Income and Currency Gain or Loss With Respect to a Qualified Business Unit, 78134-78210 [2023-24649]

Download as PDF 78134 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules DEPARTMENT OF THE TREASURY Background Internal Revenue Service I. Overview This document contains proposed regulations (the ‘‘proposed regulations’’) under section 987 and related provisions under sections 861, 985 through 989, and 1502 of the Internal Revenue Code (‘‘Code’’). Section 987 applies to any taxpayer that has a qualified business unit (‘‘QBU’’) with a functional currency other than the dollar. Section 987(1) and (2) provide rules for determining and translating taxable income or loss (‘‘section 987 taxable income or loss’’) with respect to the QBU. In addition, foreign currency gain or loss must be determined under section 987(3) (‘‘section 987 gain or loss’’), which requires proper adjustments (as prescribed by the Secretary) for transfers of property between QBUs of the taxpayer having different functional currencies. Section 989(c) authorizes the Secretary to prescribe necessary and appropriate regulations, including regulations limiting the recognition of foreign currency loss on certain remittances from QBUs. 26 CFR Part 1 [REG–132422–17] RIN 1545–BO07 Income and Currency Gain or Loss With Respect to a Qualified Business Unit Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking and partial withdrawal of notice of proposed rulemaking. AGENCY: This document contains proposed regulations relating to the determination of taxable income or loss and foreign currency gain or loss with respect to a qualified business unit. These proposed regulations include an election to treat all items of a qualified business unit as marked items (subject to a loss suspension rule), an election to recognize all foreign currency gain or loss with respect to a qualified business unit on an annual basis, and a new transition rule. DATES: Written or electronic comments and requests for a public hearing must be received by February 12, 2024. ADDRESSES: Commenters are strongly encouraged to submit public comments electronically via the Federal eRulemaking Portal at https:// www.regulations.gov (indicate IRS and REG–132422–17) by following the online instructions for submitting comments. Requests for a public hearing must be submitted as prescribed in the ‘‘Comments and Requests for a Public Hearing’’ section. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of the Treasury (Treasury Department) and the IRS will publish for public availability any comments submitted to the IRS’s public docket. Send paper submissions to: CC:PA:01:PR (REG–132422–17), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations generally, Raphael J. Cohen at (202) 317–6938; concerning consolidated groups, Jeremy Aron-Dine at (202) 317– 6847; concerning submissions of comments, requests for a public hearing, and access to a public hearing, Vivian Hayes at (202) 317–5306 (not toll-free numbers) or by email to publichearings@irs.gov (preferred). SUPPLEMENTARY INFORMATION: khammond on DSKJM1Z7X2PROD with PROPOSALS3 SUMMARY: VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 II. Regulations Addressing the Application of Section 987 A. 1991 Proposed Regulations and Notice 2000–20 On September 25, 1991, the Treasury Department and the IRS published in the Federal Register proposed regulations under section 987 (56 FR 48457, September 25, 1991) (‘‘1991 proposed regulations’’). The 1991 proposed regulations provided that section 987 taxable income or loss is computed in the QBU’s functional currency and is translated into the taxpayer’s functional currency at the weighted average exchange rate for the taxable year. For purposes of determining section 987 gain or loss, taxpayers were required to maintain an equity pool in the QBU’s functional currency and a basis pool in the taxpayer’s functional currency. The equity and basis pools were increased by the QBU’s earnings and by capital contributed to the QBU, and they were reduced by remittances, losses, and other transfers from the QBU. Taxpayers recognized section 987 gain or loss at the time of a remittance or upon a termination of the QBU. The amount of section 987 gain or loss recognized was equal to the difference between the value of the remittance in the taxpayer’s functional currency (translated at the applicable spot rate) and the portion of the basis pool attributable to the remittance. Thus, under the 1991 PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 proposed regulations, section 987 gain or loss was determined by reference to a taxpayer’s entire equity interest in a QBU. The 1991 proposed regulations reserved on the treatment of partnerships. On April 3, 2000, the Treasury Department and the IRS issued Notice 2000–20, 2000–1 C.B. 851. The Notice expressed concern that the 1991 proposed regulations may not have achieved their goal of providing administrable rules that result in foreign currency gain and loss recognition under the appropriate circumstances. The Notice also identified certain abusive transactions that could inappropriately accelerate recognition of section 987 loss under the 1991 proposed regulations. B. 2006 Proposed Regulations 1. Concerns Relating to the 1991 Proposed Regulations On September 7, 2006, the Treasury Department and the IRS withdrew the 1991 proposed regulations and published in the Federal Register new proposed regulations under section 987 (71 FR 52876, September 7, 2006) (‘‘2006 proposed regulations’’). The preamble to the 2006 proposed regulations explained that the IRS had identified many cases in which taxpayers inappropriately claimed substantial section 987 losses resulting from the application of the 1991 proposed regulations when a QBU’s functional currency depreciated relative to the functional currency of its owner. The 1991 proposed regulations also could create a ‘‘trap for the unwary’’ by requiring recognition of large section 987 gains when a QBU’s functional currency appreciated. These results arose because the 1991 proposed regulations imputed section 987 gain or loss to all assets and liabilities of a QBU, regardless of whether those assets and liabilities were economically exposed to currency fluctuations or had been subject to a realization event, and because the 1991 proposed regulations did not limit the selective recognition of section 987 losses. Consequently, under the 1991 proposed regulations, exchange rate fluctuations that, at most, had only an uncertain and remote effect on the economic results experienced by the owner of a QBU could give rise to substantial section 987 gains and losses that taxpayers could selectively recognize by strategically timing remittances or causing a termination of the QBU. For example, the 1991 proposed regulations provided taxpayers with substantial flexibility to E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules recognize section 987 losses selectively by causing QBUs with a weak functional currency to make remittances while avoiding remittances from QBUs with a strong functional currency that would give rise to gains. khammond on DSKJM1Z7X2PROD with PROPOSALS3 2. Foreign Exchange Exposure Pool Method To address the concerns relating to the 1991 proposed regulations, the 2006 proposed regulations provided a new method of applying section 987, referred to as the foreign exchange exposure pool (‘‘FEEP’’) method. Under the FEEP method, the owner of a QBU that is subject to section 987 (‘‘section 987 QBU’’) determines all items of income, gain, deduction, and loss attributable to the QBU in the QBU’s functional currency, and then translates those items into the owner’s functional currency. For this purpose, the basis of certain assets (referred to as ‘‘historic assets’’) is translated at the exchange rate for the date on which the asset was acquired (the ‘‘historic rate’’). For example, cost recovery deductions, such as depreciation, in respect of historic assets are translated at the historic rate. Other items (including the amount realized on a sale or exchange of a historic asset) are translated into the owner’s functional currency at the average exchange rate for the taxable year. In addition, the owner of a section 987 QBU must determine the pool of unrecognized section 987 gain or loss (‘‘net unrecognized section 987 gain or loss’’) based on the annual increase or decrease to the section 987 QBU’s balance sheet that is attributable to foreign exchange rate fluctuations. The amount of section 987 gain or loss that is added to the pool each year is equal to the increase or decrease in the basis of assets (net of the amount of liabilities) of the section 987 QBU, measured in the owner’s functional currency and adjusted for transfers between the section 987 QBU and its owner and section 987 taxable income or loss. See § 1.987–4(d) of the 2006 proposed regulations. For this purpose, certain assets and liabilities (referred to as ‘‘historic items’’) are translated into the owner’s functional currency at the historic rate, while others (referred to as ‘‘marked items’’) are translated into the owner’s functional currency at the applicable spot rate. As a result, when translated into the owner’s functional currency, the balance sheet value of marked items fluctuates when the QBU’s functional currency strengthens or weakens, but the balance sheet value of historic items does not. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Marked items and historic items are defined by reference to section 988. A marked item is an asset or liability that would generate gain or loss under section 988 if it were held or entered into directly by the owner of the section 987 QBU but is not a section 988 transaction with respect to the QBU itself. A historic item is an asset or liability that is not a marked item. Thus, under the FEEP method, section 987 gain or loss reflects currency fluctuations with respect to marked items, which would be subject to section 988 in the hands of the QBU’s owner. By contrast, section 987 gain or loss is not imputed to historic items that are not subject to section 988. As a result of the use of a balance sheet approach, together with the use of historic rates for historic items, the FEEP method distinguishes between those items whose value is highly correlated with exchange rates and those items for which exchange rate fluctuations have no effect on value, or only an uncertain or remote effect that is more appropriately recognized upon a realization event with respect to that item. Unlike the 1991 proposed regulations, which imputed section 987 gain or loss to all assets and liabilities of a QBU, section 987 gain or loss under the FEEP method relates to those assets and liabilities that are economically exposed to currency fluctuations. The FEEP method also minimizes a taxpayer’s ability to recognize large section 987 losses unrelated to its economic exposure and, thus, the need for a limitation on the selective recognition of such losses. 3. Partnerships The 2006 proposed regulations applied section 987 to partnerships using an aggregate approach. Under this approach, an individual or corporation that is a partner in a partnership is treated as an indirect owner of a portion of the assets and liabilities of the partnership for purposes of section 987. If the partner indirectly owns a QBU with a functional currency different from that of the partner, the QBU is a section 987 QBU, and the partner determines and recognizes section 987 gain or loss with respect to the section 987 QBU under the FEEP method. An elective de minimis exception was provided for partners with a less than five percent interest in a partnership. 4. Transition Rules The 2006 proposed regulations provided two alternative methods for taxpayers to transition from their prior method of applying section 987: the ‘‘deferral transition method’’ and the PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 78135 ‘‘fresh start transition method.’’ Under both transition methods, all the taxpayer’s section 987 QBUs were deemed to terminate on the day before the transition date, and the owner was treated as having transferred each section 987 QBU’s assets and liabilities to a new section 987 QBU on the transition date. The transition date was defined as the first day of the first taxable year to which the 2006 proposed regulations apply to a taxpayer. Under the deferral transition method, section 987 gain or loss determined on the date of the deemed termination (under the taxpayer’s prior method) was treated as net unrecognized section 987 gain or loss of the new section 987 QBU, which could be recognized on a remittance (or termination) in subsequent taxable years. The assets and liabilities that were deemed transferred to the section 987 QBU on the transition date (including marked assets and liabilities) were translated using historic rates, increased or decreased to take into account any amount treated as net unrecognized section 987 gain or loss determined with respect to the deemed termination. The deferral transition method thus preserved the taxpayer’s section 987 gain or loss computed under its prior method and adjusted the applicable exchange rates to avoid double counting. Under the fresh start transition method, section 987 gain or loss that would have been recognized under the taxpayer’s prior method as a result of the deemed termination was neither recognized nor carried forward as net unrecognized section 987 gain or loss. The assets and liabilities that were deemed transferred to the section 987 QBU on the transition date (including marked assets and liabilities) were translated using historic rates without adjustment. The fresh start transition method was designed to prevent recognition of noneconomic section 987 gain or loss that was not recognized before the transition date. Because marked assets and liabilities were translated at historic rates under the fresh start transition method, any section 987 gain or loss inherent in those assets and liabilities would be added to the pool of net unrecognized section 987 gain or loss in the taxable year beginning on the transition date. However, exchange rate fluctuations with respect to historic items would not give rise to section 987 gain or loss. In addition, section 987 gain or loss attributable to items that were no longer reflected on the section 987 QBU’s balance sheet on the transition date (for example, assets that E:\FR\FM\14NOP3.SGM 14NOP3 78136 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 had been sold before the transition date) would never be taken into account. Only taxpayers that were applying section 987(3) using a reasonable method before the transition date were permitted to use the deferral transition method. A taxpayer whose prior method was unreasonable, or that failed to make required determinations under section 987 in prior years, was required to use the fresh start transition method. For this purpose, the preamble to the 2006 proposed regulations explained that the method of applying section 987 provided in the 1991 proposed regulations would be treated as a reasonable method. The preamble to the 2006 proposed regulations further stated that the use of an ‘‘earnings only’’ method would be treated as a reasonable method. Under an ‘‘earnings only’’ method, section 987 gain or loss is recognized on a distribution out of a QBU’s earnings, but not on a distribution in excess of earnings (which represents a return of capital). C. 2016 Final Regulations On December 8, 2016, the Treasury Department and the IRS published final regulations (TD 9794) in the Federal Register (81 FR 88806, December 8, 2016) (the ‘‘2016 final regulations’’). The 2016 final regulations largely adopt the FEEP method contained in the 2006 proposed regulations but modify those regulations to make the FEEP method easier for the IRS to administer and for taxpayers to apply. For example, the 2016 final regulations permit taxpayers to use the yearly average exchange rate as the historic rate applicable to historic items. See § 1.987–3(c)(3). The 2016 final regulations also modify the computation of net unrecognized section 987 gain or loss for a taxable year by requiring adjustments for nondeductible expenses and tax-exempt income. See § 1.987–4(d)(7) and (8). The 2016 final regulations maintain the aggregate approach of the 2006 proposed regulations for partnerships. However, in response to comments relating to the complexity of the aggregate approach, the 2016 final regulations apply only to partnerships that are wholly owned by related persons (‘‘section 987 aggregate partnerships’’). The preamble to the 2016 final regulations indicated that the treatment of other partnerships under section 987 would be addressed separately and such partnerships might be subject to a different approach. The 2016 final regulations require taxpayers to transition using the fresh start transition method. See § 1.987–10. The Treasury Department and the IRS were concerned that an election VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 between two transition methods (as permitted under the 2006 proposed regulations) would result in a whipsaw to the fisc, because each taxpayer could choose the method that produces more section 987 loss and less section 987 gain (as was noted by comments on the 2006 proposed regulations). The Treasury Department and the IRS were also concerned about administrative difficulties and planning opportunities associated with adjustments to the translation rate under the deferral transition method. Section 1.987–11(a) provides that the 2016 final regulations generally apply to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. However, taxpayers could choose to apply them to an earlier taxable year under § 1.987–11(b). D. 2016 Temporary and Proposed Regulations On December 8, 2016, the Treasury Department and the IRS published Treasury Decision 9795 (the ‘‘temporary regulations’’) in the Federal Register (81 FR 88854, December 8, 2016) and published a notice of proposed rulemaking (81 FR 88882, December 8, 2016) (the ‘‘2016 proposed regulations’’) in the Federal Register by crossreference to the temporary regulations. The temporary regulations (other than § 1.987–12T) had the same applicability date as the 2016 final regulations. The temporary regulations and the 2016 proposed regulations include: (1) rules relating to the recognition and deferral of section 987 gain or loss in connection with certain QBU terminations and certain other transactions involving partnerships; (2) an annual deemed termination election; (3) an elective method, available to taxpayers that make the annual deemed termination election, for translating all