualified business unit. If foreign currency gain or loss arises from a financial statement hedging transaction (as defined in this paragraph (g)(2)(ii)(C)(2)) with respect to a qualified business unit (as defined in § 1.989(a)–1) (QBU) of a controlled foreign corporation that is not treated as an entity separate from the controlled foreign corporation for federal income tax purposes, either because it is a branch or division of the controlled foreign corporation or because it is a business entity that is disregarded as separate from its owner under § 301.7701–3 of this chapter, the amount of the qualifying portion (as determined under this paragraph (g)(2)(ii)(C)(2)) of foreign currency gain or loss that is allocable to non-subpart F income under this paragraph (g)(2)(ii)(C)(2) is directly related to the business needs of the controlled foreign corporation. Generally, the controlled foreign corporation must allocate the qualifying portion of foreign currency gain or loss arising from the financial statement hedging transaction between subpart F income and non-subpart F income in the same proportion as it would characterize gain or loss determined under section 987 as subpart F income and non-subpart F income under the principles of § 1.987–6(b). A financial statement hedging transaction is a transaction that is entered into by a CFC for the purpose of managing exchange rate risk with respect to part or all of that CFC’s net investment in a QBU that is included in the consolidated financial statements of a United States PO 00000 Frm 00017 Fmt 4702 Sfmt 4702 shareholder of the CFC (or a corporation that directly or indirectly owns such United States shareholder). The qualifying portion of foreign currency gain or loss is the amount of foreign currency gain or loss arising from a financial statement hedging transaction that is properly accounted for under U.S. generally accepted accounting principles as a cumulative foreign currency translation adjustment to shareholders’ equity. * * * * * (iii) Special rule for foreign currency gain or loss from an interest-bearing liability and bona fide hedges of an interest-bearing liability. Except as provided in paragraph (g)(2)(ii)(D)(2) or (g)(5)(iv) of this section, foreign currency gain or loss arising from an interest-bearing liability is characterized as subpart F income and non-subpart F income in the same manner that interest expense associated with the liability would be allocated and apportioned between subpart F income and nonsubpart F income under §§ 1.861–9T and 1.861–12T. Likewise, foreign currency gain or loss arising from a bona fide hedging transaction entered into by the controlled foreign corporation that has the effect of managing exchange rate risk with respect to an interest-bearing liability that is not subject to paragraph (g)(2)(ii)(D)(2) (certain interest-bearing liabilities treated as dealer property) or (g)(5)(iv) (gain or loss allocated under § 1.861–9) of this section is characterized as subpart F income and non-subpart F income in the same manner that interest expense associated with the interest-bearing liability would be allocated and apportioned between subpart F income and non-subpart F income under §§ 1.861–9T and 1.861– 12T. Paragraph (g)(2)(ii) of this section does not apply to any foreign currency gain or loss described in this paragraph (g)(2)(iii). (3) * * * (iii) Revocation of election. This election is effective for the taxable year of the controlled foreign corporation for which it is made and all subsequent taxable years of such corporation unless revoked by the Commissioner or the controlling United States shareholders (as defined in § 1.964–1(c)(5)) of the controlled foreign corporation. The controlling United States shareholders of a controlled foreign corporation may revoke such corporation’s election at any time. If an election has been revoked under this paragraph (g)(3)(iii), a new election under paragraph (g)(3) of this section cannot be made until the sixth taxable year following the year in which the previous election was E:\FR\FM\19DEP1.SGM 19DEP1 sradovich on DSK3GMQ082PROD with PROPOSALS Federal Register / Vol. 82, No. 242 / Tuesday, December 19, 2017 / Proposed Rules revoked, and such subsequent election cannot be revoked until the sixth taxable year following the year in which the subsequent election was made. The controlling United States shareholders revoke an election on behalf of a controlled foreign corporation by filing a statement that clearly indicates such election has been revoked with their original or amended income tax returns for the taxable year of such United States shareholders ending with or within the taxable year of the controlled foreign corporation for which the election is revoked. * * * * * (4) * * * (iii) Revocation of election. This election is effective for the taxable year of the controlled foreign corporation for which it is made and all subsequent taxable years of such corporation unless revoked by the Commissioner or the controlling United States shareholders (as defined in § 1.964–1(c)(5)) of the controlled foreign corporation. The controlling United States shareholders of a controlled foreign corporation may revoke such corporation’s election at any time. If an election has been revoked under this paragraph (g)(4)(iii), a new election under paragraph (g)(4) of this section cannot be made until the sixth taxable year following the year in which the previous election was revoked, and such subsequent election cannot be revoked until the sixth taxable year following the year in which the subsequent election was made. The controlling United States shareholders revoke an election on behalf of a controlled foreign corporation by filing a statement that clearly indicates such election has been revoked with their original or amended income tax returns for the taxable year of such United States shareholders ending with or within the taxable year of the controlled foreign corporation for which the election is revoked. * * * * * (i) * * * (2) Other paragraphs. * * * The second sentence of paragraph (a)(4)(ii)(A), paragraph (g)(2)(ii)(C)(1), and the second sentence of paragraph (g)(2)(iii) apply to a bona fide hedging transaction entered into on or after the date the proposed regulations are published as final regulations in the Federal Register. Paragraphs (g)(2)(ii)(C) (other paragraph (g)(2)(ii)(C)(1), insofar as it applies to a bona fide hedging transaction), (g)(3)(iii), and (g)(4)(iii) of this section apply to taxable years of controlled foreign corporations ending on or after the date that these VerDate Sep<11>2014 16:10 Dec 18, 2017 Jkt 244001 regulations are published as final regulations in the Federal Register. ■ Par. 5. Section 1.988–7 is added to read as follows: § 1.988–7 Election to mark-to-market foreign currency gain or loss on section 988 transactions. (a) In general. Except as provided in paragraph (b) of this section, a taxpayer may elect under this section to apply the foreign currency mark-to-market method of accounting described in this section with respect to all section 988 transactions (including the acquisition and holding of nonfunctional currency described in section 988(c)(1)(C)(ii)). Under the foreign currency mark-tomarket method of accounting, the timing of section 988 gain or loss on section 988 transactions is determined under the principles of section 1256. Only section 988 gain or loss is taken into account under the foreign currency mark-to-market method of accounting. Consistent with section 1256(a)(2), 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. (b) Exceptions. The election described in paragraph (a) of this section does not apply to: (1) Any security, commodity, or section 1256 contract that is marked to market under any other provision, including section 475 or section 1256; (2) Any security, commodity, or section 1256 contract that, pursuant to an election or an identification made by the taxpayer, is excepted from mark-tomarket treatment under another provision, including section 475 or section 1256; (3) Any transaction of a qualified business unit (as defined in section 1.989(a)–1(b)) that is subject to section 987; or (4) Any section 988 transaction denominated in, or determined by reference to, a hyperinflationary currency. See § 1.988–2(b)(15), (d)(5), and (e)(7) for rules relating to such transactions. (c) Time and manner of election. A taxpayer makes the election under paragraph (a) of this section by filing a statement that clearly indicates that PO 00000 Frm 00018 Fmt 4702 Sfmt 9990 60143 such election has been made with the taxpayer’s timely-filed original federal income tax return for the taxable year for which the election is made. In the case of a controlled foreign corporation, the controlling United States shareholders (as defined in § 1.964– 1(c)(5)) make the election under paragraph (a) of this section on behalf of the controlled foreign corporation by filing a statement that clearly indicates that such election has been made with their timely-filed, original federal income tax returns for the taxable year of such United States shareholders ending with or within the taxable year of the controlled foreign corporation for which the election is made. (d) Revocation and subsequent election. A taxpayer may revoke its election under paragraph (a) of this section at any time. If an election has been revoked under this paragraph (d), a new election under paragraph (a) of this section cannot be made until the sixth taxable year following the year in which the previous election was revoked, and such subsequent election cannot be revoked until the sixth taxable year following the year in which the subsequent election was made. A taxpayer revokes the election by filing a statement that clearly indicates that such election has been revoked with its original or amended federal income tax return for the taxable year for which the election is revoked. In the case of a controlled foreign corporation, the controlling United States shareholders revoke the election on behalf of the controlled foreign corporation by filing a statement that clearly indicates that such election has been revoked with their original or amended federal income tax returns for the taxable year of such United States shareholders ending with or within the taxable year of the controlled foreign corporation for which the election is revoked. (e) Applicability dates. This section applies to taxable years of taxpayers (including controlled foreign corporations) ending on or after the date these regulations are published as final regulations in the Federal Register. Kirsten Wielobob, Deputy Commissioner for Services and Enforcement. [FR Doc. 2017–27320 Filed 12–18–17; 8:45 am] BILLING CODE 4830–01–P E:\FR\FM\19DEP1.SGM 19DEP1