items of income or loss with respect to a section 987 QBU at the yearly average exchange rate; (4) rules regarding the treatment of section 988 transactions of a section 987 QBU; (5) rules regarding QBUs with the U.S. dollar as their functional currency; (6) rules regarding combinations and separations of section 987 QBUs; (7) rules regarding the translation of income used to pay creditable foreign income taxes; (8) rules regarding the allocation of assets and liabilities of certain partnerships for purposes of section 987; and (9) rules requiring the deferral of certain section 988 loss that arises with respect to related-party loans. Under the annual deemed termination election provided in the temporary regulations, a taxpayer could elect to PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 deem all of its section 987 QBUs to terminate on the last day of each taxable year, resulting in the recognition of all net unrecognized section 987 gain or loss on an annual basis. See § 1.987– 8T(d). The assets and liabilities of a section 987 QBU subject to the election were deemed to be distributed to the owner pursuant to the deemed termination on the last day of each taxable year and recontributed on the first day of the following taxable year. The temporary regulations further provided that a taxpayer who made an annual deemed termination election could elect to translate all items of section 987 taxable income or loss at the yearly average exchange rate. See § 1.987–3T(d). The temporary regulations (other than those finalized or withdrawn in 2019, as described in part II.E of this Background section) expired on December 6, 2019. The Treasury Department and the IRS intend to remove the temporary regulations from the Federal Register when the proposed regulations are finalized. The following parts of the 2016 proposed regulations remain outstanding: (1) rules regarding the treatment of section 988 transactions of a section 987 QBU (see §§ 1.987–1, 1.987–3, and 1.988–1 of the 2016 proposed regulations); (2) rules regarding QBUs with the U.S. dollar as their functional currency (see §§ 1.987– 1 and 1.987–6 of the 2016 proposed regulations); (3) rules regarding the translation of income used to pay creditable foreign income taxes (see § 1.987–3 of the 2016 proposed regulations); and (4) rules requiring the deferral of certain section 988 loss that arises with respect to related-party loans (see § 1.988–2 of the 2016 proposed regulations). A notice reopening the comment period for the parts of the 2016 proposed regulations that remain outstanding is published in this issue of the Federal Register. E. 2019 Final Regulations On May 13, 2019, the Treasury Department and the IRS published Treasury Decision 9857 (84 FR 20790, May 13, 2019) (the ‘‘2019 final regulations’’ and, collectively with the 2016 final regulations, the ‘‘final regulations’’) in the Federal Register. The 2019 final regulations finalized parts of the 2016 proposed regulations relating to combinations and separations of section 987 QBUs and the recognition and deferral of section 987 gain or loss in connection with certain QBU terminations and certain other transactions involving partnerships. The 2019 final regulations also withdrew E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules § 1.987–7T of the temporary regulations, relating to the allocation of assets and liabilities of a section 987 aggregate partnership to its partners for purposes of section 987, in response to comments noting that these rules could cause distortions in the computation of section 987 gain or loss. The 2019 final regulations (other than § 1.987–12) have the same applicability date as the 2016 final regulations. khammond on DSKJM1Z7X2PROD with PROPOSALS3 III. Executive Order 13789 and Interim Report to the President Executive Order 13789, issued on April 21, 2017, instructs the Secretary of the Treasury (the ‘‘Secretary’’) to review all significant tax regulations issued on or after January 1, 2016, and to take action to mitigate the burden of regulations that, in relevant part, impose an undue financial burden on U.S. taxpayers or add undue complexity to the Federal tax laws. The Executive order further instructs the Secretary to submit two reports to the President: an interim report that identifies regulations that meet the criteria described in the Executive order; and a report that recommends specific actions to mitigate the burden imposed by regulations identified in the interim report. In an interim report to the President dated June 22, 2017, the Treasury Department identified eight regulations, including the 2016 final regulations, as meeting at least one of the criteria described in the Executive order. In Notice 2017–38, 2017–30 I.R.B. 147, which was published on July 24, 2017, the Treasury Department and the IRS requested comments on whether the regulations identified in the interim report (including the 2016 final regulations) should be rescinded or modified and, if not rescinded, how the regulations should be modified to reduce the burden and complexity. The Treasury Department and the IRS received several comments in response to Notice 2017–38. In addition, one comment was submitted in response to Notice 2017–57, 2017–42 I.R.B. 325 (which was the first of the deferral notices described in part V of this Background section). The comments that are relevant to the proposed regulations are discussed in the Explanation of Provisions. IV. Second Report to the President on Identifying and Reducing Tax Regulatory Burdens On October 16, 2017, the Secretary published a report (the ‘‘Report’’) in the Federal Register (82 FR 48013, October 16, 2017) recommending specific actions to mitigate the burden imposed by the regulations identified in the VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 interim report. The Report stated that the Treasury Department and the IRS intend to propose modifications to the 2016 final regulations and to issue guidance permitting taxpayers to elect to defer the application of §§ 1.987–1 through 1.987–10. In particular, the Report stated that, in response to comments, the Treasury Department and the IRS intend to propose rules that would permit taxpayers to elect to adopt a simplified method of calculating section 987 gain or loss and translating section 987 taxable income or loss, subject to certain limitations on the recognition of section 987 loss. One simplified method discussed in the Report would allow a taxpayer to treat all assets and liabilities of a section 987 QBU as marked items and to translate all items of income and expense at the average exchange rate for the taxable year. Under this method, the amount of section 987 gain or loss would generally be consistent with the amount determined under the 1991 proposed regulations and would more closely conform to the applicable financial accounting rules. The Report also noted that the Treasury Department and the IRS were considering limitations on the recognition of section 987 loss that would apply to taxpayers using the simplified method. Two potential limitations were mentioned in the Report: (1) a rule that would allow the electing taxpayer to recognize net section 987 loss only to the extent of net section 987 gain recognized in prior or subsequent years; and (2) a rule that would defer the recognition of all section 987 gain or loss until the earlier of (i) the year that the trade or business conducted by the section 987 QBU ceases to be performed by any member of its controlled group or (ii) the year that substantially all of the assets and activities of the QBU are transferred outside of the controlled group. Finally, the Report stated that the Treasury Department and the IRS were considering alternative transition rules. One alternative would allow taxpayers to carry forward unrealized section 987 gains and losses (measured on the transition date with appropriate adjustments), and a second alternative would allow taxpayers to translate all items of the section 987 QBU at the spot rate on the transition date without carrying forward any unrecognized section 987 gain or loss. V. Deferral Notices The Treasury Department and the IRS have issued several notices stating that future guidance would defer the applicability dates of the 2016 final PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 78137 regulations, §§ 1.987–2(c)(9) and 1.987– 4(c)(2) and (f) of the 2019 final regulations (the ‘‘related 2019 final regulations’’), and §§ 1.987–1T (other than §§ 1.987–1T(g)(2)(i)(B) and (g)(3)(i)(H)) through 1.987–4T, 1.987– 6T, 1.987–7T, 1.988–1T, and 1.988– 2T(i) of the temporary regulations. Most recently, on August 22, 2022, Notice 2022–34, 2022–34 I.R.B. 150, announced that future guidance would defer the applicability date of the 2016 final regulations and the related 2019 final regulations by one additional year to taxable years beginning after December 7, 2023. Thus, following the amendments described in that Notice, the 2016 final regulations and the related 2019 final regulations would first apply to the taxable year beginning on January 1, 2024, for calendar year taxpayers. The applicability date of § 1.987–12 would not be affected by these amendments. VI. Financial Accounting Rules The rules of the final regulations under section 987 differ from the U.S. generally accepted accounting principles (‘‘U.S. GAAP’’) relating to foreign currency translation gain or loss.1 For financial accounting purposes, the consolidated financial statements of a reporting entity may include operations denominated or measured in currencies other than the reporting currency (each such operation, a foreign entity),2 resulting in the need to translate those operations into the reporting currency of the reporting entity. FASB, 2023, ASC par. 830–10– 10–1. The assets and liabilities and other elements, such as revenues and expenses, of the financial statements of a foreign entity are translated to the reporting currency using a current exchange rate. FASB, 2023, ASC pars. 830–30–45–3 through 830–30–45–5. For example, assets and liabilities of the foreign entity are translated into the reporting currency using the spot rate on the balance sheet date. Translation adjustments resulting from the process of translating a foreign entity’s financial statements to the reporting currency are not included in determining net income 1 The relevant U.S. GAAP financial accounting rules are contained in Financial Accounting Standards Board (‘‘FASB’’), Accounting Standards Codification (‘‘ASC’’), Foreign Currency Matters, Topic 830 (formerly known as FASB Statement No. 52, Foreign Currency Translation). 2 A foreign entity is an operation, including a subsidiary, division, and branch, whose financial statements are both (a) prepared in a currency other than the reporting currency of the reporting entity, and (b) combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity. FASB, 2023, ASC sec. 830–10–20. E:\FR\FM\14NOP3.SGM 14NOP3 78138 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules but are reported in the cumulative translation adjustment (CTA), which is part of other comprehensive income, included in the in the equity section of the reporting entity’s consolidated balance sheet. FASB, 2023, ASC par. 830–30–45–12. Upon the sale or liquidation of the investment in the foreign entity, the CTA attributable to that foreign entity is removed from equity and is reported as part of the gain or loss on the sale or liquidation of the investment. FASB, 2023, ASC par. 830– 30–40–1. The treatment of translation gain or loss under FASB, ASC Topic 830, under which translation gain or loss is deferred until a sale or liquidation, differs from the requirements of section 987(3), under which a taxpayer is required to make proper adjustments for the transfer of property between QBUs of a taxpayer by including section 987 gain or loss in income upon a remittance. Further, in contrast to the translation adjustments in the financial accounting rules, which apply to all assets and liabilities of a foreign entity, the FEEP method imputes section 987 gain or loss only to marked items of a section 987 QBU and requires the basis of historic assets to be translated at historic rates for purposes of computing section 987 taxable income or loss. khammond on DSKJM1Z7X2PROD with PROPOSALS3 Explanation of Provisions The proposed regulations retain the basic approach and structure of the final regulations, while adopting a number of the simplifications discussed in the Report and providing additional guidance regarding the determination of section 987 taxable income or loss and section 987 gain or loss. I. FEEP Method As explained in parts II.B and II.C of the Background section, the final regulations provide that section 987 gain or loss and section 987 taxable income or loss are determined under the FEEP method. This method uses a balance sheet approach to determine section 987 gain or loss. In addition, historic items are translated at historic rates (both for purposes of determining section 987 gain or loss and for purposes of translating recovery of basis with respect to historic assets in computing section 987 taxable income or loss). As a result, the FEEP method does not impute section 987 gain or loss to historic items, for which exchange rate changes have only an uncertain or remote effect on value that is more appropriately recognized upon a realization event. Several comments asserted that the FEEP method is overly complex and VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 presents significant compliance burdens, primarily related to the treatment of historic items. Comments stated that, because the requirement to use historic rates to translate historic items diverges from financial accounting rules, taxpayers would need to keep a separate set of books with respect to each section 987 QBU and to develop costly reporting systems to maintain information that is not used for any other purpose. Comments recommended that, to reduce the complexity and administrative burden of the final regulations, taxpayers should be permitted to apply a method similar to that provided in the 1991 proposed regulations. Comments noted that this method could be coupled with rules to prevent the selective recognition of section 987 losses, as discussed in part III of this Explanation of Provisions. The proposed regulations retain the FEEP method of the 2016 final regulations, with modifications discussed in this Explanation of Provisions, as the default rule for determining section 987 taxable income or loss and net unrecognized section 987 gain and loss. See proposed §§ 1.987–3 and 1.987–4. The FEEP method is an appropriate default rule because it generally provides a more precise measure of section 987 gain or loss. Moreover, the enactment of the Tax Cuts and Jobs Act, Public Law 115–97, 131 Stat. 2054 (2017), on December 22, 2017, has made it even more important to accurately calculate taxable income with respect to a section 987 QBU. For example, section 951A, relating to global intangible low-taxed income (‘‘GILTI’’), has significantly expanded the scope of taxable income of a controlled foreign corporation (‘‘CFC’’) that is subject to current U.S. taxation.3 In addition, because the 2016 final regulations permit the yearly average exchange rate to be used as the historic rate, a taxpayer that knows the year in which an asset was acquired or placed in service can determine the applicable historic rate based on publicly available information. Information relating to the year in which an asset was acquired or placed in service is often tracked for other reasons, including for purposes of computing depreciation and amortization. For example, in computing a CFC’s qualified business asset investment, section 951A(d)(3)(A) 3 Previously, section 987 gain or loss recognized by a CFC generally would be taken into account in determining a U.S. shareholder’s taxable income only if a portion of the section 987 gain or loss affected the calculation of subpart F income or when the earnings of the CFC were relevant, such as on a distribution or sale. PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 now requires the adjusted basis of assets to be determined using the alternative depreciation system under section 168(g). However, the Treasury Department and the IRS acknowledge that in some cases it may be burdensome to translate the basis of each historic asset using a different historic rate (including for purposes of depreciation) in determining section 987 taxable income or loss. Accordingly, as described in parts II and IV of this Explanation of Provisions, the proposed regulations provide several simplifying elections that permit section 987 to be applied in a way that more closely conforms to the financial accounting rules and reduces the compliance burden. Taxpayers who make these elections would still compute section 987 gain or loss by reference to the year-end balance sheet of the section 987 QBU (though the computation would be modified, as described in part V of this Explanation of Provisions). The proposed regulations do not include an election to use the method prescribed in the 1991 proposed regulations, because the use of fundamentally different computational methods by different taxpayers (or by the same taxpayer in different years) would increase the complexity of the section 987 regulations and make them more difficult to administer. II. Current Rate Election As discussed in part I of this Explanation of Provisions section, comments noted that the compliance burden associated with the FEEP method relates primarily to the treatment of historic items. Under the 2016 final regulations, taxpayers are required to track the historic rate for historic items and to use the historic rate for purposes of computing section 987 taxable income or loss and section 987 gain or loss. To alleviate this compliance burden, proposed § 1.987–1(d)(2) would provide an election to treat all items that are properly reflected on the books and records of a section 987 QBU as marked items (the ‘‘current rate election’’). If a current rate election applies, all items of income, gain, deduction, and loss with respect to a section 987 QBU would be translated at the yearly average exchange rate for the current taxable year for purposes of computing section 987 taxable income or loss. See proposed § 1.987–3(c)(2). In addition, all items of a section 987 QBU would be translated at the year-end spot rate for purposes of computing section 987 gain or loss. The current rate election is expected to produce an amount of section 987 E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 gain or loss and section 987 taxable income