Agencies

[Federal Register Volume 82, Number 242 (Tuesday, December 19, 2017)]
[Proposed Rules]
[Pages 60135-60143]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-27320]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-119514-15]
RIN 1545-BM80


Exclusion of Foreign Currency Gain or Loss Related to Business 
Needs From Foreign Personal Holding Company Income; Mark-to-Market 
Method of Accounting for Section 988 Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance on the treatment of foreign currency gain or loss of a 
controlled foreign corporation (CFC) under the business needs exclusion 
from foreign personal holding company income (FPHCI). The proposed 
regulations also provide an election for a taxpayer to use a mark-to-
market method of accounting for foreign currency gain or loss 
attributable to section 988 transactions. In addition, the proposed 
regulations permit the controlling United States shareholders of a CFC 
to automatically revoke certain elections concerning the treatment of 
foreign currency gain or loss. The proposed regulations affect 
taxpayers and United States shareholders of CFCs that engage in 
transactions giving rise to foreign currency gain or loss under section 
988 of the Internal Revenue Code (Code).

DATES: Written or electronic comments and requests for a public hearing 
must be received by March 19, 2018.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-119514-15), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
119514-15), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW, Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-119514-15).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jeffery G. Mitchell, (202) 317-6934; concerning submissions of comments 
or requests for a public hearing, Regina Johnson, (202) 317-6901 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, 
Washington, DC 20224. Comments on the collection of information should 
be received by February 20, 2018.
    Comments are specifically requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the duties of the IRS, including whether the 
information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information;
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchases of services to provide information.
    The collection of information in these proposed regulations is in 
proposed Sec. Sec.  1.954-2(g)(3)(iii) and (4)(iii) and 1.988-7. The 
information is required to be provided by taxpayers and United States 
shareholders of CFCs that make an election or revoke an election with 
respect to the treatment of foreign currency gains and losses. The 
information provided will be used by the IRS for tax compliance 
purposes.
    Estimated total annual reporting burden: 5,000 hours.
    Estimated average annual burden hours per respondent: One hour.
    Estimated number of respondents: 5,000.
    Estimated annual frequency of responses: One.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or 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 proposed amendments to 26 CFR part 1 under 
sections 446, 954(c)(1)(D), and 988 of the Code. Section 446 requires 
taxpayers to compute taxable income using accounting methods that 
clearly reflect income. Section 954(c)(1)(D) provides that FPHCI 
includes the excess of foreign currency gains over foreign currency 
losses (as defined in section 988(b)) attributable to section 988 
transactions, other than transactions directly related to the business 
needs of the CFC. Section 988 provides rules for determining the source 
and character of

[[Page 60136]]

gain or loss from certain foreign currency transactions.

A. Business Needs Exclusion

1. In General
    Section 954 defines foreign base company income (FBCI), which 
generally is income earned by a CFC that is taken into account in 
computing the amount that a United States shareholder of the CFC must 
include in income under section 951(a)(1)(A). Under section 954(a)(1), 
FBCI includes FPHCI, which is defined in section 954(c). The excess of 
foreign currency gains over foreign currency losses from section 988 
transactions is generally included in FPHCI pursuant to section 
954(c)(1)(D).
    Section 988 transactions generally include the following: The 
accrual of any item of income or expense that is to be paid or received 
in a nonfunctional currency after the date of accrual; lending or 
borrowing in a nonfunctional currency; entering into or acquiring a 
forward, future, option, or similar contract denominated in a 
nonfunctional currency; and the disposition of nonfunctional currency. 
See section 988(c). Thus, accruals in connection with ordinary business 
transactions, such as purchases and sales of inventory or the provision 
of services, are section 988 transactions if the receivable or payable 
is denominated in, or determined by reference to, a currency other than 
the taxpayer's functional currency, as determined under Sec.  1.985-1.
    Notwithstanding the general rule that includes the excess of 
foreign currency gains over foreign currency losses from section 988 
transactions in FPHCI, section 954(c)(1)(D) excludes from FPHCI any 
foreign currency gain or loss attributable to a transaction directly 
related to the business needs of the CFC (business needs exclusion). To 
qualify for the business needs exclusion, a foreign currency gain or 
loss must, in addition to satisfying other requirements, arise from a 
transaction entered into, or property used, in the normal course of the 
CFC's business that does not itself (and could not reasonably be 
expected to) give rise to subpart F income (as defined in section 952) 
other than foreign currency gain or loss. See Sec.  1.954-
2(g)(2)(ii)(B)(1).
    Foreign currency gain or loss attributable to a bona fide hedging 
transaction (as defined in Sec.  1.954-2(a)(4)(ii)) with respect to a 
transaction or property that qualifies for the business needs exclusion 
also qualifies for the business needs exclusion, provided that any gain 
or loss with respect to such transaction or property that is 
attributable to changes in exchange rates is clearly determinable from 
the records of the CFC as being derived from such property or 
transaction. See Sec.  1.954-2(g)(2)(ii)(B)(2). Generally, bona fide 
hedging transactions are transactions that meet the requirements for a 
hedging transaction under Sec.  1.1221-2(a) through (d), except that a 
bona fide hedging transaction also includes a transaction entered into 
in the normal course of business primarily to manage risk with respect 
to section 1231 property or a section 988 transaction. Under Sec.  
1.1221-2(b), a hedging transaction is defined as a transaction that a 
taxpayer enters into in the normal course of its trade or business 
primarily to manage the risk of price changes or currency fluctuations 
with respect to ordinary property that is held or to be held by the 
taxpayer, or to manage the risk of interest rate or price changes or 
currency fluctuations with respect to borrowings made or to be made, or 
ordinary obligations incurred or to be incurred, by the taxpayer. 
Transactions that manage risks related to assets that would produce 
capital gain or loss on disposition (capital assets), or assets owned 
or liabilities owed by a related party, do not qualify as hedging 
transactions under Sec.  1.1221-2(b). To qualify as a bona fide hedging 
transaction, the transaction must be clearly identified as a hedging 
transaction before the end of the day on which the CFC acquired, 
originated, or entered into the transaction. See Sec. Sec.  1.1221-2(f) 
and 1.954-2(a)(4)(ii)(A) and (B).
    Section 1.954-2(g)(2)(ii)(C) provides special rules for applying 
the business needs exclusion to CFCs that are regular dealers as 
defined in Sec.  1.954-2(a)(4)(iv). Transactions in dealer property (as 
defined in Sec.  1.954-2(a)(4)(v)) that are entered into by a CFC that 
is a regular dealer in such property in its capacity as a dealer are 
treated as directly related to the business needs of the CFC. See Sec.  
1.954-2(g)(2)(ii)(C)(1). In addition, an interest-bearing liability 
denominated in a nonfunctional currency and incurred by a regular 
dealer is treated as dealer property if it reduces the CFC's currency 
risk with respect to dealer property and is identified on the CFC's 
records as a liability treated as dealer property. See Sec.  1.954-
2(g)(2)(ii)(C)(2). A regular dealer is a CFC that regularly and 
actively offers to, and in fact does, purchase property from and sell 
property to unrelated customers in the ordinary course of business, or 
that regularly and actively offers to, and in fact does, enter into, 
assume, offset, assign or otherwise terminate positions in property 
with unrelated customers in the ordinary course of business. See Sec.  
1.954-2(a)(4)(iv).
2. Use of Net Foreign Currency Losses
    Under section 954(c)(1)(D), although a foreign currency loss that 
does not qualify for the business needs exclusion reduces the amount of 
foreign currency gain that is included in FPHCI, an excess of foreign 
currency losses over foreign currency gains from section 988 
transactions generally does not reduce FPHCI. Such a net foreign 
currency loss does, however, reduce earnings and profits for purposes 
of the current earnings and profits limitation on subpart F income in 
section 952(c)(1). Additionally, as described in Part D of this 
Background section, when an election under Sec.  1.954-2(g)(3) or (4) 
is in effect, a foreign currency loss can reduce FPHCI or, in the case 
of an election under Sec.  1.954-2(g)(3), another category of subpart F 
income.
3. Inapplicability of Business Needs Exclusion to Transactions and 
Property That Give Rise to Both Subpart F Income and Non-Subpart F 
Income
    In order for the business needs exclusion to apply to exclude 
foreign currency gain and loss from the computation of FPHCI, the 
foreign currency gain or loss must arise from a transaction or property 
that does not itself (and could not reasonably be expected to) give 
rise to any subpart F income other than foreign currency gain or loss. 
For example, foreign currency gains and losses related to the purchase 
and sale of inventory are excluded from the computation of FPHCI if 
none of the income from the purchase and sale is subpart F income under 
section 952. However, if the transaction or property gives rise to, or 
could reasonably be expected to give rise to, any amount of subpart F 
income (other than foreign currency gain or loss), none of the foreign 
currency gain or loss attributable to the transaction or property would 
qualify for the business needs exclusion. Thus, there is a cliff 
effect: If even a de minimis amount of income or gain from the 
transaction or property is subpart F income, the entire amount of the 
foreign currency gain or loss from the transaction or property, or from 
a bona fide hedging transaction with respect to the transaction or 
property, is included in the FPHCI computation.
4. Transactions That Manage the Risk of Currency Fluctuation in a 
Qualified Business Unit
    A CFC may conduct business through a qualified business unit (as 
defined in

[[Page 60137]]

Sec.  1.989(a)-1) (QBU) that is not treated as a separate entity for 
federal income tax purposes, either because it is a branch or division 
of the CFC or because it is a business entity that is disregarded as 
separate from its owner. Although the QBU is not treated as a separate 
entity, it may have a functional currency under Sec.  1.985-1 that is 
different from that of the CFC owner, with consequences for the 
determination of foreign currency gain and loss under sections 987 and 
988. The QBU's transactions in its own functional currency are not 
section 988 transactions of the CFC, and accordingly the CFC does not 
realize foreign currency gain or loss on such transactions. The CFC 
generally must, however, take into account under section 987 foreign 
currency gain or loss with respect to the QBU upon remittances from the 
QBU.
    For business and financial accounting reasons, a CFC may enter into 
transactions to manage the exchange rate risk associated with its net 
investment in its QBU. Under generally accepted accounting principles 
in the United States (U.S. GAAP), a majority owner of a business entity 
(parent corporation) must consolidate the accounts of the majority-
owned entity, including a foreign entity, with its own accounts for 
purposes of financial reporting. Under U.S. GAAP, the income, assets, 
liabilities, and other financial results of foreign operations that are 
conducted in a functional currency that differs from the consolidated 
parent's functional currency must be translated into the functional 
currency of the consolidated parent. Foreign currency gains or losses 
arising from the translation are recorded in a ``cumulative translation 
adjustment'' account and reported as a component of shareholders' 
equity on the balance sheet. See generally Accounting Standards 
Codification (ASC) 830-30-45. Foreign currency gain or loss from 
transactions that effectively hedge the risk of currency fluctuations 
in the net equity investment in foreign operations also are recorded in 
the cumulative translation adjustment account. See ASC 815-35-35. A 
cumulative translation adjustment is not taken into account in 
computing the income of the consolidated group until the relevant 
operations are disposed of or liquidated.
    The transactions that a CFC uses to manage its exchange rate risk 
with respect to its net investment in a QBU are typically section 988 
transactions. Thus, foreign currency gains or losses attributable to 
those transactions are taken into account in computing FPHCI, unless 
the transactions qualify as bona fide hedging transactions that satisfy 
the requirements of the business needs exclusion. See Sec.  1.954-
2(g)(2)(ii)(B)(2). Neither the Code nor the section 954 regulations 
provide specific guidance on whether a transaction entered into to 
manage exchange rate risk arising from a CFC's net investment in a QBU 
can qualify as a bona fide hedging transaction eligible for the 
business needs exclusion. This issue can be consequential because 
foreign currency gain, but not loss, from a transaction erroneously 
identified as a bona fide hedging transaction is included in the 
computation of FPHCI, unless the CFC qualifies for the inadvertent 
identification exception. See Sec.  1.954-2(a)(4)(ii)(C) and 
(g)(2)(ii)(B)(2). Additionally, even if a transaction entered into to 
manage exchange rate risk arising from a CFC's net investment in a QBU 
is eligible for treatment as a bona fide hedging transaction, the 
transaction would not qualify for the business needs exclusion unless 
the hedged property did not, and could not reasonably be expected to, 
give rise to any subpart F income.
    Also for business and financial accounting reasons, a CFC may enter 
into transactions to manage the exchange rate risk with respect to its 
net investment in a subsidiary CFC. A transaction that manages the risk 
of price or currency fluctuation with respect to a CFC's net investment 
in a subsidiary CFC is not considered a hedging transaction for federal 
income tax purposes. In Hoover Co. v. Commissioner, 72 T.C. 706 (1979), 
the Tax Court held that transactions entered into to manage the risk of 
a decline in value of a taxpayer's net investment in a foreign 
subsidiary that might occur if the value of the subsidiary's functional 
currency declined relative to the U.S. dollar were not hedging 
transactions for federal income tax purposes. See also Sec.  1.1221-
2(b) (providing that a hedging transaction must manage risk with 
respect to ``ordinary property . . . that is held or to be held by the 
taxpayer''). Thus, foreign currency gains and losses on transactions 
that manage the risk of currency fluctuation on a CFC's net investment 
in a subsidiary CFC are taken into account in computing FPHCI.

B. Timing of Foreign Currency Gains and Losses

1. Hedge Timing Rules of Sec.  1.446-4
    Section 1.446-4 generally requires gain or loss from a hedging 
transaction, as defined in Sec.  1.1221-2(b), to be taken into account 
at the same time as the gain or loss from the item being hedged. As 
noted in Part A.1 of this Background section, bona fide hedging 
transactions under Sec.  1.954-2(a)(4)(ii) include both hedging 
transactions as defined in Sec.  1.1221-2(b) and transactions that 
manage the risk of price or currency fluctuation with respect to 
section 1231 property and section 988 transactions. Thus, Sec.  1.446-4 
does not explicitly apply to all bona fide hedging transactions, which 
has led to some uncertainty about whether gain or loss from a bona fide 
hedging transaction that is not described in Sec.  1.1221-2(b) is 
properly taken into account in the same taxable year as gain or loss on 
the hedged item. The Department of the Treasury (Treasury Department) 
and the IRS understand that some taxpayers have applied the hedge 
timing rules of Sec.  1.446-4 to all bona fide hedging transactions, 
irrespective of whether those transactions are hedging transactions as 
defined in Sec.  1.1221-2(b).
2. Treasury Center CFCs
    It is common for a U.S.-parented multinational group to own one or 
more CFCs that serve as financing entities for other group members. 
Such CFCs (treasury center CFCs) may borrow in various currencies from 
third party lenders or from other members of the group and lend the 
proceeds to other members of the group. Treasury center CFCs also may 
be used to centralize the management of currency and other risks of 
other CFCs within the multinational group. Treasury center CFCs 
typically qualify as securities dealers under section 475, but if a 
treasury center CFC transacts primarily or exclusively with related 
persons, as is often the case, it would not qualify as a regular dealer 
under Sec.  1.954-2(a)(4)(iv) and thus would not be eligible for the 
special rules applying the business needs exclusion to certain 
transactions of regular dealers under Sec.  1.954-2(g)(2)(ii)(C).
    When a treasury center CFC borrows nonfunctional currency from 
related or unrelated parties and makes loans denominated in that 
nonfunctional currency to a related CFC, the foreign currency gain or 
loss attributable to the principal amount borrowed by the treasury 
center CFC will economically offset all or a portion of the foreign 
currency loss or gain, respectively, attributable to the lending 
activity. Similarly, the foreign currency gain or loss attributable to 
the treasury center CFC's accrual of interest income and expense with 
respect to its lending and borrowing activities, respectively, will 
offset each other, in whole or in part. Thus, by borrowing and lending 
in the same nonfunctional currency, a treasury