or loss that is similar to the amounts determined under the 1991 proposed regulations. If a current rate election is made, all assets and liabilities of a section 987 QBU would generate section 987 gain or loss, in conformity with the approach used for financial reporting purposes and the 1991 proposed regulations. In general, a current rate election would increase the pool of net unrecognized section 987 gain or loss with respect to a section 987 QBU (relative to the pool that would be determined without the current rate election). In addition, under a current rate election amounts in the pool may substantially exceed any economic gain or loss attributable to currency fluctuations. The Treasury Department and the IRS are concerned that without appropriate limitation, the current rate election would facilitate the abuses and inappropriate outcomes that occurred under the 1991 proposed regulations, including the potential for taxpayers to choose to recognize significant, and potentially uneconomic, section 987 losses while avoiding or deferring section 987 gains. Accordingly, the proposed regulations include a rule that would suspend the recognition of section 987 loss when a current rate election is in effect. See part III of this Explanation of Provisions. III. Suspension of Section 987 Loss Under a Current Rate Election Comments discussed several options for addressing the potential for selective recognition of section 987 losses. First, comments asserted that certain rules provided in the 2016 final regulations (for example, the annual netting of contributions and distributions to determine the amount of a remittance under § 1.987–5(c)) would be sufficient to prevent abuse. Alternatively, comments recommended that the recognition of section 987 gain or loss be deferred until a QBU is terminated or its assets are sold to an unrelated party, consistent with the financial accounting rules. Comments also suggested that section 987 loss could be deferred until the owner recognizes an equal or greater amount of section 987 gain from the same QBU. Finally, some comments proposed a ‘‘lookback’’ approach, under which section 987 loss would be deferred only to the extent that the loss exceeded section 987 gain previously recognized with respect to the same section 987 QBU. The Treasury Department and the IRS are concerned that, notwithstanding the annual netting rule of § 1.987–5(c) and the other rules provided in the 2016 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 final regulations, taxpayers generally have a significant degree of control over whether and when their section 987 QBUs make remittances and, therefore, could still selectively recognize section 987 losses. In addition, because taxpayers that make a current rate election are expected to have substantial pools of net unrecognized section 987 gain or loss, special rules are needed to prevent the selective recognition of losses. Accordingly, if a current rate election is in effect, the proposed regulations generally would suspend the recognition of section 987 loss until a taxable year in which an equal or greater amount of section 987 gain is recognized (as described in part III.A of this Explanation of Provisions) or until the occurrence of certain recognition events (as described in part III.B of this Explanation of Provisions). A. General Rules Relating to Suspended Section 987 Loss 1. In General In a taxable year in which a current rate election applies, any section 987 loss that would otherwise be recognized as a result of a remittance (including a deemed remittance resulting from the termination of a section 987 QBU) is treated as suspended section 987 loss. Proposed § 1.987–11(c). In general, an owner of a section 987 QBU would recognize suspended section 987 loss in a taxable year in which the owner recognizes section 987 gain that has the same source and character as the suspended section 987 loss (the ‘‘lossto-the-extent-of-gain rule’’). Proposed § 1.987–11(e). Whether section 987 gain has the same source and character as suspended section 987 loss would be determined on the basis of the initial assignment in proposed § 1.987– 6(b)(2)(i). See proposed § 1.987–11(e)(1) and (f). The Treasury Department and the IRS considered applying the loss-to-theextent-of-gain rule at the QBU level, such that suspended section 987 loss with respect to a section 987 QBU would be recognized only to the extent of section 987 gain recognized with respect to the same section 987 QBU (as was recommended by some comments). However, the Treasury Department and the IRS were concerned that a QBUlevel limitation would be overly restrictive. Moreover, if an owner has suspended section 987 loss with respect to one QBU, the concern of selective loss recognition may be mitigated to the extent that the same owner recognizes section 987 gain with respect to another QBU. PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 78139 Therefore, under the proposed regulations, the loss-to-the-extent-ofgain rule applies at the owner level. An owner of a section 987 QBU recognizes suspended section 987 loss to the extent that it recognizes section 987 gain, regardless of which QBU generates the gain. However, because this rule applies at the owner level, the Treasury Department and the IRS were concerned that an owner might trigger the recognition of section 987 gain that is not subject to residual U.S. tax (or is taxed at a low rate) to release suspended section 987 loss of a different source or character. Accordingly, proposed § 1.987–11(e)(1) provides that an owner does not recognize suspended section 987 loss until it recognizes section 987 gain in the same recognition grouping as the suspended section 987 loss. In general, section 987 gain and suspended section 987 loss are in the same recognition grouping if they are both initially assigned to U.S. source income or to foreign source income in the same section 904 category. Proposed § 1.987–11(f)(1). In addition, if the owner of a section 987 QBU is a CFC, in order to be in the same recognition grouping, section 987 gain and suspended section 987 loss must both be initially assigned to the same statutory and residual grouping of subpart F income, tentative tested income, income described in section 952(b) (certain income that is effectively connected with the conduct of a trade or business within the United States (‘‘ECI’’) and excluded from subpart F income), or other income.4 Proposed § 1.987–11(f)(2). Suspended section 987 loss that is not recognized in a taxable year is recognized in the next taxable year in which (and to the extent that) the owner recognizes section 987 gain in the same recognition grouping. The Treasury Department and the IRS also considered a lookback rule, under which suspended section 987 loss could be recognized to the extent that section 987 gain was recognized in a prior taxable year. However, a lookback rule would permit taxpayers to selectively trigger section 987 gain in taxable years in which such gain would not give rise to additional U.S. tax (for example, because the gain is offset by losses or because the additional U.S. tax is offset with foreign tax credits). In light of these concerns, the Treasury Department and the IRS request comments regarding, if a lookback rule were to be adopted, how to prevent section 987 gain that has no 4 See part VI of this Explanation of Provisions (requesting comments concerning the treatment of section 987 gain or loss as ECI). E:\FR\FM\14NOP3.SGM 14NOP3 78140 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules net effect on U.S. tax from releasing suspended section 987 loss that reduces U.S. tax. khammond on DSKJM1Z7X2PROD with PROPOSALS3 2. Suspension of Section 987 Loss When an Annual Recognition Election Is Made In general, a taxpayer who makes an annual recognition election will recognize the full amount of net unrecognized section 987 gain or loss that is added to the pool each year. If an annual recognition election and a current rate election are both in effect for a taxable year, section 987 loss generally would not be suspended under proposed § 1.987–11(c). See part IV of this Explanation of Provisions. The Treasury Department and the IRS are concerned that taxpayers who are subject to a current rate election might seek to avoid the application of the lossto-the-extent-of-gain rule by making an annual recognition election after net unrecognized section 987 loss has accrued. Similarly, the Treasury Department and the IRS are concerned that taxpayers that have not made a current rate election, but which have substantial pools of net unrecognized section 987 loss, might make an annual recognition election to recognize the loss without the need for a remittance. Accordingly, the proposed regulations would treat any net accumulated unrecognized section 987 loss and deferred section 987 loss as suspended section 987 loss in the first year in which an annual recognition election takes effect if either (1) a current rate election was in effect in the previous year or (2) the owner had more than $5 million of net section 987 losses. Proposed § 1.987–11(d). 3. Recognition of Suspended Section 987 Loss When an Annual Recognition Election Is in Effect The proposed regulations also contain a special rule relating to the recognition of suspended section 987 loss when a current rate election and an annual recognition election are both in effect. The Treasury Department and the IRS are concerned that, absent a modification to the general loss-to-theextent-of-gain rule in proposed § 1.987– 11(e)(1), taxpayers that have suspended section 987 loss would get an unwarranted benefit from making an annual recognition election. Specifically, absent a modification, these taxpayers would be able to recognize suspended section 987 loss even if they had net losses on a cumulative basis for the taxable years to which the annual recognition election applied. For example, assume that an owner of a section 987 QBU has suspended VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 section 987 loss of $400 that arose in prior years (for example, under a current rate election). The owner’s functional currency is the U.S. dollar, and the section 987 QBU’s functional currency is the euro. In year 1, the owner makes an annual recognition election. The euro weakens in year 1 and partially recovers in year 2. As a result of the annual recognition election, the owner recognizes section 987 loss of $200 in year 1 and recognizes section 987 gain of $150 in year 2. Under the general loss-to-the-extent-of-gain rule in § 1.987–11(e)(1), even though the owner recognized net section 987 loss of $50 on a cumulative basis (over years 1 and 2), the owner would recognize suspended section 987 loss equal to the section 987 gain in the same recognition grouping that it recognizes in year 2. Assuming all of the section 987 gain or loss is in the same recognition grouping, the owner would recognize $350 of total section 987 loss (equal to $200 of section 987 loss recognized under the annual recognition election in year 1 and $150 of suspended section 987 loss recognized under the loss-to-the-extentof-gain rule in year 2), even though it recognizes only $150 of section 987 gain. Accordingly, if a taxpayer makes both an annual recognition election and a current rate election, the loss-to-theextent-of-gain rule would apply by reference to the net cumulative amount of section 987 gain in each recognition grouping that is recognized by the taxpayer during the relevant testing period (rather than the gross amount recognized each taxable year). Proposed § 1.987–11(e)(2). The testing period generally is the period in which section 987 loss is suspended and both a current rate election and an annual recognition election are in effect. Proposed § 1.987–11(e)(2)(iii). The Treasury Department and the IRS request comments on whether any modifications to the limitation in proposed § 1.987–11(e)(2) would allow for simplification while preventing inappropriate outcomes. B. Suspended Section 987 Loss Recognized or Attributed to a Successor on Termination The proposed regulations provide a successor rule that applies when a section 987 QBU with suspended section 987 loss terminates. Under the successor rule, suspended section 987 loss is not recognized in the taxable year of termination, but instead becomes attributable to a successor suspended loss QBU. For this purpose, an eligible QBU is treated as a successor of a section 987 PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 QBU if it holds a significant portion of the assets of the section 987 QBU following its termination, is engaged in the same trade or business, and is owned by the owner of the section 987 QBU or a member of the owner’s controlled group. Proposed § 1.987– 13(b)(1). For this purpose, any eligible QBU may qualify as a successor, whether or not it is a section 987 QBU (that is, whether or not it has a different functional currency than its owner). Thus, for example, if an owner of a section 987 QBU with suspended section 987 loss contributes the assets of the section 987 QBU to a subsidiary where they are held by an eligible QBU of the subsidiary that uses them in the same trade or business (the ‘‘subsidiary QBU’’), the subsidiary QBU is a successor suspended loss QBU even if it is not a section 987 QBU. Similar principles apply when a successor terminates. Proposed § 1.987–13(c)(1). If a section 987 QBU (or its successor) terminates without a successor, the original owner of the section 987 QBU recognizes all of its suspended section 987 loss with respect to the section 987 QBU (or its successor). Proposed § 1.987–13(b)(2) and (c)(2). Therefore, an owner generally would recognize suspended section 987 loss when it transfers the section 987 QBU’s assets to an unrelated party or the section 987 QBU ceases its trade or business (such that there is no successor suspended loss QBU). These events are similar to the events that result in a release of the CTA for financial reporting purposes. Moreover, the Treasury Department and the IRS expect that taxpayers would be less likely to sell or wind up the trade or business of a section 987 QBU for the purpose of selectively recognizing section 987 losses and, accordingly, there is less of a need for continued suspension of section 987 loss after these events occur. In addition, suspended section 987 loss is recognized if the owner of the successor ceases to be related to the original owner of the suspended loss QBU due to a direct or indirect transfer of interests in the owner of the successor. Proposed § 1.987–13(d). If the owner of a successor suspended loss QBU ceases to be related to the original owner of the section 987 QBU for a different reason (for example, due to a transfer of interests in the original owner of the suspended loss QBU), the successor suspended loss QBU is no longer treated as a successor, and suspended section 987 loss can no longer be recognized in connection with a termination (though it can still be recognized under the loss-to-the-extentof-gain rule). Proposed § 1.987–13(e). E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 This rule is intended to prevent taxpayers from transferring the stock of the original owner out of its controlled group for the purpose of selectively recognizing suspended section 987 loss, while leaving behind the assets and activities of the section 987 QBU in the hands of a different controlled group member. Similarly, suspended section 987 loss is not recognized when the owner of a section 987 QBU liquidates in a transaction described in section 331. Proposed § 1.987–13(f). Instead, suspended section 987 loss that is not recognized in the taxable year of the liquidation is eliminated and will never be recognized. This rule is intended to prevent taxpayers from entering into section 331 transactions in order to trigger the recognition of suspended section 987 loss. For example, a U.S. shareholder could cause an upper-tier CFC that owns a section 987 QBU with suspended section 987 loss to transfer all of its assets and liabilities to a lowertier CFC in a section 351 contribution, and then cause the upper-tier CFC to liquidate in a transaction described in section 331 in order to recognize the suspended loss. The Treasury Department and the IRS are aware that similar transactions have been used to claim large section 987 losses under current law. In the case of a combination or separation, the suspended section 987 loss of a combined or separated QBU is determined under rules similar to those applicable to net accumulated unrecognized section 987 gain or loss under proposed § 1.987–4(f). Proposed § 1.987–11(b)(2) and (3). Therefore, the suspended section 987 loss of a separating QBU is allocated to the separated QBUs in proportion to the assets properly reflected on the books and records of each separated QBU after the separation. Proposed § 1.987– 11(b)(3) C. Special Rule for Inbound Liquidations and Reorganizations Under the proposed regulations, if a foreign corporation liquidates or merges into a domestic corporation in a section 381(a) transaction, the domestic corporation does not succeed to or take into account any unused suspended section 987 loss of the foreign corporation. Proposed § 1.987–13(g). This rule is intended to prevent the importation of suspended section 987 loss that was generated offshore. Due to differences in how income of a CFC is taxed to its U.S. shareholders, these losses may relate to income subject to tax at a significantly reduced effective rate. For example, a suspended section VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 987 loss that is allocated and apportioned to the other income grouping under proposed § 1.987–6 may effectively reduce only earnings that would typically not be subject to current U.S. tax, and which may be eligible for a dividends received deduction under section 245A upon distribution. As a result, depending on the particular facts, such losses may have little or no impact on the U.S. tax liability of a CFC’s U.S. shareholder when they are recognized and are generally not equivalent to the section 987 gains or losses typical of a domestic corporation. Furthermore, even if the domestic corporation could, in theory, succeed to the suspended section 987 loss, the loss may have been assigned to an income group, such as the tested income group, that is not relevant to a domestic corporation, in which case, it would be highly unlikely that the suspended section 987 loss could ever be used (absent a subsequent outbound asset transfer by the domestic corporation to a foreign successor) under the loss-tothe-extent-of-gain rule because the domestic corporation