[[Page 60138]]

center CFC is said to be ``naturally hedged.''
    Although foreign currency gain and loss attributable to lending and 
borrowing transactions that are denominated in the same nonfunctional 
currency will typically partially or fully economically offset, the 
applicable tax accounting methods may cause the treasury center CFC to 
recognize a gain and an offsetting loss in different taxable years. If 
a treasury center CFC qualifies as a dealer under section 475, for 
example because it regularly purchases debt from related CFCs in the 
ordinary course of a trade or business, the treasury center CFC 
generally must use a mark-to-market method of accounting for its 
securities. See section 475 and Sec.  1.475(c)-1(a)(3)(i). However, 
Sec.  1.475(c)-2(a)(2) provides that a dealer's own issued debt 
liabilities are not securities for purposes of section 475. Thus, a 
treasury center CFC that funds its nonfunctional currency lending 
activities in whole or in part by issuing matching nonfunctional 
currency debt must mark to market its loan receivables and generally 
will include any foreign currency gain or loss recognized as a result 
of the mark to market in the computation of FPHCI each year, but, 
pursuant to Sec.  1.475(c)-2(a)(2), offsetting foreign currency loss or 
gain, respectively, on its borrowing transactions generally is not 
taken into account until principal and interest is paid. Moreover, the 
rule in Sec.  1.1221-2(d)(5) prohibits taxpayers from treating the 
purchase or sale of a debt instrument as a hedging transaction, which 
will generally prevent a treasury center CFC from relying on the Sec.  
1.446-4 hedge timing rules to match foreign currency gains and losses 
on borrowing transactions and loan receivables. The resulting mismatch 
in the timing of offsetting foreign currency gains and losses may have 
significant adverse consequences on the computation of the treasury 
center CFC's subpart F income because, as discussed in Part A.2 of this 
Background section, a foreign currency loss generally will not reduce 
the CFC's subpart F income except to the extent there are other foreign 
currency gains in the year the loss is recognized. Treasury and the IRS 
understand that some taxpayers have taken the position that the 
offsetting foreign currency gains and losses on the naturally hedged 
nonfunctional currency loans and borrowings may be taken into account 
in the same taxable years.

C. Foreign Currency Gain or Loss on Interest-Bearing Liabilities and 
Related Hedging Transactions

    As explained in Part A.3 of this Background section, the business 
needs exclusion does not apply to foreign currency gain or loss with 
respect to a transaction or property if any subpart F income arises, or 
could reasonably be expected to arise, from the transaction or 
property. Sec.  1.954-2(g)(2)(ii)(B)(2). However, Sec.  1.954-
2(g)(2)(iii) provides a special rule for foreign currency gain or loss 
arising from an interest-bearing liability. Under Sec.  1.954-
2(g)(2)(iii), such foreign currency gain or loss generally is 
characterized as subpart F income and non-subpart F income in the same 
manner that interest expense associated with the liability would be 
allocated and apportioned between subpart F income and non-subpart F 
income under Sec. Sec.  1.861-9T and 1.861-12T. Section 1.954-2(g) does 
not provide a corresponding rule for a bona fide hedging transaction 
with respect to an interest-bearing liability. However, Sec.  1.861-
9T(b)(2) and (b)(6) provide rules that allocate foreign currency gain 
or loss on certain hedging transactions in the same manner as interest 
expense. A foreign currency gain or loss arising from a transaction 
that hedges an interest-bearing liability and that is not governed by 
Sec.  1.861-9T is subject to the general rule of Sec.  1.954-
2(g)(2)(ii)(B)(2) and its ``cliff effect.'' Consequently, although the 
foreign currency gain or loss on the hedge of an interest-bearing 
liability economically offsets the foreign currency loss or gain on 
that liability, the interaction of the regulations under sections 861 
and 954 could result in different allocations of foreign currency gains 
and losses between subpart F income and non-subpart F income.

D. Elections To Treat Foreign Currency Gain or Loss as a Specific 
Category of Subpart F Income or FBCI or FPHCI

    Section 1.954-2 provides two elections with respect to foreign 
currency gains or losses. Under the first election, the controlling 
United States shareholders of a CFC may elect to include foreign 
currency gain or loss that relates to a specific category of subpart F 
income or, in the case of FBCI, a specific subcategory of FBCI 
described in Sec.  1.954-1(c)(1)(iii)(A)(1) or (2), in that category of 
subpart F income or FBCI, rather than in FPHCI. See Sec.  1.954-
2(g)(3). Thus, for example, under this election, foreign currency gain 
or loss on a transaction that hedges currency risk with respect to 
transactions that result in foreign base company sales income would be 
included in the foreign base company sales income category for purposes 
of determining subpart F income. This election associates foreign 
currency gain or loss that otherwise would be included in the 
computation of FPHCI with the categories of subpart F income and 
foreign base company income to which it relates and allows net foreign 
currency losses with respect to a category to reduce the income in that 
category. For this treatment to apply, however, the relationship 
between the foreign currency gain or loss and the category of income 
must be clearly determinable from the CFC's records. See Sec.  1.954-
2(g)(3)(i)(A).
    Under the second election, the controlling United States 
shareholders of a CFC may elect to include in the computation of FPHCI 
all foreign currency gain or loss attributable to any section 988 
transaction (except a transaction in which gain or loss is treated as 
capital gain or loss under section 988(a)(1)(B)) and to certain section 
1256 contracts. See Sec.  1.954-2(g)(4). When this election is in 
effect, net foreign currency loss reduces gross income in other 
categories of FPHCI. Controlling United States shareholders typically 
make the Sec.  1.954-2(g)(4) election if a CFC has relatively little 
net foreign currency gain or loss. In those circumstances, the 
administrative burden of tracing foreign currency gain and loss to 
specific transactions or property, as is required under the business 
needs exclusion and the Sec.  1.954-2(g)(3) election, may outweigh the 
benefit of those provisions. As the CFC's foreign currency gain or loss 
becomes more significant, the net benefit of the business needs 
exclusion or the Sec.  1.954-2(g)(3) election may increase and the 
relative benefit of the Sec.  1.954-2(g)(4) election may decrease.

Explanation of Provisions

A. Business Needs Exclusion

1. Transactions and Property That Give Rise to Both Subpart F Income 
and Non-Subpart F Income
    The Treasury Department and the IRS believe that foreign currency 
gain or loss arising from a transaction or property, or from a bona 
hedging transaction with respect to such a transaction or property, 
should be eligible for the business needs exclusion to the extent the 
transaction or property generates non-subpart F income. Accordingly, 
proposed Sec.  1.954-2(g)(2)(ii)(C)(1) provides that foreign currency 
gain or loss attributable to a transaction or property that gives rise 
to both subpart F income and non-subpart F income, and that otherwise 
satisfies the

[[Page 60139]]

requirements of the business needs exclusion, is allocated between 
subpart F income and non-subpart F income in the same proportion as the 
income from the underlying transaction or property. As a result, the 
amount of foreign currency gain or loss allocable to non-subpart F 
income qualifies for the business needs exclusion, and the amount 
allocable to subpart F income is taken into account in computing FPHCI. 
Under proposed Sec.  1.954-2(g)(2)(ii)(C)(1), the entire foreign 
currency gain or loss arising from property that does not give rise to 
income (as defined in Sec.  1.954-2(e)(3)), or from a bona fide hedging 
transaction with respect to such property, is attributable to subpart F 
income because any gain upon a disposition of such property would be 
subpart F income.
2. Hedges of Net Investment in a QBU
    The Treasury Department and the IRS believe that a transaction that 
manages exchange rate risk with respect to a CFC's net investment in a 
QBU that is not treated as a separate entity for federal income tax 
purposes should qualify for the business needs exclusion to the extent 
the underlying property of the QBU does not give rise to subpart F 
income. Accordingly, proposed Sec.  1.954-2(g)(2)(ii)(C)(2) provides 
that the qualifying portion of any foreign currency gain or loss that 
arises from a ``financial statement hedging transaction'' with respect 
to a QBU and that is allocable to non-subpart F income is directly 
related to the business needs of a CFC. A financial statement hedging 
transaction is defined as a transaction that is entered into by a CFC 
for the purpose of managing exchange rate risk with respect to part or 
all of that CFC's net investment in a QBU that is included in the 
consolidated financial statements of a United States shareholder of the 
CFC or a corporation that directly or indirectly owns such United 
States shareholder. The qualifying portion is defined as the amount of 
foreign currency gain or loss arising from a financial statement 
hedging transaction that is properly accounted for under U.S. GAAP as a 
cumulative foreign currency translation adjustment to shareholders' 
equity. The qualifying portion of any foreign currency gain or loss 
arising from a financial statement hedging transaction must be 
allocated between subpart F income and non-subpart F income using the 
principles of Sec.  1.987-6(b). The amount of the qualifying portion 
allocated to non-subpart F income qualifies for the business needs 
exclusion.
    The proposed amendment to Sec.  1.446-4(a), discussed in Part B.1 
of this Explanation of Provisions section, provides that a bona fide 
hedging transaction (as defined in Sec.  1.954-2(a)(4)(ii)) is subject 
to the hedge timing rules of Sec.  1.446-4. Additionally, as noted 
earlier, proposed Sec.  1.954-2(g)(2)(ii)(C)(2) provides that part or 
all of the qualifying portion of any foreign currency gain or loss 
arising from a financial statement hedging transaction is eligible for 
the business needs exclusion. However, financial statement hedging 
transactions are not included in the definition of bona fide hedging 
transaction under Sec.  1.954-2(a)(4)(ii), as proposed to be amended 
pursuant to these proposed regulations. Thus, foreign currency gain or 
loss arising from a financial statement hedging transaction is not 
subject to the hedge timing rules of Sec.  1.446-4 and is taken into 
account in accordance with the taxpayer's method of accounting. 
Generally, a taxpayer's financial statement hedging transaction is a 
section 988 transaction with respect to the taxpayer. Accordingly, to 
the extent that the taxpayer elects to use a mark-to-market method of 
accounting for section 988 gain or loss under proposed Sec.  1.988-7, 
and also makes the annual deemed termination election described in 
Sec.  1.987-8T(d), the taxpayer generally would recognize annually 
foreign currency gain or loss from both the financial statement hedging 
transaction and the QBU with respect to which exchange rate risk is 
managed. The Treasury Department and the IRS request comments regarding 
whether the hedge timing rules of Sec.  1.446-4 should apply to a 
financial statement hedging transaction (as defined in proposed Sec.  
1.954-2(g)(2)(ii)(C)(2)) with respect to section 987 QBUs with respect 
to which no annual deemed termination election is in effect, and, if 
so, how the appropriate matching should be achieved.
    The Treasury Department and the IRS also request comments regarding 
whether the business needs exclusion should apply to a transaction that 
is entered into for the purpose of managing the risk of foreign 
currency fluctuation with respect to a CFC's net investment in a 
subsidiary CFC. Comments are requested regarding how the gain or loss 
on such a transaction could or should be allocated between subpart F 
and non-subpart F income and whether and how the gain or loss could or 
should be matched with the foreign currency gain or loss on the 
``hedged'' item.
    The Treasury Department and the IRS are aware that a CFC may enter 
into a transaction that manages exchange rate risk arising from a 
disregarded loan to a QBU. The Treasury Department and the IRS 
understand that, for U.S. GAAP purposes, exchange gain or loss with 
respect to a transaction that manages exchange rate risk with respect 
to the disregarded loan generally would not be reflected as a 
cumulative foreign currency translation adjustment. For federal income 
tax purposes, the loan would be disregarded, and exchange gain or loss 
on the hedging transaction potentially could be subpart F income. The 
Treasury Department and the IRS request comments regarding whether, 
taking into account the amendments in the proposed regulations, 
additional amendments to the business needs exclusion are appropriate 
to account for foreign currency gain or loss arising from a transaction 
that is entered into for the purpose of managing the risk of foreign 
currency fluctuation with respect to disregarded transactions, 
including disregarded loans, between a CFC and its QBU. Specifically, 
comments are requested regarding how the foreign currency gain or loss 
on such a hedging transaction could or should be allocated between 
subpart F and non-subpart F income and when such foreign currency gain 
or should be recognized.

B. Timing of Foreign Currency Gains and Losses

1. Extension of Sec.  1.446-4 Hedge Timing Rules to Bona Fide Hedging 
Transactions
    The proposed amendment to Sec.  1.446-4(a) extends the hedge timing 
rules of Sec.  1.446-4 to all bona fide hedging transactions as defined 
in Sec.  1.954-2(a)(4)(ii). Although this amendment will be 
particularly useful in connection with foreign currency gains and 
losses from bona fide hedging transactions of treasury center CFCs, the 
amendment will eliminate timing mismatches for gains and losses arising 
from all bona fide hedging transactions and from the hedged property or 
transaction.
    In addition, proposed Sec.  1.954-2(a)(4)(ii) revises the 
definition of a bona fide hedging transaction to permit the acquisition 
of a debt instrument by a CFC to be treated as a bona fide hedging 
transaction with respect to an interest-bearing liability of the CFC, 
provided that the acquisition of the debt instrument has the effect of 
managing the CFC's exchange rate risk with respect to the liability 
within the meaning of Sec.  1.1221-2(c)(4) and (d), determined without 
regard to Sec.  1.1221-2(d)(5), and otherwise meets the requirements of 
a bona fide hedging