would not recognize section 987 gain in the same recognition grouping. D. Rejection of Financial Accounting Deferral Rule The Treasury Department and the IRS also considered a rule that would defer the recognition of all section 987 gain and loss of a section 987 QBU until a taxable year in which the section 987 QBU’s trade or business ceases to be performed by any member of the controlled group or substantially all of the assets and activities of the QBU are transferred outside of the controlled group. This approach would more closely parallel the rules for determining when the CTA is released for financial accounting purposes. However, the loss limitation rule provided in the proposed regulations is more consistent with the statutory provisions of section 987(3), which contemplates the recognition of section 987 gain or loss at the time of a remittance, and section 989(c)(2), which authorizes regulations limiting the recognition of foreign currency loss on certain remittances. Moreover, the Treasury Department and the IRS are concerned that a rule that defers the recognition of all section 987 gain or loss may be difficult to administer. For example, as a practical matter, taxpayers might not properly track section 987 gain or loss on an annual basis if it is not expected to be recognized in the foreseeable future and the sale or liquidation of a section 987 QBU might occur many years after the accrual of PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 78141 section 987 gain or loss (at which time the necessary records may no longer be available). IV. Annual Recognition Election A. Annual Deemed Termination Election Provided in the 2016 Temporary and Proposed Regulations As explained in part II.D of the Background section, the 2016 temporary and proposed regulations contained an annual deemed termination election. Under this election, a section 987 QBU would be deemed to terminate on the last day of each taxable year, resulting in the remittance of all the gross assets of the section 987 QBU to its owner and the recognition of all net unrecognized section 987 gain or loss on an annual basis. See §§ 1.987–8T(d) and 1.987– 8(e). The assets and liabilities of a section 987 QBU subject to the election would then be deemed to be contributed to the section 987 QBU on the first day of the following taxable year. See § 1.987–8T(d). A comment asserted that it was difficult to apply the rules under the annual deemed termination election. If the election was made, a section 987 QBU’s historic assets and the amount of its historic liabilities would be translated at the end of each year into the owner’s functional currency using historic rates (due to the deemed termination and remittance); the historic rate would generally be the yearly average exchange rate for the year of the deemed termination. The assets and liabilities would then be retranslated into the section 987 QBU’s functional currency at the beginning of the following taxable year at the yearly average exchange rate for the following taxable year (due to the deemed contribution). See §§ 1.987–2(d)(2) and 1.987–5(f)(3). As a result, the basis of a section 987 QBU’s assets and the amount of its liabilities (determined in the section 987 QBU’s functional currency) generally would change from one year to the next, which would increase the compliance burden of applying the section 987 regulations. B. Annual Recognition Election Provided in the Proposed Regulations The proposed regulations would replace the annual deemed termination election with an annual recognition election. Like the annual deemed termination election, an owner that makes the annual recognition election would recognize the full amount of net unrecognized section 987 gain or loss each year. However, the proposed annual recognition election does not result in a deemed termination of a E:\FR\FM\14NOP3.SGM 14NOP3 78142 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section 987 QBU and a deemed remittance of its assets or a deemed contribution to the section 987 QBU. Instead, the owner of a section 987 QBU simply recognizes the full amount of its net unrecognized section 987 gain or loss on an annual basis. Therefore, the annual recognition election would not alter the functional currency basis of a section 987 QBU’s assets, the amount of its liabilities, or their historic exchange rates. C. Special Rules That Apply When a Current Rate Election and an Annual Recognition Election Are Both in Effect The annual recognition election is available to owners whether or not they make a current rate election. If an owner makes both an annual recognition election and a current rate election for a taxable year, the loss suspension rule described in part III of this Explanation of Provisions does not apply to net unrecognized section 987 loss accrued while the election is in effect. Because the annual recognition election requires both gains and losses to be recognized without regard to whether a remittance occurs, selective recognition of losses is not possible and, accordingly, a loss limitation should not be needed. However, see part III.A.3 of this Explanation of Provisions regarding the application of the loss-to-the-extent-ofgain rule when an annual recognition election is in effect. khammond on DSKJM1Z7X2PROD with PROPOSALS3 D. Translation of Taxable Income Under an Annual Recognition Election When a Current Rate Election Is Not in Effect If an owner of a section 987 QBU makes an annual recognition election, but does not make a current rate election, section 987 taxable income or loss is determined by translating all items at the yearly average exchange rate. Unlike under the 2016 temporary and proposed regulations, this rule is mandatory (rather than elective). Use of the yearly average exchange rate simplifies the determination of section 987 taxable income or loss without sacrificing accuracy and is consistent with financial accounting principles. Therefore, an election to use historic rates for this purpose should not be needed. E. Consequences of Making an Annual Recognition Election if a Current Rate Election Is Not in Effect As described in part IV.D of this Explanation of Provisions, if an owner of a section 987 QBU makes an annual recognition election, and does not make a current rate election, the owner would use the yearly average exchange rate for purposes of determining section 987 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 taxable income or loss. However, the owner would use historic rates to translate historic items for purposes of determining section 987 gain or loss. Thus, the same historic item would be translated at different exchange rates for different purposes. Under the mechanics of the FEEP method, if a historic asset is sold or depreciated during the taxable year, the difference between the historic rate basis and the current year average rate basis would be added to the pool of unrecognized section 987 gain or loss (and recognized pursuant to the annual recognition election). The effect of these rules is that—with respect to historic assets of a section 987 QBU—an owner that does not make a current rate election would recognize the same total amount of taxable income each year regardless of whether it makes an annual recognition election. For example, assume a section 987 QBU has the euro as its functional currency, and its owner is a calendar year taxpayer with the U.S. dollar as its functional currency. At the end of year 1, the section 987 QBU owns a nondepreciable historic asset (Asset A) with a basis of 100 euros, and the historic rate for Asset A is Ö1=$1. The yearly average exchange rate in year 2 and the spot rate on December 31, year 2 is Ö1=$2. In year 2, the section 987 QBU sells Asset A for 150 euros and holds the 150 euros on its balance sheet until the end of year 2. If the owner does not make an annual recognition election, the owner will have section 987 taxable income of $200 for year 2. This reflects the excess of the amount realized (150 euros, translated at the yearly average exchange rate of Ö1=$2 into $300) over the basis of Asset A (100 euros, translated at the historic rate of Ö1=$1 into $100). The owner will have no unrecognized section 987 gain or loss for the taxable year under § 1.987–4(d). A comparison of the year 2 and year 1 year-end balance sheets under § 1.987–4(d)(1) will reflect an increase of $200 (the excess of 150 euros held at the end of year 2, translated at the year 2 year-end spot rate of Ö1=$2 into $300, over the Ö100 basis of Asset A, which was held at the end of year 1, translated at the historic rate of Ö1=$1 into $100). However, this increase is fully offset by the negative adjustment for taxable income of $200 under § 1.987–4(d)(6). By contrast, if the owner makes an annual recognition election, the owner will have section 987 taxable income in year 2 of only $100 (50 euros of taxable income, translated at the yearly average exchange rate of Ö1=$2). The owner will also have unrecognized section 987 gain PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 for the taxable year of $100 under § 1.987–4(d), which reflects the balance sheet increase of $200 (computed under § 1.987–4(d)(1) as described in the preceding paragraph) reduced by the negative adjustment for taxable income of $100. Thus, the difference between Asset A’s basis translated at the yearly average exchange rate (which is $200) and its basis translated at the historic rate (which is $100) is added to the pool of unrecognized section 987 gain or loss and this amount is recognized in year 2 due to the annual recognition election. The example illustrates that, whether or not the annual recognition election is made, the owner recognizes the same amount of total income with respect to Asset A (that is, $200). However, the annual recognition election has the effect of converting a portion of the owner’s income into section 987 gain or loss. Because section 987 gain or loss is subject to special source and character rules under proposed § 1.987–6, the annual recognition election can change the source and character of an owner’s taxable income. F. Impact of an Annual Recognition Election on the Timing of Recognition With Respect to Marked and Historic Items Under an annual recognition election, section 987 gain or loss with respect to marked items would be recognized annually (whereas, in the absence of an annual recognition election, section 987 gain or loss would be deferred until the section 987 QBU makes a remittance). Therefore, with respect to marked items, an annual recognition election would accelerate the recognition of section 987 gain or loss. If a current rate election is in effect, all items of the section 987 QBU will be treated as marked items generating section 987 gain or loss; this gain or loss would be accelerated if an annual recognition election is made. However, if a current rate election is not in effect, the annual recognition election would not accelerate the recognition of income with respect to historic assets. As explained in part IV.E of this Explanation of Provisions, in the absence of a current rate election, the owner of a section 987 QBU recognizes the same amount of total income with respect to historic assets whether or not an annual recognition election is in effect (though the annual recognition election has the effect of changing the portion of the income that is section 987 gain or loss and the portion that is section 987 taxable income or loss). In addition, as explained in part IV.D of this Explanation of Provisions, an annual recognition election is expected to simplify the computation of section E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 987 taxable income or loss (because all items would be translated at the yearly average exchange rate). Therefore, for section 987 QBUs that do not have a significant amount of marked assets or liabilities, the election is expected to reduce the compliance burden on taxpayers without materially accelerating the recognition of income. V. Changes to the Computation of Unrecognized Section 987 Gain or Loss for a Taxable Year The proposed regulations contain several changes to the computation of unrecognized section 987 gain or loss for a taxable year under § 1.987–4(d) (that is, the amount added to the pool of net unrecognized section 987 gain or loss each year).5 These modifications are intended to ensure that section 987 gain or loss is attributable only to exchange rate fluctuations. For example, the proposed regulations would modify the adjustments for tax-exempt income and non-deductible expenses to cover all items of income, gain, deduction, or loss that affect the section 987 QBU’s balance sheet but are not taken into account in determining section 987 taxable income or loss for the taxable year. Proposed § 1.987–4(d)(7) and (8). The proposed regulations would also require an adjustment for items of income, gain, deduction, or loss that are taken into account in determining section 987 taxable income or loss but do not affect the section 987 QBU’s balance sheet for the taxable year. Proposed § 1.987–4(d)(9). Thus, the proposed regulations would account for deferred items that are expected to be taken into account in computing taxable income in a subsequent year by taking them into account in the year in which they impact the section 987 QBU’s balance sheet and effectively backing them out in the future year when they impact taxable income but do not change the balance sheet. For example, if a section 987 QBU incurs an expense in year 1, but the deduction associated with the expense is deferred until year 5, proposed § 1.987–4(d)(7) would treat the expense as a non-deductible expense in year 1, increasing the year 1 unrecognized section 987 gain or loss. In year 5, the deduction would have no net effect on unrecognized section 987 gain or loss, since the deduction would 5 Proposed § 1.987–4(g) contains new examples illustrating the proposed modifications to the computation of unrecognized section 987 gain or loss under proposed § 1.987–4(d). The Treasury Department and the IRS intend to make conforming changes to the existing examples in § 1.987–4 of the final regulations when the proposed regulations are finalized. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 result in a positive adjustment under proposed § 1.987–4(d)(6) (because the deduction reduces taxable income, and taxable income is a negative adjustment to unrecognized section 987 gain or loss), and an offsetting negative adjustment under proposed § 1.987– 4(d)(9) (since the deduction represents a taxable deduction that does not affect the balance sheet). As a result, the expense would impact the calculation of section 987 gain or loss in the same manner as if it had been deductible in year 1. In addition, the proposed regulations require an adjustment to unrecognized section 987 gain or loss for any residual increase or decrease to the adjusted balance sheet of the section 987 QBU (determined in the functional currency of the section 987 QBU) that is not accounted for under the other computational steps. Proposed § 1.987– 4(d)(10). This residual amount is translated into the owner’s functional currency at the yearly average exchange rate. The residual increase or decrease is computed by applying the other computational steps described in proposed § 1.987–4(d) (steps 1 through 9) in the functional currency of the section 987 QBU. Because these steps must already be performed in the owner’s functional currency, determining the residual increase or decrease to the adjusted balance sheet under proposed § 1.987–4(d)(10) is not expected to significantly increase the burden of determining net unrecognized section 987 gain or loss. The application of proposed § 1.987– 4(d)(10) would ensure that noncurrency-related changes to the balance sheet do not artificially increase or decrease the pool of net unrecognized section 987 gain or loss. However, if the computational steps are applied correctly in the functional currency of a section 987 QBU, there should not be any residual increase or decrease to the balance sheet under proposed § 1.987– 4(d)(10) (unless a current rate election or an annual recognition election is made). Rather, the year-over-year increase (or decrease) to the functional currency balance sheet (step 1) should equal the functional currency amount of net transfers to the section 987 QBU (steps 2 through 5) and income of the section 987 QBU (steps 6 through 8), after backing out items of income that do not impact the balance sheet (step 9). By contrast, when these steps are applied in owner functional currency, they serve to identify the balance sheet change attributable to currency movements. For taxpayers that make a current rate election or an annual recognition PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 78143 election, the proposed regulations provide that steps 6 through 9 of the computation (relating to income, gain, deduction, or loss) do not need to be applied. For these taxpayers, all items of income, gain, deduction, or loss would be taken into account as a residual increase or decrease to the section 987 QBU’s balance sheet and translated at the yearly average exchange rate. The Treasury Department and the IRS request comments on whether any additional adjustments are needed for section 988 gain or loss of a section 987 QBU that is subject to a current rate election or an annual recognition election. See part XV of this Explanation of Provisions (requesting comments as to whether section 988 gain or loss of a section 987 QBU should be determined in the owner’s functional currency or the section 987 QBU’s functional currency). VI. Source and Character of Section 987 Gain or Loss The final regulations provide that the source and character of section 987 gain or loss is determined in the year of a remittance using the asset method of §§ 1.861–9(g) and 1.861–9T(g). See § 1.987–6(b)(2). For this purpose, only the assets of the section 987 QBU are taken into account. The proposed regulations would generally retain this character and source rule, subject to certain modifications, and would further provide that taxpayers must apply only the tax book value method in characterizing the assets under proposed §§ 1.861–9(g) and 1.861– 9T(g).6 See proposed § 1.987– 6(b)(2)(i)(A). Proposed § 1.987–6(b)(2)(i) would provide special rules for the application of the tax book value method for initially characterizing section 987 gain or loss. Under these proposed regulations, the assets of the section 987 QBU would be initially assigned to statutory and residual groupings under the tax book value method. However, to prevent circularity, the proportions in which the tax book value of the assets would be initially assigned to the statutory and residual groups are determined without regard to section 987 gain or loss. Proposed § 1.987– 6(b)(2)(i)(B). The initial assignment would occur after the application of the income attribution rules of § 1.904– 4(f)(2)(vi) or 1.951A–2(c)(7) (or the 6 The proposed regulations would also make a clarifying change to § 1.861–9T(g)(2)(ii)(A)(1) to clarify that the references to beginning-of-year and end-of-year functional currency amounts are to the owner functional currency amounts and to move certain provisions from § 1.861–9T to proposed § 1.861–9. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78144 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules principles of these rules), but before expenses are allocated and apportioned to gross income and before the application of provisions that require a net income computation, such as the high-tax exception to passive category income in § 1.904–4(c), the high-tax exception to foreign base company income in § 1.954–1(d), and the high-tax exclusion from tested income in § 1.951A–2(c)(7). In addition, because, at the time of the initial assignment, a taxpayer may not yet know whether a GILTI high-tax election will be in effect in the taxable year in which the section 987 gain or loss is recognized (since deferred section 987 gain or loss and suspended section 987 loss may be recognized in future year), the proposed regulations would initially assign all of the section 987 gain or loss that would have been assigned to a tested income group if no GILTI high-tax election was in effect to a tentative tested income group. See proposed § 1.987–6(b)(2)(i)(D). The initial assignment would generally be made in the taxable year in which section 987 gain or loss is treated as recognized, deferred, or suspended under proposed § 1.987–6(b)(1). Then, in the taxable year in which the section 987 gain or loss is recognized (which may be the same taxable year as the year in which the initial assignment was made or a future taxable year), any section 987 gain or loss that was initially assigned to a tentative tested income group would be reassigned to a tested income group or residual group based on whether the GILTI high-tax election is in effect in that taxable year and, if so, whether the income is hightax. The initial characterization under proposed § 1.987–6(b)(2)(i) would be used for purposes of applying the lossto-the-extent-of-gain rule in proposed § 1.987–11(e) and (f), and also applies as the starting point for net income calculations required for other provisions such as the high-tax exception to passive category income under § 1.904–4(c) and the GILTI and subpart F high-tax exceptions under §§ 1.954–1(d) and 1.951A–2(c)(7). Proposed § 1.987–6(b)(2)(ii). Proposed § 1.987–6(b)(2)(iii) would also provide that if a GILTI high-tax election is made under § 1.951A– 2(c)(7)(viii), it applies to all of the section 987 gain or loss in a tentative tested income group that is recognized by the CFC in the taxable year as if the section 987 gain and loss were all assigned to its own separate tested unit of the CFC. In other words, all section 987 gain or loss recognized by the CFC in that taxable year in the same section 904 category would be treated as a VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 single tentative tested income item for purposes of applying the GILTI high-tax exclusion. For example, if section 987 gain and loss in a section 904 category is initially assigned to a tentative tested income group under proposed § 1.987–6(b)(i) and a GILTI high-tax election is in effect in the year in which the section 987 gain or loss is recognized, the section 987 gain or loss in the section 904 category would be treated as its own tentative tested income item for purposes of determining whether it is excluded from tested income under § 1.951A–2(c)(7), after which the section 987 gain or loss will be reassigned to a tested income group (if the item is not excluded from tested income) or to the residual category (if the item is excluded from tested income). Because foreign countries generally do not impose tax on section 987 gain, allocation and apportionment of a foreign income tax to section 987 gain under § 1.861–20 and proposed § 1.987– 6(b)(3) will likely be uncommon. As a result, a tentative tested income item consisting of section 987 gain may often have a zero percent effective rate of foreign tax and, therefore, would generally not qualify for the GILTI hightax exclusion. As described above, the proposed regulations would provide that, for purposes of determining the source and character of section 987 gain and loss, the initial assignment of suspended section 987 loss and deferred section 987 gain and loss is generally made in the taxable year it becomes suspended or deferred (generally in the year of a remittance or the year the section 987 QBU is transferred to a related party), rather than the taxable year in which it is recognized. Proposed § 1.987–6(b)(1). The Treasury Department and the IRS anticipate that making the initial assignment in the year of suspension or deferral, rather than the year the section 987 gain or loss is recognized, will generally result in determining the source and character in a year closer in time to the year in which the section 987 loss originated, and therefore will tend to be more accurate. In addition, making an initial assignment in the taxable year of deferral or suspension means that the source and character are determined by reference to the assets of the section 987 QBU while they are still owned by the owner, rather than after they have been transferred, which would be both administratively difficult and more likely to introduce distortions to the determination. The Treasury Department and the IRS request comments as to whether it would be appropriate to determine the PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 source and character of unrecognized section 987 gain or loss by making the initial assignment in the taxable year in which the section 987 gain or loss is initially included in unrecognized section 987 gain or loss under § 1.987– 4(d), rather than in the year of a remittance. Making the initial assignment on an annual basis would require more extensive tracking of section 987 gain or loss in separate categories. However, this approach could avoid distortions that could arise from changes in the bases of a section 987 QBU’s assets or shifts in the character of its income or assets between the time unrecognized section 987 gain or loss is added to the pool and the time it is recognized. In addition, this approach could align more closely with the character of income generated by the section 987 QBU’s assets at the time of the exchange rate fluctuations that give rise to section 987 gain or loss. The proposed regulations would not change the rule in the final regulations that section 987 gain or loss that is assigned to a subpart F income group is treated as foreign currency gain or loss attributable to section 988 transactions not directly related to the business needs of the CFC. See proposed § 1.987– 6(b)(2)(i)(C). The Treasury Department and the IRS request comments as to whether it would be appropriate to eliminate this rule and characterize section 987 gain or loss by reference to subpart F income groups (as defined in § 1.960–1(d)(2)(ii)(B)) or whether to retain this rule generally but apply a different rule to taxpayers that make a current rate election (under which section 987 gain or loss can arise with respect to assets that would not generate section 988 gain or loss in the hands of the owner). A qualified business unit that produces income or loss that is, or is treated as, ECI is required to use the dollar as its functional currency. See § 1.985–1(b)(1)(v). The 2016 proposed regulations would provide an election under which a qualified business unit with a dollar functional currency may be treated as a section 987 QBU. See § 1.987–1(b)(6)(iii) of the 2016 proposed regulations. The Treasury Department and the IRS also request comments as to whether, and in what circumstances, section 987 gain or loss should be treated as ECI. VII. Expansion of Entities Covered In general, the final regulations do not apply to a bank, insurance company, leasing company, finance coordination center, regulated investment company, or real estate investment trust (a ‘‘specified entity’’), unless it engages in E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules transactions primarily with related persons within the meaning of section 267(b) or section 707(b) that are not themselves specified entities. Additionally, the final regulations do not apply to trusts, estates, S corporations, and partnerships other than section 987 aggregate partnerships. See § 1.987–1(b)(1)(ii). The Treasury Department and the IRS are concerned that excluding these entities from the application of the regulations under section 987 would not provide taxpayers with sufficient guidance to ensure these entities are using an appropriate method to calculate their section 987 gain or loss. Furthermore, if these entities are not subject to the regulations under section 987, they may use different methods of applying section 987 that vary in material ways. Applying a consistent set of rules to all taxpayers facilitates the fair and effective administration of the tax law by treating similarly situated taxpayers similarly as well as eliminating subjectivity and uncertainty. In addition, the Treasury Department and the IRS anticipate that the new current rate election and annual recognition election described in parts II and IV of this Explanation of Provisions would provide sufficient flexibility to permit the entities excluded under the 2016 final regulations to apply the proposed regulations. As discussed in part VIII of this Explanation of Provisions, the proposed regulations also provide new rules relating to partnerships (other than section 987 aggregate partnerships) and S corporations. See part VIII of this Explanation of Provisions. These rules are expected to significantly reduce the administrative burden and complexity of applying section 987 to partnerships as compared to the aggregate rules. Accordingly, proposed § 1.987– 1(b)(1)(ii) generally removes the exclusion for entities excluded from the 2016 final regulations, making them subject to the proposed regulations. The proposed regulations generally continue to exclude foreign non-grantor trusts and foreign estates if the aggregate interests of beneficiaries that are United States persons is less than 10 percent, and foreign partnerships if the aggregate interests of the partners that are United States persons is less than 10 percent of the capital and profits interests. Proposed § 1.987–1(b)(1)(ii). The Treasury Department and the IRS are concerned that the shareholders, partners, and beneficiaries of these entities may not be able to obtain the information needed to apply the regulations to these entities, and it VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 would be difficult for the IRS to administer the regulations with respect to these entities. For the same reason, the proposed regulations generally exclude foreign corporations that are not CFCs and foreign corporations that are CFCs but which have no U.S. shareholders (which are not excluded under the final regulations). Foreign individuals are also generally excluded as they are typically not subject to U.S. tax. The Treasury Department and the IRS request comments on whether any additional rules are needed to facilitate the application of the proposed regulations to the entities that were excluded from the 2016 final regulations. See also part VIII of this Explanation of Provisions, requesting comments on the application of the proposed regulations to partnerships and S corporations. VIII. Partnerships A. Background As explained in part II.C of the Background section, the 2006 proposed regulations and 2016 final regulations applied aggregate theory to partnerships. As explained in the preamble to the 2006 proposed regulations, the 2006 proposed regulations applied the FEEP method directly at the partner level under aggregate theory with the goal of more appropriately preserving the correct amounts of exchange gain or loss as measured from the perspective of the partner. Measuring the currency gain or loss by reference to the partner, rather than the partnership, was considered preferable because the partners would generally bear the economic risk from the exposure. Comments to the 2006 proposed regulations requested that the Treasury Department and the IRS reconsider the aggregate approach and instead treat a partnership as a separate entity with its own functional currency. The comments indicated that the aggregate approach was overly complex and that minority partners would not have the power to compel a partnership to provide them with the information needed to make the calculations required under the aggregate approach. One comment acknowledged the economic rationale for the aggregate approach but, in light of its complexity, recommended that it apply only in cases in which a partner’s interest in partnership capital or profits exceeds a certain threshold, such as 10 percent. In the preamble to the 2016 final regulations, the Treasury Department and the IRS acknowledged concerns PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 78145 regarding the complexity of the applying the aggregate approach to partnerships, but determined that it would be feasible to apply an aggregate approach to partnerships that are wholly owned by related persons. Furthermore, the aggregate approach was preserved in order to prevent a group of related parties from holding eligible QBUs through partnerships instead of directly, and thereby altering the section 987 treatment of the eligible QBU without meaningfully altering the group’s economic position. As a result, the 2016 final regulations retained the aggregate approach to partnerships, but applied it only to section 987 aggregate partnerships, as discussed in Part II.C of the Background section. The 2016 final regulations did not address other partnerships. Under the aggregate approach set forth in the 2016 final regulations, assets and liabilities reflected on the books and records of an eligible QBU of a section 987 aggregate partnership are allocated to each partner, which is considered an indirect owner of the eligible QBU. If the eligible QBU has a different functional currency than its indirect owner, then the assets and liabilities of the eligible QBU that are allocated to the partner are treated as a section 987 QBU of the indirect owner. B. Method for Determining Share of Assets and Liabilities The 2006 proposed regulations provided that a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU is determined in a manner consistent with how the partners had agreed to share the economic benefits and burdens corresponding to partnership assets and liabilities, taking into account the rules and principles of subchapter K.7 A comment noted that the rules in the 2006 proposed regulations for allocating assets and liabilities to a partner’s indirectly owned section 987 QBU were ambiguous and that the rules and principles of subchapter K do not provide sufficient guidance in this regard. The Treasury Department and the IRS acknowledged the ambiguity in the preamble to the 2016 final regulations, and the 2016 temporary regulations provided more specific rules for determining a partner’s share of the assets and liabilities reflected on the books and records of an eligible QBU owned indirectly through a section 987 aggregate partnership. 7 A partner’s basis in the partnership was adjusted to take into account any section 987 gain or loss that it recognized on any section 987 QBUs owned indirectly through the partnership. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78146 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules In particular, the temporary regulations provided that, in any taxable year, a partner’s share of each asset and liability of a section 987 aggregate partnership was proportional to the partner’s liquidation value percentage with respect to the aggregate partnership. A partner’s liquidation value percentage was defined as the ratio of the liquidation value of the partner’s interest in the partnership to the aggregate liquidation value of all the partners’ interests in the partnership. The liquidation value of the partner’s interest in the partnership was defined as the amount of cash the partner would receive with respect to its interest if, immediately following the applicable determination date, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in § 1.752–7), paid an unrelated third party to assume all of its § 1.752–7 liabilities in a fully taxable transaction, and then liquidated. Comments recommended alternative approaches for determining a partner’s share of the assets and liabilities of a section 987 aggregate partnership. Some comments recommended that § 1.987–7 be withdrawn and replaced with the approach of the 2006 proposed regulations under section 987, which provided that a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU held indirectly through the partnership must be determined in a manner consistent with how the partners have agreed to share the economic benefits and burdens corresponding to those partnership assets and liabilities, taking into account the rules and principles of subchapter K. A comment indicated that the liquidation value percentage approach was inconsistent with certain principles of subchapter K, resulting in distortions in the calculation of section 987 gain or loss in certain cases. The Treasury Department and the IRS determined that, in the absence of a more comprehensive set of rules for determining a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU held indirectly through the partnership that also articulates the interaction of those rules with applicable rules in subchapter K, a more flexible approach was warranted. Moreover, the Treasury Department and the IRS determined that, in certain instances, the liquidation value percentage methodology set forth in the 2016 temporary regulations could be interpreted as applying in a way that inappropriately distorts the computation of section 987 gain or loss. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Specifically, under such an interpretation, certain changes in a partner’s liquidation value percentage could introduce distortions in the calculation of net unrecognized section 987 gain or loss under § 1.987–4, giving rise to net unrecognized section 987 gain or loss that is not attributable to fluctuations in exchange rates. For example, an appreciation or depreciation in property value could result in a change in liquidation value percentage that causes a change in owner functional currency net value for purposes of step 1 of the § 1.987–4(d) calculation of unrecognized section 987 gain or loss for a taxable year without creating an offsetting adjustment under step 6 or otherwise that would prevent the change in liquidation value percentage from distorting the calculation of unrecognized section 987 gain or loss. As a result, such unrecognized appreciation or depreciation generally could result in unrecognized section 987 gain or loss for a taxable year being allocated to each partner that indirectly owned a section 987 QBU even when there was no change in exchange rates. Accordingly, the Treasury Department and the IRS withdrew § 1.987–7T in the 2019 final regulations. The preamble to the 2019 final regulations stated that, until new regulations are proposed and finalized, taxpayers may use any reasonable method for determining a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU held indirectly through the partnership. For this purpose, taxpayers may rely on subchapter K principles (consistent with the 2006 proposed regulations) or an approach similar to the liquidation value percentage method set forth in § 1.987–7T. However, it would not be reasonable to apply the liquidation value percentage method in § 1.987–7T without corresponding adjustments to the determination of net unrecognized section 987 gain or loss. Thus, for example, a taxpayer using the liquidation value percentage method may be required to adjust its determination of net unrecognized section 987 gain or loss of a section 987 QBU that is owned indirectly through a partnership to prevent the determination of unrecognized section 987 gain or loss that is not attributable to fluctuations in exchange rates. These adjustments may include, for example, treating any change in a partner’s owner functional currency net value that is attributable to a change in the partner’s liquidation value percentage as resulting in a transfer to or from an indirectly owned section 987 QBU. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 C. The Proposed Regulations Apply Entity Theory to Non-Section 987 Aggregate Partnerships As previously discussed in part VIII.A of this Explanation of Provisions, although the final regulations applied the aggregate approach to section 987 aggregate partnerships, the final regulations did not provide rules for applying section 987 to other partnerships. The preamble to the 2016 final regulations stated that section 987 regulations would be developed for these other partnerships in a separate project and indicated that a different approach might be taken. To that end, the preamble requested comments on how an entity approach should work for non-section 987 aggregate partnerships. Several comments were received asserting that the aggregate approach to partnerships under the 2016 final regulations was overly complex. Comments recommended that a partnership be treated as a separate entity with its own functional currency that can be the owner of a section 987 QBU. Comments also indicated that entity treatment would be more consistent with the principles of subchapter K. The Treasury Department and the IRS agree that treating non-section 987 aggregate partnerships as an entity and therefore potentially an ‘‘owner’’ of section 987 QBUs would be more administrable than an aggregate approach and would reduce the compliance burden on taxpayers and the IRS. However, the Treasury Department and the IRS continue to study whether partners might be able to achieve inappropriate outcomes under entity theory. For example, the Treasury Department and the IRS are concerned that if partnerships maintained section 987 gain and loss pools under a ‘‘pure’’ entity theory paradigm, partners would effectively be able to transfer their share of net unrecognized section 987 gain or loss to another partner, thereby avoiding gain recognition or trafficking in losses. To prevent a partner from transferring its share of net unrecognized section 987 gain or loss to another partner, the proposed regulations would generally apply a hybrid approach to entity theory, under which a partnership’s net unrecognized section 987 gain or loss with respect to its section 987 QBUs is allocated to its partners on an annual basis (the ‘‘hybrid approach to entity theory’’), as described in part VIII.D of this Explanation of Provisions. The hybrid approach to entity theory may reduce concerns about inappropriate outcomes that might otherwise arise from the transfer of E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 partnership interests under an entity theory approach. However, as described in part VIII.D and E of this Explanation of Provisions, while the Treasury Department and the IRS study whether the hybrid approach to entity theory (or a variation thereof) is suitable for all partnerships, the proposed regulations maintain the aggregate approach to section 987 aggregate partnerships in the final regulations, as modified by the 2019 final regulations, with minimal changes. Special rules are provided in proposed § 1.987–7C for partnerships that become (or cease to be) section 987 aggregate partnerships. In addition, for consistency with other transfers of a section 987 QBU, the proposed regulations would treat a change in the form of ownership from direct to indirect as a termination of the section 987 QBU under proposed § 1.987– 8(b)(6), subject to the deferral rules pursuant to proposed § 1.987– 12(g)(1)(i)(A). The Treasury Department and the IRS anticipate publishing a subsequent notice of proposed rulemaking that more thoroughly addresses the application of section 987 to partnerships. D. The Hybrid Approach to Entity Theory Under the proposed regulations, a partnership (other than a section 987 aggregate partnership) would be treated as a qualified business unit having its own functional currency. See § 1.989(a)–1(b)(2)(i)(C); see also § 1.985– 1(a)(1). If a partnership owns an eligible QBU with a functional currency that is different from the functional currency of the partnership, the eligible QBU would be treated as a section 987 QBU and the partnership (and not the partner) would generally be treated as the owner of the eligible QBU. See proposed §§ 1.987– 1(b)(4) through (5) and 1.987–7A(b). A partnership that owns a section 987 QBU would determine its unrecognized section 987 gain or loss for a taxable year under proposed § 1.987–4(d) by reference to the functional currency of the partnership and the section 987 QBU. Proposed § 1.987–7A(b). Under the hybrid approach, the partnership would allocate to each partner a share of the unrecognized section 987 gain or loss for the taxable year with respect to each section 987 QBU owned by the partnership on an annual basis. The partnership would determine a partner’s share of the unrecognized section 987 gain or loss for the taxable year for each section 987 QBU based on the partner’s distributive share of profits and losses attributable to that section 987 QBU for the taxable year. At the partner level, each partner would translate its share of VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 the unrecognized section 987 gain or loss into its functional currency at the yearly average exchange rate and calculate its net unrecognized section 987 gain or loss with respect to each section 987 QBU of the partnership based on this share. Proposed § 1.987– 7A(c)(1). Section 987 gain or loss attributable to a section 987 QBU owned by a partnership would be recognized and taken into account at the partner level. Notwithstanding that the section 987 gain or loss pools are allocated to the partners and maintained at the partner level, the portion of the net unrecognized section 987 gain or loss that a partner would recognize (or suspend) each year under proposed § 1.987–5(a) would be determined by reference to the partnership’s remittance proportion with respect to the section 987 QBU. Proposed § 1.987–7A(c)(3). In other words, if the section 987 QBU is treated as remitting 20 percent of its gross assets to its owner, the partnership, in a taxable year of the partnership, each partner that has net unrecognized section 987 gain or loss with respect to the section 987 QBU would recognize (or suspend) 20 percent of the net unrecognized section 987 gain or loss. The proposed regulations provide a framework for adjusting a partner’s basis in its partnership interest based on the principles of section 705 when a partner recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss attributable to a partnership. See proposed § 1.987– 7A(d). Similarly, if a partner in an upper-tier partnership (UTP) recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss attributable to a lower-tier partnership (LTP), then the proposed regulations would provide that UTP makes a corresponding basis adjustment to its interest in LTP, with similar rules applying to each successive partnership through which the section 987 gain or loss is attributable. The basis adjustment between UTP and LTP or between LTPs constitutes a basis adjustment solely with respect to the partner that recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss attributable to the partnership. The Treasury Department and the IRS request comments on the coordination of these proposed regulations applicable to partnerships with rules for capital accounts determined and maintained in accordance with § 1.704–1(b)(2)(iv). Additionally, the Treasury Department and the IRS request comments on the appropriate currency in which section PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 78147 743(b) basis adjustments with respect to assets of a section 987 QBU of a partnership should be maintained. The proposed regulations would also provide rules for applying proposed §§ 1.987–11 through 1.987–13 (regarding deferred section 987 gain or loss and suspended section 987 loss) to partners and partnerships. Specifically, the application of the loss-to-the-extentof-gain rule to suspended section 987 loss of the partner is done at the partner level. Proposed § 1.987–7A(c)(4). As a result, any section 987 gain recognized by a partner is taken into account in determining the suspended section 987 loss that may be recognized by the partner under proposed § 1.987–11(e), without regard to whether the section 987 gain was allocated to the partner from that partnership (or any other partnership) or was attributable to a section 987 QBU owned directly by the partner. Other rules under proposed §§ 1.987–11 through 1.987–13 would generally apply with respect to a partnership, but may be applied with respect to a partner that ceases to be a partner in the partnership. In general, the section 987 elections would be made by the partnership. However, if a partner terminates its partnership interest, any annual recognition election in effect with respect to the partner would apply with respect to its deferred section 987 gain or loss or suspended section 987 loss that had been allocated to the partner by the partnership. The partner would also be permitted to make the election to recognize pretransition section 987 gain or loss ratably over the transition period under the transition rules. See proposed §§ 1.987–7A(c)(5)(ii) and 1.987– 10(e)(5)(ii). The Treasury Department and the IRS are studying the appropriate method for determining the portion of a partner’s net unrecognized section 987 gain or loss, deferred section 987 gain or loss, and suspended section 987 loss that should be recognized, deferred, or suspended when a portion of a partner’s interest in a partnership is transferred or redeemed (or the partner’s interest in the partnership is otherwise reduced) and whether any special rules are needed in respect of a transfer or redemption of a partnership interest to account for the recognition of section 987 gain or loss at the partner level. Accordingly, the proposed regulations reserve on the treatment of transfers and redemptions of a partner’s partnership interest. The Treasury Department and the IRS request comments on the appropriate method of determining the partner’s interest in the partnership and the reduction to its interest in the E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78148 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules partnership, as well as how increases to a partner’s partnership interest during the year should be taken into account. In addition, the Treasury Department and the IRS request comments on the appropriate treatment of transfers of a partnership interest between related parties or between member of a consolidated group. In general, proposed § 1.987–6 would provide rules governing the character and source of section 987 gain or loss. See part VI of this Explanation of Provisions. The proposed regulations reserve on whether any special rules are needed in addition to proposed § 1.987– 6 for purposes of determining the character and source of section 987 gain or loss of a partner with respect to a section 987 QBU owned by a partnership. Proposed § 1.987–7A(e). Comments are requested on whether special rules are needed. The proposed regulations would treat S corporations in the same manner as partnerships. Proposed § 1.987–7A(f). Comments are requested on whether additional guidance is needed with regard to S corporations and whether there are instances in which the rules for S corporations should differ from the rules for partnerships. The Treasury Department and the IRS also request comments as to whether, under an entity theory of partnerships, section 987 gain or loss could be recognized at the partnership level and then allocated to the partners while preventing the transfer of unrecognized section 987 gain or loss among the partners or between a transferor and transferee partner. Under the hybrid approach in the proposed regulations, a partner’s recognition of section 987 gain or loss upon a sale or other disposition of a partnership interest results in the conversion of capital gain or loss to ordinary gain or loss without any remittance from the partnership QBU and without any change in the relationship between the QBU and its owner. Comments are requested on whether special rules are needed to prevent the conversion of capital gain or loss to ordinary gain or loss. In addition, comments are requested on whether the recognition of section 987 gain or loss upon a transfer or redemption of a partnership interest should be limited to the gain or loss that would otherwise be recognized on transfer or redemption, under rules similar to § 1.988–2(b)(8). E. Expanding the Application of Entity Theory The Treasury Department and the IRS continue to study the application of entity theory and aggregate theory to partnerships in the section 987 context, VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 including whether it would be appropriate to apply a hybrid approach to entity theory to all partnerships, regardless of whether the partners are related parties. Such an approach would generally result in a partnership generating the same amount of section 987 gain or loss as it would if it were a corporation or an individual. In connection with these considerations, the Treasury Department and the IRS are studying the concerns expressed in the 2006 proposed regulations and the final regulations that parties could achieve a substantially different section 987 result by owning a section 987 QBU through a partnership, rather than owning the section 987 QBU directly, without meaningfully changing the economic relationship of the parties. Consider, for example, a domestic corporation that wholly owns two CFCs, each of which use the euro as their functional currency, and which each own fifty percent of an entity treated as a foreign partnership (‘‘P’’) that operates a British trade or business for which books and records are maintained in pounds. P also has a smaller separate French trade or business that is an eligible QBU that maintains books and records in euros. If just one CFC owned P, then P would be treated as an entity disregarded from its owner, and the CFC would have section 987 gain or loss with respect to its interest in P’s pound operations. However, if an election was made to treat P as a corporation under § 301.7701–3, P would be treated as a CFC that uses the pound as its functional currency and section 987 gain or loss with respect to P’s euro operations would be measured against the pound, rather than against the functional currency of P’s partners. Accordingly, it could be argued that, for section 987 purposes, when a partnership is held by CFCs, aggregate theory achieves a result that is more akin to treating P as a disregarded entity and entity theory achieves a result more akin to treating P as a corporation. However, if instead of being owned by two CFCs, P were owned by two domestic corporations that use the dollar as their functional currency, aggregate theory would achieve a result akin to treating P as a disregarded entity, while entity theory may provide a means of allowing the domestic corporations to avoid the application of section 987 to P’s pound trade or business without needing to contribute the trade or business to a CFC, which might have other tax consequences. See, e.g., section 367(a) and (d). Accordingly, the Treasury Department and the IRS are concerned that if only entity theory PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 is applied to partnerships, there may be instances in which the business of the partnership should be subject to section 987 but is not, such as when two domestic corporations own a partnership doing business in the pound. When a partner’s functional currency differs from that of the partnership, creating a separate layer of currency exposure, the Treasury Department and the IRS are studying whether it might be possible to achieve a result consistent with aggregate theory without the administrative burden of allocating a portion of a partnership’s assets and liabilities to each partner and calculating the income and balance sheets of the partnership in the functional currency of each partner. One such approach might determine a partner’s section 987 gain or loss with respect to the partnership by reference to the partner’s outside basis in the partnership, rather than its share of the inside asset basis and liabilities (the ‘‘outside basis approach’’). The outside basis approach would be layered on top of the hybrid approach to entity theory taken by the proposed regulations. Under