[[Page 60140]]

transaction. If a CFC, including a treasury center CFC, identifies a 
debt instrument that manages exchange rate risk as a hedge of an 
interest-bearing liability, the foreign currency gain or loss arising 
from that debt instrument will be taken into account under Sec.  1.446-
4 at the same time as the foreign currency gain or loss arising from 
the hedged interest-bearing liability.
    Treating a debt instrument as a hedge of an interest-bearing 
liability, rather than treating the interest-bearing liability as a 
hedge of the debt instrument, is consistent with the principles 
underlying Sec.  1.861-9T(b)(2), which allocates and apportions foreign 
currency gain or losses on a transaction that hedges an interest-
bearing liability in the same manner as interest expense with respect 
to the liability is allocated and apportioned. See part C of this 
Explanation of Provisions section for further discussion of the impact 
of this rule on the allocation of foreign currency gain or loss on a 
debt instrument between subpart F income and non-subpart F income.
2. Elective Mark-to-Market Method of Accounting for Foreign Currency 
Gain and Loss
    Proposed Sec.  1.988-7 permits a taxpayer, including a CFC, to 
elect to use a mark-to-market method of accounting for section 988 gain 
or loss with respect to section 988 transactions, including becoming an 
obligor under an interest-bearing liability. This elective mark-to-
market method of accounting takes into account only changes in the 
value of the section 988 transaction attributable to exchange rate 
fluctuations and does not take into account changes in value due to 
other factors, such as changes in market interest rates or the 
creditworthiness of the borrower. The proposed regulations require 
appropriate adjustments to be made to prevent section 988 gain or loss 
taken into account under the mark-to-market method of accounting from 
being taken into account again under section 988 or another provision 
of the Code.
    This election is available to any taxpayer but is expected to be 
particularly relevant in the case of a treasury center CFC. A treasury 
center CFC that uses a mark-to-market method for securities under 
section 475 and that makes the election under proposed Sec.  1.988-7 
will be able to match the timing of foreign currency gain or loss with 
respect to an interest-bearing liability (such as a loan from a related 
or unrelated party) with economically offsetting foreign currency loss 
or gain arising from its nonfunctional currency-denominated assets 
(such as a receivable from a related party). Whether the corresponding 
foreign currency gains and losses qualify for the business needs 
exclusion is determined under the rules of Sec.  1.954-2(g)(2), as 
proposed to be amended pursuant to these proposed regulations. Thus, if 
the foreign currency gains or losses do not fully offset each other, 
the difference may increase or decrease the CFC's FPHCI. However, the 
election under proposed Sec.  1.988-7 does not apply to the following: 
(1) Any securities that are marked to market under any other provision; 
(2) any securities that, pursuant to an election or an identification 
made by the taxpayer, are excepted from mark-to-market treatment under 
any other provision; (3) any transactions of a QBU that is subject to 
section 987; or (4) any section 988 transactions denominated in, or 
determined by reference to, a hyperinflationary currency.
    The election applies for the year in which the election is made and 
all subsequent taxable years unless it is revoked by the Commissioner 
or the taxpayer or, in the case of a CFC, the controlling domestic 
shareholders of the CFC. Proposed Sec.  1.988-7(d) permits a taxpayer 
or CFC to revoke the election to use a mark-to-market method of 
accounting for foreign currency gains or losses on section 988 
transactions at any time. A subsequent election cannot be made until 
the sixth taxable year following the year of revocation and cannot be 
revoked until the sixth taxable year following the year of such 
subsequent election.

C. Hedges of Exchange Rate Risk Arising From an Interest-Bearing 
Liability

    The Treasury Department and the IRS believe that it is appropriate 
to require foreign currency gain or loss from transactions that have 
the effect of managing exchange rate risk arising from an interest-
bearing liability to be allocated between subpart F income and non-
subpart F income in the same manner as the foreign currency gain or 
loss on the hedged liability. Accordingly, the proposed amendments to 
Sec.  1.954-2(g)(2)(iii) require foreign currency gains and losses 
arising from a transaction or property (including debt instruments) 
that manages exchange rate risk with respect to an interest-bearing 
liability to be allocated and apportioned between subpart F income and 
non-subpart F income in the same manner that foreign currency gain or 
loss from the interest-bearing liability would be allocated and 
apportioned. As noted in Part B.1 of this Explanation of Provisions, 
the proposed amendment to Sec.  1.954-2(a)(4)(ii) revises the 
definition of a bona fide hedging transaction to permit the acquisition 
of a debt instrument by a CFC to be treated as a bona fide hedging 
transaction with respect to an interest-bearing liability of the CFC 
under certain circumstances. As a result of that proposed amendment and 
the amendment described in this Part C, if a CFC identifies a debt 
instrument that manages exchange rate risk as a hedge of an interest-
bearing liability, the foreign currency gain or loss arising from that 
debt instrument will be allocated between subpart F income and non-
subpart F income in the same manner as the foreign currency gain or 
loss arising from the hedged interest-bearing liability. Thus, the 
proposed amendments to the regulations permit a CFC that timely and 
properly identifies a debt instrument as a hedge of an interest-bearing 
liability to alleviate the character mismatch that may occur under the 
existing regulations, as described in Part C of the Background section 
of this preamble. The proposed amendments to Sec.  1.954-2(g)(2)(iii) 
also clarify that the special rules in that paragraph apply to foreign 
currency gain or loss arising from an interest-bearing liability, or 
from a bona fide hedging transaction with respect to the liability, in 
lieu of the general rule of the business needs exclusion in Sec.  
1.954-2(g)(2)(ii).

D. Revocation of Election To Treat Foreign Currency Gain or Loss as a 
Specific Category of Subpart F Income or as FPHCI

    Proposed Sec.  1.954-2(g)(3)(iii) permits a CFC to revoke its 
election under Sec.  1.954-2(g)(3) (to characterize foreign currency 
gain or loss that arises from a specific category of subpart F income 
as gain or loss in that category) at any time without securing the 
prior consent of the Commissioner. Similarly, proposed Sec.  1.954-
2(g)(4)(iii) permits a CFC to revoke its election under Sec.  1.954-
2(g)(4) (to treat all foreign currency gain or loss as FPHCI) at any 
time without securing the prior consent of the Commissioner. The 
Treasury Department and the IRS remain concerned about CFCs frequently 
changing these elections without a substantial business reason but also 
believe that the ability of a taxpayer to automatically revoke these 
elections would promote sound tax administration. Therefore, the 
proposed regulations provide that, if an election has been revoked 
under proposed Sec.  1.954-2(g)(3)(iii) or proposed Sec.  1.954-
2(g)(4)(iii), a subsequent election cannot be made until the sixth 
taxable year following the year of revocation and any subsequent 
election cannot be revoked

[[Page 60141]]

until the sixth year following the year of such subsequent election.

E. Applicability Dates

    The proposed amendments generally are proposed to apply to taxable 
years ending on or after the date the proposed regulations are 
published as final regulations in the Federal Register. However, the 
proposed amendments to Sec. Sec.  1.446-4(a), 1.954-2(a)(4)(ii)(A), 
1.954-2(g)(2)(ii)(C)(1), and 1.954-2(g)(2)(iii) are proposed to apply 
to bona fide hedging transactions entered into on or after the date the 
proposed regulations are published as final regulations in the Federal 
Register. A taxpayer may rely on any of the proposed amendments, other 
than the amendments to Sec. Sec.  1.446-4(a), 1.954-2(a)(4)(ii)(A), 
1.954-2(g)(2)(ii)(C)(1), and 1.954-2(g)(2)(iii), insofar as each 
applies to a bona fide hedging transaction, for taxable years ending on 
or after December 19, 2017, provided the taxpayer consistently applies 
the proposed amendment for all such taxable years that end before the 
first taxable year ending on or after the date the proposed regulations 
are published as final regulations in the Federal Register. A taxpayer 
may rely on any of the proposed amendments to Sec. Sec.  1.446-4(a), 
1.954-2(a)(4)(ii)(A), 1.954-2(g)(2)(ii)(C)(1), and 1.954-2(g)(2)(iii) 
with respect to a bona fide hedging transaction entered into on or 
after December 19, 2017 and prior to the applicability date, provided 
the taxpayer consistently applies the proposed amendment to all bona 
fide hedging transactions entered into on or after December 19, 2017 
and prior to the date that these regulations are published as final 
regulations in the Federal Register.

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 impact assessment is 
not required. It is hereby certified that the collection of information 
requirement will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that these regulations primarily will affect domestic 
corporations that have foreign operations, which tend to be larger 
businesses, and that the average burden is minimal. Accordingly, the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. 
Pursuant to section 7805(f), this notice of proposed rulemaking has 
been submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under ADDRESSES. The Treasury 
Department and the IRS request comments on all aspects of the proposed 
rules. All comments will be available at www.regulations.gov or upon 
request. A public hearing will be scheduled if requested in writing by 
any person that timely submits comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these regulations is Jeffery G. Mitchell 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.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be 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. 7805 * * *
    Section 1.954-2 also issued under 26 U.S.C. 954(b) and (c). * * 
*
    Section 1.988-7 also issued under 26 U.S.C. 446, 988(d), and 
989(c). * * *
0
Par. 2. Section 1.446-4 is amended by:
0
1. Revising the first sentence of paragraph (a).
0
2. Revising the heading of paragraph (g) and adding a sentence at the 
end of paragraph (g).
0
3. Removing paragraph (h).
    The revisions and addition read as follows:


Sec.  1.446-4   Hedging transactions.

    (a) In general. Except as provided in this paragraph (a), a hedging 
transaction as defined in Sec.  1.1221-2(b) (whether or not the 
character of gain or loss from the transaction is determined under 
Sec.  1.1221-2) and a bona fide hedging transaction as defined in Sec.  
1.954-2(a)(4)(ii) must be accounted for under the rules of this 
section. * * *
* * * * *
    (g) Applicability date. * * * This section applies to a bona fide 
hedging transaction (as defined in Sec.  1.954-2(a)(4)(ii)) entered 
into on or after the date that these regulations are published as final 
regulations in the Federal Register.
0
Par. 3. Section 1.954-0(b) is amended by:
0
1. Redesignating the entry for Sec.  1.954-2(g)(2)(ii)(D) as the entry 
for Sec.  1.954-2(g)(2)(ii)(E).
0
2. Redesignating the entries for Sec.  1.954-2(g)(2)(ii)(C), 
(g)(2)(ii)(C)(1), (g)(2)(ii)(C)(2), (g)(2)(ii)(C)(2)(i), 
(g)(2)(ii)(C)(2)(ii), and (g)(2)(ii)(C)(2)t(iii) as the entries for 
Sec.  1.954-2(g)(2)(ii)(D), (g)(2)(ii)(D)(1), (g)(2)(ii)(D)(2), 
(g)(2)(ii)(D)(2)(i), (g)(2)(ii)(D)(2)(ii), and (g)(2)(ii)(D)(2)(iii), 
respectively.
0
3. Adding new entries for Sec.  1.954-2(g)(2)(ii)(C), (g)(2)(ii)(C)(1), 
and (g)(2)(ii)(C)(2).
0
4. Revising the entry for Sec.  1.954-2(g)(2)(iii).
    The additions and revision read as follows:


Sec.  1.954-0   Introduction.

* * * * *
    (b) * * *


Sec.  1.954-2   Foreign personal holding company income.

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (C) Foreign currency gains and losses arising from a transaction or 
property that gives rise to both non-subpart F income and subpart F 
income or from a bona fide hedging transaction with respect to such a 
transaction or property.
    (1) In general.
    (2) Financial statement hedging transaction with respect to the net 
investment in a qualified business unit.
* * * * *
    (iii) Special rule for foreign currency gain or loss from an 
interest-bearing liability and bona fide hedges of an interest-bearing 
liability.
* * * * *
0
Par. 4. Section 1.954-2 is amended by:
0
1. Adding a sentence after the first sentence in paragraph 
(a)(4)(ii)(A).
0
2. Redesignating paragraph (g)(2)(ii)(D) as paragraph (g)(2)(ii)(E).
0
3. Redesignating paragraph (g)(2)(ii)(C) as paragraph (g)(2)(ii)(D).
0
4. In newly redesignated paragraph (g)(2)(ii)(D)(2)(i), removing 
``paragraph

[[Page 60142]]

(g)(2)(ii)(C)'' and adding ``paragraph (g)(2)(ii)(D)'' in its place and 
removing ``paragraph (g)(2)(ii)(C)(1)'' and adding ``paragraph 
(g)(2)(ii)(D)(1)'' in its place.
0
5. In newly redesignated paragraph (g)(2)(ii)(D)(2)(ii), removing 
``paragraph (g)(2)(ii)(C)(2)(i)'' and adding ``paragraph 
(g)(2)(ii)(D)(2)(i)'' each place it appears.
0
6. In newly redesignated paragraph (g)(2)(ii)(D)(2)(iii), removing 
``paragraph (g)(2)(ii)(C)(2)'' and adding ``paragraph 
(g)(2)(ii)(D)(2)'' in its place.
0
7. Adding new paragraph (g)(2)(ii)(C).
0
8. Revising paragraph (g)(2)(iii).
0
9. Revising paragraph (g)(3)(iii).
0
10. Revising paragraph (g)(4)(iii).
0
11. Adding two sentences after the third sentence in paragraph (i)(2).
    The additions and revisions read as follows:


Sec.  1.954-2   Foreign personal holding company income.

    (a) * * *
    (4) * * *
    (ii) * * *
    (A) * * * Additionally, the acquisition of a debt instrument by a 
controlled foreign corporation may be treated as a bona fide hedging 
transaction with respect to an interest-bearing liability of the 
controlled foreign corporation, provided that the acquisition of the 
debt instrument has the effect of managing the controlled foreign 
corporation's exchange rate risk with respect to the liability within 
the meaning of Sec.  1.1221-2(c)(4) and (d), determined without regard 
to Sec.  1.1221-2(d)(5), and otherwise meets the requirements of 
paragraph (a)(4)(ii) of this section. * * *
* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (C) Foreign currency gains and losses arising from a transaction or 
property that gives rise to both non-subpart F income and subpart F 
income or from a bona fide hedging transaction with respect to such a 
transaction or property--(1) In general. If a foreign currency gain or 
loss would be directly related to the business needs of the controlled 
foreign corporation pursuant to paragraph (g)(2)(ii)(B)(1) or (2) of 
this section except that it arises from a transaction or property that 
gives rise, or is reasonably expected to give rise, to both non-subpart 
F income and subpart F income (other than foreign currency gain or 
loss), or from a bona fide hedging transaction with respect to such a 
transaction or property, the amount of foreign currency gain or loss 
that is allocable to non-subpart F income under this paragraph 
(g)(2)(ii)(C)(1) is directly related to the business needs of the 
controlled foreign corporation. The amount of foreign currency gain or 
loss arising from a transaction or property described in this paragraph 
(g)(2)(ii)(C)(1), or from a bona fide hedging transaction with respect 
to such a transaction or property, that is allocable to non-subpart F 
income equals the product of the total amount of foreign currency gain 
or loss arising from the transaction or property and the ratio of non-
subpart F income (other than foreign currency gain or loss) that the 
transaction or property gives rise to, or is reasonably expected to 
give rise to, to the total income that the transaction or property 
gives rise to, or is reasonably expected to give rise to. However, none 
of the foreign currency gain or loss arising from property that does 
not give rise to income (as defined in paragraph (e)(3) of this 
section), or from a bona fide hedging transaction with respect to such 
property, is allocable to non-subpart F income.
    (2) Financial statement hedging transaction with respect to a 
qualified business unit. If foreign currency gain or loss arises from a 
financial statement hedging transaction (as defined in this paragraph 
(g)(2)(ii)(C)(2)) with respect to a qualified business unit (as defined 
in Sec.  1.989(a)-1) (QBU) of a controlled foreign corporation that is 
not treated as an entity separate from the controlled foreign 
corporation for federal income tax purposes, either because it is a 
branch or division of the controlled foreign corporation or because it 
is a business entity that is disregarded as separate from its owner 
under Sec.  301.7701-3 of this chapter, the amount of the qualifying 
portion (as determined under this paragraph (g)(2)(ii)(C)(2)) of 
foreign currency gain or loss that is allocable to non-subpart F income 
under this paragraph (g)(2)(ii)(C)(2) is directly related to the 
business needs of the controlled foreign corporation. Generally, the 
controlled foreign corporation must allocate the qualifying portion of 
foreign currency gain or loss arising from the financial statement 
hedging transaction between subpart F income and non-subpart F income 
in the same proportion as it would characterize gain or loss determined 
under section 987 as subpart F income and non-subpart F income under 
the principles of Sec.  1.987-6(b). A financial statement hedging 
transaction is a transaction that is entered into by a CFC for the 
purpose of managing exchange rate risk with respect to part or all of 
that CFC's net investment in a QBU that is included in the consolidated 
financial statements of a United States shareholder of the CFC (or a 
corporation that directly or indirectly owns such United States 
shareholder). The qualifying portion of foreign currency gain or loss 
is the amount of foreign currency gain or loss arising from a financial 
statement hedging transaction that is properly accounted for under U.S. 
generally accepted accounting principles as a cumulative foreign 
currency translation adjustment to shareholders' equity.
* * * * *
    (iii) Special rule for foreign currency gain or loss from an 
interest-bearing liability and bona fide hedges of an interest-bearing 
liability. Except as provided in paragraph (g)(2)(ii)(D)(2) or 
(g)(5)(iv) of this section, foreign currency gain or loss arising from 
an interest-bearing liability is characterized as subpart F income and 
non-subpart F income in the same manner that interest expense 
associated with the liability would be allocated and apportioned 
between subpart F income and non-subpart F income under Sec. Sec.  
1.861-9T and 1.861-12T. Likewise, foreign currency gain or loss arising 
from a bona fide hedging transaction entered into by the controlled 
foreign corporation that has the effect of managing exchange rate risk 
with respect to an interest-bearing liability that is not subject to 
paragraph (g)(2)(ii)(D)(2) (certain interest-bearing liabilities 
treated as dealer property) or (g)(5)(iv) (gain or loss allocated under 
Sec.  1.861-9) of this section is characterized as subpart F income and 
non-subpart F income in the same manner that interest expense 
associated with the interest-bearing liability would be allocated and 
apportioned between subpart F income and non-subpart F income under 
Sec. Sec.  1.861-9T and 1.861-12T. Paragraph (g)(2)(ii) of this section 
does not apply to any foreign currency gain or loss described in this 
paragraph (g)(2)(iii).
    (3) * * *
    (iii) Revocation of election. This election is effective for the 
taxable year of the controlled foreign corporation for which it is made 
and all subsequent taxable years of such corporation unless revoked by 
the Commissioner or the controlling United States shareholders (as 
defined in Sec.  1.964-1(c)(5)) of the controlled foreign corporation. 
The controlling United States shareholders of a controlled foreign 
corporation may revoke such corporation's election at any time. If an 
election has been revoked under this paragraph (g)(3)(iii), a new 
election under paragraph (g)(3) of this section cannot be made until 
the sixth taxable year following the year in which the previous 
election was