this system, a partnership would first determine its section 987 gain or loss with respect to any section 987 QBUs of the partnership, and allocate the pool to the partners, as described in § 1.987–7A of the proposed regulations. If a partner has the same functional currency as the partnership, no additional steps are taken. If a partner has a different functional currency than the partnership, under one alternative (‘‘alternative 1’’), the partner would calculate its section 987 gain or loss with respect to its interest in the partnership (including its interest in the functional currency trade or business of the partnership and its interest in each of the partnership’s section 987 QBUs) using a method similar to the calculation of unrecognized section 987 gain or loss for an owner applying the current rate election under proposed § 1.987–4(d) (that is, steps 1 through 5 and 10), but by reference to the partner’s adjusted basis in its partnership interest (‘‘outside basis’’) in the partnership. Specifically, the partner’s annual section 987 gain or loss attributable to its share of the partnership as a whole would be equal to its outside basis determined as of the end of the partnership’s taxable year (after taking into account other adjustments prescribed under section 705 but before any adjustments for section 987 gain or loss recognized under the outside basis approach) and translated into the E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules partnership’s functional currency reduced by its outside basis determined as of the beginning of the same partnership taxable year and translated into the partnership’s functional currency (the ‘‘partnership functional currency change in value’’) (step 1). The partnership functional currency change in value would then be adjusted to subtract the partnership functional currency amounts of contributions to the partnership from the partner and add the partnership functional currency amounts of distributions from the partnership to the partner (steps 2 through 5). The result would then be adjusted to back out the partnership functional currency amount of the partner’s allocable share of income, gain, deduction, and loss of the partnership (step 10). The result is the partner’s unrecognized section 987 gain or loss attributable to its partnership interest. Under alternative 1, the partner’s unrecognized section 987 gain or loss attributable to its partnership interest would be recognized annually and its basis in the partnership would be increased or decreased accordingly. Alternative 1 approximates the result a partner would achieve under aggregate theory if it applied the current rate election and the annual recognition election. Annual recognition is necessary under alternative 1 to prevent differences in the partnership’s adjusted bases in its assets (‘‘inside basis’’) attributable to fluctuations in the functional currency of the partnership itself or any section 987 QBUs owned by the partnership and the partners’ outside bases (an ‘‘inside-outside basis disparity’’). By adjusting outside basis for these currency fluctuations, the partner’s section 987 gain or loss with respect to the partnership will include section 987 gain or loss on the partnership’s owner functional currency net value of the partnership’s section 987 QBUs. As a result, the sum of the owner’s section 987 gain or loss attributable to its partnership interest under the outside basis approach, plus its allocable share of the partnership’s net unrecognized section 987 gain or loss attributable to the partnership’s section 987 QBUs should generally be equivalent to the sum of its unrecognized section 987 gain or loss attributable to section 987 QBUs indirectly owned by the partner through the partnership under the aggregate approach (assuming there are no other inside-outside basis disparities). Alternatively, under another alternative (‘‘alternative 2’’), it may not be necessary to require recognition of the partner’s section 987 gain or loss VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 annually. Under this approach, the same method is used to determine the partner’s section 987 gain or loss with respect to its partnership interest as in alternative 1, except that the partnership functional currency change in value would be determined, not just by reference to the partner’s outside basis in the partnership, but to the sum of its outside basis and its net accumulated unrecognized section 987 gain or loss attributable to the partnership and the partnership’s section 987 QBUs (that is, the amount that would have been recognized if the partner had been recognizing its section 987 gain and loss attributable to the partnership annually as under alternative 1). Under alternative 2, the partner’s unrecognized section 987 gain or loss attributable to its partnership interest might be recognized when it receives a distribution from the partnership or disposes of a portion of its partnership interest. Both alternative 1 and alternative 2 approximate the result a partner would achieve under aggregate theory if it applied the current rate election to its partnership interest. However, alternative 1, but not alternative 2, requires annual recognition of the partner’s net unrecognized section 987 gain or loss. Accordingly, no additional loss limitations may be needed for alternative 1. See part IV.C of this Explanation of Provisions. However, it may be appropriate for the partner’s net accumulated unrecognized section 987 gain or loss under alternative 2 to be subject to the loss-to-the-extent-of-gain rule in § 1.987–11(e) of the proposed regulations. Under one variation to these alternative approaches, the partner’s net accumulated unrecognized section 987 gain or loss attributable to its partnership interest would net with the partner’s net unrecognized section 987 gain or loss with respect to the partnership’s section 987 QBUs when one amount reflects section 987 gain and the other reflects section 987 loss. Comments are requested on whether the outside basis approach or a similar system would achieve results consistent with aggregate theory in a more administrable manner. Furthermore, comments are requested on instances in which this system might inappropriately diverge from aggregate theory and how such divergences might be addressed. For example, if inside basis and outside basis are not equivalent (for example, because a partner acquires a partnership interest in a year in which a section 754 election is not in effect), how the resulting mismatch might be minimized or PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 78149 eliminated for purposes of measuring the partner’s currency exposure with respect to the partnership. Comments are also requested on whether the outside basis approach or a similar system should apply to partners of (i) all partnerships, (ii) only those partnerships currently treated as section 987 aggregate partnerships, or (iii) only those partnerships in which the partner owns more than 50 percent of the partnership interest (taking into account constructive ownership). In addition, comments are also requested on any additional rules that might be necessary to coordinate the outside basis approach or a similar system with the section 987 regulations or with subchapter K, when the functional currency of a partner, the partnership, and the partnership’s section 987 QBU differ. IX. Attribution of Items to the Section 987 QBU The final regulations provide rules regarding when assets and liabilities, as well as items of income, gain, deduction, and loss are attributable to an eligible QBU, and when a section 987 QBU is treated as making a contribution or distribution to its owner or another eligible QBU of the owner. See § 1.987– 2. In general, the proposed regulations retain the rules in the final regulations with minor or clarifying revisions. However, in a change from the final regulations, the proposed regulations would treat a change in the form of ownership of a section 987 QBU as a termination, as discussed above. In general, the final regulations provide that items are attributable to an eligible QBU if they are reflected on the separate set of books and records of the eligible QBU, as defined in § 1.989(a)– 1(d). § 1.987–2(b)(1). The proposed regulations would revise the crossreference to refer to § 1.989(a)–1(d)(1) or (2), as § 1.989(a)–1(d)(3) refers back to § 1.987–2(b). Proposed § 1.987–2(b)(1). In addition, the final regulations provide that an eligible QBU is not treated as owning stock of a corporation unless the owner of the eligible QBU owns less than 10 percent of the value of the corporation (after taking into account certain attribution rules). § 1.987–2(b)(2)(i). In order to generally prevent an eligible QBU from owning stock of a CFC, the proposed regulations would expand the exclusion to cover all stock unless the owner owns less 10 percent of both the vote and value of the corporation, and to revise the relevant attribution rules. Proposed § 1.987– 2(b)(2)(i). The proposed regulations also provide that any type of basis that does not affect the income and loss of the E:\FR\FM\14NOP3.SGM 14NOP3 78150 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 eligible QBU, such as section 743(b) basis, would not be treated as included on the books and records of the eligible QBU. Proposed § 1.987–2(b)(5). Similarly, the final regulations provide rules regarding when a transaction or the recording of an asset or liability as on (or not on) the books and records of a section 987 QBU is treated as a disregarded transaction between the section 987 QBU and its owner or another eligible QBU of the owner. § 1.987–2(c). The proposed regulations generally retain the substance of these rules but make minor revisions for clarity. See proposed § 1.987–2(c). X. Transition Rules As explained in part II.C of the Background section, the 2016 final regulations require all owners of section 987 QBUs to apply the fresh start transition method. Under this method, unrecognized section 987 gain or loss determined for years before the transition date generally would not be taken into account under section 987. In addition, for purposes of applying the FEEP method in the first year in which the regulations apply, the assets and liabilities of the section 987 QBU must be translated using historic rates. Comments stated that the fresh start transition method is difficult to apply because taxpayers did not track historic rates before the transition date and the data needed to determine historic rates for items acquired in prior taxable years is not readily available. In addition, comments asserted that the fresh start transition method imposes an undue financial burden by permanently eliminating unrecognized section 987 losses determined before the transition date. The Treasury Department and the IRS acknowledge that the fresh start transition method could increase the compliance burden on taxpayers for the initial year in which the regulations apply and would fail to account for section 987 gain or loss that arose before the transition date (to the extent attributable to assets and liabilities that are no longer reflected on the books and records of the section 987 QBU on the transition date). Therefore, the proposed regulations provide a new transition rule that would replace the fresh start transition method. The new transition rule would account for unrecognized section 987 gain or loss accrued before the transition date. In addition, the new transition rule would not require taxpayers to retrospectively determine historic rates for items acquired before the transition date. As explained in the Applicability VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Dates section, the fresh start transition method can no longer be applied to any taxable year for which the tax return or information return is filed on or after November 9, 2023. A. Translation of a Section 987 QBU’s Assets and Liabilities at the Spot Rate The transition rules under proposed § 1.987–10 would apply in the taxable year beginning on the transition date (that is, the first day of the first taxable year in which the regulations apply). For purposes of determining unrecognized section 987 gain or loss in the first taxable year in which the regulations apply, the assets and liabilities reflected on a section 987 QBU’s balance sheet at the end of the previous year would be translated into the owner’s functional currency at the spot rate on the day before the transition date. Proposed § 1.987–10(d)(1). Similarly, for taxpayers that do not make a current rate election, the historic rate for historic assets and liabilities would generally be the spot rate on the day before the transition date. Proposed § 1.987–10(d)(2). These rules are intended to simplify the application of the FEEP method by eliminating the need to determine actual historic rates in the first taxable year in which the regulations apply. B. Pretransition Gain or Loss Under the proposed regulations, an owner of a section 987 QBU must determine the amount of section 987 gain or loss that has accrued before the transition date (‘‘pretransition gain or loss’’). Proposed § 1.987–10(e). By default, in the first taxable year in which the regulations apply, pretransition gain is treated as net unrecognized section 987 gain, and pretransition loss is treated as suspended section 987 loss. Proposed § 1.987–10(e)(5)(i). This proposed rule is intended to prevent taxpayers from selectively recognizing pretransition loss (which, like section 987 loss generated under a current rate election, may be computed using a method that results in large section 987 pools) while deferring pretransition gain until a remittance. Alternatively, taxpayers can elect to amortize pretransition gain or loss over a period of ten years beginning on the transition date. Proposed § 1.987–10(e)(5)(ii). In order to prevent owners subject to this election from offshoring pretransition gain or importing pretransition loss, proposed § 1.987– 10(e)(5)(ii)(B) provides that, immediately before an inbound or outbound transaction described in section 381(a), any unrecognized PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 pretransition gain is recognized and any unrecognized pretransition loss is suspended. As a result, the suspended section 987 loss may be recognized, subject to the loss-to-the-extent-of-gainrule under § 1.987–11(e). In the case of an inbound section 381(a) transaction of a foreign owner with pretransition loss, any suspended section 987 loss that is not recognized before the transaction would not carry over to the domestic acquiring corporation under proposed § 1.987–13(g). See part III.C of this Explanation of Provisions. C. Computation of Pretransition Gain or Loss Under proposed § 1.987–10(e)(2), a taxpayer that applied section 987 before the transition date using an ‘‘eligible pretransition method’’ (described in part X.D of this Explanation of Provisions) would use that method to compute pretransition gain or loss. Pretransition gain or loss generally is equal to the amount of section 987 gain or loss that would have been recognized under the eligible pretransition method if the QBU terminated on the day before the transition date. Proposed § 1.987– 10(e)(2)(i)(A). The amount of pretransition gain or loss must be adjusted to reflect any change to the basis of the section 987 QBU’s assets (net of liabilities) that occurs as a result of the transition (for example, where the taxpayer previously used a method that would determine the owner’s basis in distributed assets using historic rates). Proposed § 1.987–10(e)(2)(i)(B). A taxpayer that did not apply an eligible pretransition method before the transition date would determine pretransition gain or loss using the method provided in § 1.987–10(e)(3). Under this method, pretransition gain or loss is equal to the sum of the annual amounts of unrecognized section 987 gain or loss for each taxable year since the section 987 QBU’s inception, reduced by any section 987 gain or loss recognized before the transition date. Proposed § 1.987–10(e)(3)(ii). The amount of unrecognized section 987 gain or loss for each taxable year would be computed using a simplified version of the method provided in § 1.987–4(d). Proposed § 1.987– 10(e)(3)(iii). The only information needed to apply this simplified method is the information reflected in the section 987 QBU’s opening and closing balance sheets for each year. Because this method does not require the translation of contributions and distributions at the applicable spot rate, it would only approximate the actual amount of section 987 gain or loss accrued before the transition date. E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules D. Eligible Pretransition Method khammond on DSKJM1Z7X2PROD with PROPOSALS3 1. In General An eligible pretransition method includes any reasonable method of applying section 987 before the transition date that fully accounts for foreign currency gain or loss attributable to the assets and liabilities of a section 987 QBU (including foreign currency gain or loss that is recognized in computing taxable income with respect to the section 987 QBU or its owner). The method provided in the 1991 proposed regulations, which determines section 987 gain or loss based on currency fluctuations with respect to the earnings and capital of a section 987 QBU (an ‘‘earnings and capital’’ method) is considered an eligible pretransition method, provided that it is applied in a reasonable manner. Proposed § 1.987–10(e)(4)(i). In addition, any other reasonable method of applying section 987 is an eligible pretransition method if it produces the same total amount of income over the life of the owner (taking into account the aggregate of section 987 gain or loss, section 987 taxable income or loss, and gain or loss on the disposition of assets and liabilities transferred by a section 987 QBU to the owner) as a reasonable earnings and capital method. Proposed § 1.987–10(e)(4)(ii). However, a method under which the owner does not recognize section 987 gain or loss at the time of a remittance because the recognition of all section 987 gain or loss is deferred until the section 987 QBU terminates is not considered an eligible pretransition method because it is inconsistent with the statutory requirements under section 987(3). Proposed § 1.987–10(e)(4)(iv). 