[[Page 60143]]

revoked, and such subsequent election cannot be revoked until the sixth 
taxable year following the year in which the subsequent election was 
made. The controlling United States shareholders revoke an election on 
behalf of a controlled foreign corporation by filing a statement that 
clearly indicates such election has been revoked with their original or 
amended income tax returns for the taxable year of such United States 
shareholders ending with or within the taxable year of the controlled 
foreign corporation for which the election is revoked.
* * * * *
    (4) * * *
    (iii) Revocation of election. This election is effective for the 
taxable year of the controlled foreign corporation for which it is made 
and all subsequent taxable years of such corporation unless revoked by 
the Commissioner or the controlling United States shareholders (as 
defined in Sec.  1.964-1(c)(5)) of the controlled foreign corporation. 
The controlling United States shareholders of a controlled foreign 
corporation may revoke such corporation's election at any time. If an 
election has been revoked under this paragraph (g)(4)(iii), a new 
election under paragraph (g)(4) of this section cannot be made until 
the sixth taxable year following the year in which the previous 
election was revoked, and such subsequent election cannot be revoked 
until the sixth taxable year following the year in which the subsequent 
election was made. The controlling United States shareholders revoke an 
election on behalf of a controlled foreign corporation by filing a 
statement that clearly indicates such election has been revoked with 
their original or amended income tax returns for the taxable year of 
such United States shareholders ending with or within the taxable year 
of the controlled foreign corporation for which the election is 
revoked.
* * * * *
    (i) * * *
    (2) Other paragraphs. * * * The second sentence of paragraph 
(a)(4)(ii)(A), paragraph (g)(2)(ii)(C)(1), and the second sentence of 
paragraph (g)(2)(iii) apply to a bona fide hedging transaction entered 
into on or after the date the proposed regulations are published as 
final regulations in the Federal Register. Paragraphs (g)(2)(ii)(C) 
(other paragraph (g)(2)(ii)(C)(1), insofar as it applies to a bona fide 
hedging transaction), (g)(3)(iii), and (g)(4)(iii) of this section 
apply to taxable years of controlled foreign corporations ending on or 
after the date that these regulations are published as final 
regulations in the Federal Register.
0
Par. 5. Section 1.988-7 is added to read as follows:


Sec.  1.988-7   Election to mark-to-market foreign currency gain or 
loss on section 988 transactions.

    (a) In general. Except as provided in paragraph (b) of this 
section, a taxpayer may elect under this section to apply the foreign 
currency mark-to-market method of accounting described in this section 
with respect to all section 988 transactions (including the acquisition 
and holding of nonfunctional currency described in section 
988(c)(1)(C)(ii)). 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. Only 
section 988 gain or loss is taken into account under the foreign 
currency mark-to-market method of accounting. Consistent with section 
1256(a)(2), 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.
    (b) Exceptions. The election described in paragraph (a) of this 
section does not apply to:
    (1) Any security, commodity, or section 1256 contract that is 
marked to market under any other provision, including section 475 or 
section 1256;
    (2) Any security, commodity, or section 1256 contract that, 
pursuant to an election or an identification made by the taxpayer, is 
excepted from mark-to-market treatment under another provision, 
including section 475 or section 1256;
    (3) Any transaction of a qualified business unit (as defined in 
section 1.989(a)-1(b)) that is subject to section 987; or
    (4) Any section 988 transaction denominated in, or determined by 
reference to, a hyperinflationary currency. See Sec.  1.988-2(b)(15), 
(d)(5), and (e)(7) for rules relating to such transactions.
    (c) Time and manner of election. A taxpayer makes the election 
under paragraph (a) of this section by filing a statement that clearly 
indicates that such election has been made with the taxpayer's timely-
filed original federal income tax return for the taxable year for which 
the election is made. In the case of a controlled foreign corporation, 
the controlling United States shareholders (as defined in Sec.  1.964-
1(c)(5)) make the election under paragraph (a) of this section on 
behalf of the controlled foreign corporation by filing a statement that 
clearly indicates that such election has been made with their timely-
filed, original federal income tax returns for the taxable year of such 
United States shareholders ending with or within the taxable year of 
the controlled foreign corporation for which the election is made.
    (d) Revocation and subsequent election. A taxpayer may revoke its 
election under paragraph (a) of this section at any time. If an 
election has been revoked under this paragraph (d), a new election 
under paragraph (a) of this section cannot be made until the sixth 
taxable year following the year in which the previous election was 
revoked, and such subsequent election cannot be revoked until the sixth 
taxable year following the year in which the subsequent election was 
made. A taxpayer revokes the election by filing a statement that 
clearly indicates that such election has been revoked with its original 
or amended federal income tax return for the taxable year for which the 
election is revoked. In the case of a controlled foreign corporation, 
the controlling United States shareholders revoke the election on 
behalf of the controlled foreign corporation by filing a statement that 
clearly indicates that such election has been revoked with their 
original or amended federal income tax returns for the taxable year of 
such United States shareholders ending with or within the taxable year 
of the controlled foreign corporation for which the election is 
revoked.
    (e) Applicability dates. This section applies to taxable years of 
taxpayers (including controlled foreign corporations) ending on or 
after the date these regulations are published as final regulations in 
the Federal Register.

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2017-27320 Filed 12-18-17; 8:45 am]
 BILLING CODE 4830-01-P