2. Earnings Only Method An earnings only method can qualify as an eligible pretransition method under proposed § 1.987–10(e)(4)(ii) if it is applied in a way that produces the same total amount of income as a reasonable earnings and capital method. This can be accomplished by maintaining a separate set of equity and basis pools for the section 987 QBU’s capital account and assigning a proportionate amount of the capital basis pool to property distributed out of capital. See proposed § 1.987–10(l)(2) (Example 2). The Treasury Department and the IRS are aware that certain taxpayers apply an earnings only method in a manner that creates a permanent difference in their income (as compared to the earnings and capital method). Under this approach, when a section 987 QBU makes a distribution (whether out of VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 earnings or capital), the owner determines its basis in the distributed assets by translating the section 987 QBU’s basis into the owner’s functional currency at the spot rate applicable on the distribution date (‘‘spot-rate basis’’). See proposed § 1.987–10(l)(3) (Example 3). As a result, the owner’s basis may be higher or lower than the actual cost of acquiring the assets (in the owner’s functional currency) due to exchange rate fluctuations. When a section 987 QBU makes a distribution out of earnings, which triggers the recognition of section 987 gain or loss under an earnings only method, the use of a spot-rate basis is appropriate. However, when a section 987 QBU makes a distribution out of capital (on which no section 987 gain or loss is recognized under an earnings only method), the use of a spot-rate basis artificially steps up (or steps down) the basis of the distributed assets in the absence of a recognition event. As a result, if a spot-rate basis is used for capital distributions under an earnings only method, the owner would not recognize the same total amount of income as it would under an earnings and capital method. The Treasury Department and the IRS are concerned that the use of a spot-rate basis for capital distributions under an earnings only method does not accurately measure an owner’s economic income with respect to a section 987 QBU. However, the Treasury Department and the IRS acknowledge that the preamble to the 2006 proposed regulations endorsed the use of an earnings only method without explaining how the basis of distributed assets should be determined. Taxpayers may have misunderstood the preamble to suggest that an owner of a section 987 QBU can take a spot-rate basis in all distributed assets under an earnings only method. Therefore, the proposed regulations provide that an earnings only method that does not produce the same total amount of income as a reasonable earnings and capital method can qualify as an eligible pretransition method, provided it was first applied on a tax return filed before November 9, 2023 and is consistently applied to all section 987 QBUs of the same owner. Proposed § 1.987–10(e)(4)(iii). A taxpayer that begins applying this method on or after November 9, 2023 or fails to apply this method consistently to all of its section 987 QBUs will not be treated as applying an eligible pretransition method. PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 78151 XI. Deferral Events and Outbound Loss Events A. Final Regulations Section 1.987–12 of the final regulations contains rules that defer the recognition of section 987 gain or loss in connection with two categories of related party transactions: deferral events and outbound loss events. A deferral event is defined to include certain transactions in which a section 987 QBU terminates and its assets are reflected on the books and records of a successor QBU after the termination. See § 1.987–12(b)(2). A successor QBU is a section 987 QBU that is owned by a member of the same controlled group as the original owner (except if the original owner is a U.S. person and the owner of the successor QBU is a foreign person). See § 1.987–12(b)(4). Section 987 gain or loss that is not recognized in connection with a deferral event (‘‘deferred section 987 gain or loss’’) is recognized by the original owner of the section 987 QBU when the successor QBU makes a remittance to its owner. See § 1.987–12(c)(2). An outbound loss event is defined to include a termination of a section 987 QBU that is owned by a U.S. person and has net unrecognized section 987 loss in connection with a transfer of the section 987 QBU’s assets to a related foreign person. See § 1.987–12(d)(2). If the transfer is a transaction described in section 351 or section 361, any section 987 loss that is not recognized in connection with the outbound loss event (‘‘outbound section 987 loss’’) is added to the basis of stock received by the owner of the section 987 QBU. See § 1.987–12(d)(4). Otherwise, outbound section 987 loss is recognized when the owner of the section 987 QBU and the related foreign person cease to be members of the same controlled group. See § 1.987–12(d)(5). B. Proposed Regulations 1. Deferral Events The proposed regulations generally retain the principles of the final regulations relating to deferral events but modify the rules in several respects. For example, the final regulations provide a de minimis rule pursuant to which § 1.987–12 would not apply to a section 987 QBU if the section 987 gain or loss that would not be recognized under § 1.987–12 would not exceed $5 million. § 1.987–12(a)(3)(ii). To prevent the de minimis rule from allowing an owner to recognize more than the threshold by transferring multiple section 987 QBUs to members of its controlled group, the proposed E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78152 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules regulations would retain the de minimis rule but apply the threshold to the total deferred section 987 gain or loss that would otherwise be recognized by the owner in a single taxable year. Proposed § 1.987–12(a)(2)(ii). In addition, because the proposed regulations would apply the suspended section 987 loss rules to outbound loss events, any amount treated as a suspended section 987 loss is not taken into account in determining whether the threshold has been met. Id. The final regulations also provide that, if a deferral event results in multiple successor QBUs, the remittance proportion is determined by treating all the successor QBUs as a single successor QBU. § 1.987– 12(c)(2)(ii). The Treasury Department and the IRS are concerned that aggregating the contributions and distributions of various successor QBUs in order to treat them as the same successor QBU both increases the administrative burden of determining the remittance proportion and is less precise than determining a remittance proportion for each successor QBU. Therefore, the proposed regulations would apportion an amount of deferred section 987 gain or loss to each successor QBU and recognize (or suspend) a portion of deferred section 987 gain or loss annually with respect to each successor QBU based on the specific successor QBU’s remittance proportion and on whether that successor QBU is subsequently transferred. Proposed § 1.987–12(b)(2) and (c). Although the proposed regulations generally retain the deferral rules of § 1.987–12(b) with respect to those circumstances in which they apply under the final regulations, the Treasury Department and the IRS recognize that this can lead to odd results in certain cases, because similar transactions may sometimes be subject to the deferral rules and other times be subject to no limitation or the suspended loss rules. For example, if a CFC (‘‘CFC1’’) with a euro functional currency owns a section 987 QBU (‘‘QBU1’’) with a pound functional currency, and CFC1 transfers QBU1 to a wholly owned subsidiary CFC (‘‘CFC2’’), the deferral rules would generally apply if CFC2’s functional currency is not the pound. However, if CFC2’s functional currency is the pound, the deferral rules would not apply because QBU1 would cease to be a section 987 QBU upon transfer to CFC2, because it would have the same functional currency as its owner. As a result, if CFC1 does not have a current rate election in effect (or has both a current rate election and an annual recognition election in effect), CFC1 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 would recognize its net unrecognized section 987 gain or loss with respect to QBU1 on the transfer. However, if CFC1 has a current rate election in effect (and does not have an annual recognition election in effect), CFC1 would recognize net unrecognized section 987 gain on the transfer, but net unrecognized section 987 loss would become suspended section 987 loss. The Treasury Department and the IRS request comments on whether the deferral rules of proposed § 1.987–12 should remain a separate deferral regime or should be modified or combined with the suspended loss rules of proposed §§ 1.987–11 and 1.987–13. 2. Outbound Loss Events The proposed regulations generally retain the definition of an outbound loss event contained in the final regulations. However, the proposed regulations provide that outbound section 987 loss is treated as suspended section 987 loss, instead of being added to the basis of stock or recognized solely when the owner of the section 987 QBU and the related foreign person cease to be related. This rule is intended to permit the recognition of outbound section 987 loss to the extent the owner recognizes section 987 gain in the same recognition grouping, as described in part III of this Explanation of Provisions. In addition, applying the loss suspension rules to outbound loss events simplifies the proposed regulations by reducing the number of different types of deferral regimes that apply to section 987 losses. XII. Making and Revoking Elections The final regulations contain a number of elections relating to section 987. The proposed regulations contain several new elections, including the current rate election, the annual recognition election, and elections under the transition rules. Under the final regulations, elections generally are made separately for each section 987 QBU. See § 1.987–1(g)(1)(i). Elections cannot be revoked without the Commissioner’s consent. See § 1.987– 1(g)(5). Under the 2016 temporary and proposed regulations, an annual deemed termination election generally cannot be made (except in the first taxable year in which the election was relevant) if the aggregate net loss that would be recognized by all owners to which the election applied exceeds $5 million. See § 1.987–1T(g)(2)(i)(B). The annual deemed termination election provided in the 2016 temporary and proposed regulations is irrevocable. The proposed regulations would provide a consistency requirement that applies to both the existing elections PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 under the final regulations and the new elections under the proposed regulations. Under proposed § 1.987– 1(g), these elections would be required to be made or revoked consistently for all members of the same consolidated group and all CFCs, partnerships, nongrantor trusts, and estates in which the ownership interests or beneficiary interests of the U.S. shareholder (or members of its consolidated group) exceed 50 percent. The consistency requirement is intended to make the application of the proposed rules less complex and more administrable; in most cases, consistent application of the regulations is also expected to reduce the compliance burden on taxpayers. The proposed regulations would permit a current rate election or an annual recognition election to be made or revoked without the Commissioner’s consent. The Treasury Department and the IRS recognize that these elections can have important consequences for the substantive application of section 987 and the associated compliance burden, and that taxpayers may wish to change these elections in response to changes in the nature and size of their business operations. However, the current rate and annual recognition elections are proposed to be subject to timing restrictions and a loss suspension rule. If a current rate election or an annual recognition election is made, it cannot be revoked for five years without the Commissioner’s consent. Similarly, once revoked, these elections cannot be made again for five years without consent. Proposed § 1.987–1(g)(3)(ii)(B). These timing requirements are intended to make the proposed regulations easier to administer. In addition, because the Commissioner’s consent is not required to make or revoke these elections, the timing requirements are needed to prevent taxpayers from opportunistically making or revoking elections in response to exchange rate fluctuations. Proposed § 1.987–11(d)(2) provides that, in the first year in which a current rate election is revoked, net accumulated unrecognized section 987 loss is converted into suspended section 987 loss. This rule is needed to prevent net unrecognized section 987 loss generated under a current rate election from being recognized without limitation after the election is revoked. Similarly, if an annual recognition election is made, and either (1) a current rate election was in effect for the previous year or (2) the aggregate accumulated net unrecognized section 987 loss that would be recognized by the owner as a result of the recognition E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules election exceeds $5 million, net accumulated unrecognized section 987 loss is converted into suspended section 987 loss. See § 1.987–11(d)(1). As discussed in part III.A of this Explanation of Provisions, this rule is intended to prevent a taxpayer from using an annual recognition election to trigger the recognition of net unrecognized section 987 loss that arose in years before the annual recognition election was made. XIII. Removal of the Election To Use Spot Rates in Lieu of Yearly Average Exchange Rates As explained in part II.C of the Background section, the historic rate under § 1.987–1(c)(3) of the 2016 final regulations is equal to the yearly average exchange rate for the year in which a historic asset was acquired or a historic liability was entered into. The 2016 final regulations provide an election under § 1.987–1(c)(1)(iii) to use spot rates in lieu of yearly average exchange rates. The Treasury Department and the IRS understand that this election may not be helpful to taxpayers, as it would increase the compliance burden of applying section 987 due to the need to track historic spot rates for each day in a taxable year on which the section 987 QBU acquires an asset or incurs a liability. In addition, the availability of this election adds to the complexity of the regulations and makes the rules more difficult for the IRS to administer. Accordingly, the proposed regulations remove the election under § 1.987– 1(c)(1)(iii) to use spot rates in lieu of yearly average exchange rates. XIV. Consolidated Groups khammond on DSKJM1Z7X2PROD with PROPOSALS3 A. Intercompany Transactions A section 987 QBU of a member of a consolidated group is a component of that member. Therefore, a transaction between that QBU and a different member of the same group constitutes an intercompany transaction (as defined in § 1.1502–13(b)(1)(i)) and is subject to the intercompany transaction regulations in § 1.1502–13. The Treasury Department and the IRS have become aware that achieving single entity treatment under § 1.1502– 13 may be difficult for certain intercompany transactions involving section 987 QBUs. Accordingly, to facilitate single entity treatment, the proposed regulations would treat a transaction between the section 987 QBU of one member and any other member of the same group (including a section 987 QBU of that other member) as a combination of (i) an intercompany VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 transaction between the members, and (ii) a transfer between each section 987 QBU and its owner (see § 1.987–2(c)) as necessary to take into account the effect of the transaction on the assets and liabilities of each section 987 QBU. The purpose of § 1.1502–13 is to provide rules to clearly reflect the taxable income and tax liability of a consolidated group as a whole by preventing intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable income (CTI) or consolidated tax liability. See § 1.1502–13(a)(1). The matching rule in § 1.1502–13(c) (Matching Rule) is one of the principal mechanisms for achieving this goal. See § 1.1502–13(a)(6)(i). The Matching Rule is a principlebased rule that redetermines the attributes of a selling member’s (S) intercompany item and a buying member’s (B) corresponding item to produce the effect of transactions between divisions of a single corporation (single entity treatment). See § 1.1502–13(a)(2). The Matching Rule also can affect the timing of these items so that, whenever possible, the effect of these items on the group’s CTI and consolidated tax liability is the same as if S and B were divisions of a single corporation. See § 1.1502– 13(c)(1)(i). For example, assume that S sells land at a gain to B, which later sells that land at a gain to an unrelated person. To achieve the same result as if S and B were divisions of a single corporation, S does not take into account its gain or loss on the sale until B sells the land to the unrelated person, and S’s and B’s holding periods for the land are aggregated. See § 1.1502–13(a)(2), (c)(1)(ii), and (c)(2); see also Example 1 in § 1.1502–13(c)(7)(ii)(A). The Matching Rule relies on an alignment between S’s and B’s items that may be unclear in transactions involving section 987 QBUs. For example, assume that Lender (that is, S) and Borrower (that is, B) are members of a consolidated group, and Lender has a section 987 QBU (Lender QBU) whose functional currency is the euro. Lender QBU lends Ö100 to Borrower. If Borrower and Lender were divisions of a single corporation, the loan would be treated as a transfer from Lender QBU when funded and a transfer to Lender QBU when repaid (or when interest is paid). These transfers would be taken into account in determining the amount of a remittance from Lender QBU (potentially triggering the recognition of section 987 gain or loss), and the single corporation might recognize section 988 gain or loss when the loan is repaid. See §§ 1.987–5 and 1.988–1(a)(10)(ii)(A). PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 78153 However, under current law, the foreign currency gain or loss of Lender and Borrower in the foregoing example does not perfectly offset in amount on the group’s consolidated return. This is the case because Borrower has foreign currency gain or loss under section 988 when the loan is repaid, whereas Lender’s foreign currency gain or loss under section 987 will be taken into account only when Lender QBU makes a remittance. See §§ 1.987–5(a) and 1.988–2(b)(6). Because these amounts are calculated at different times based on different exchange rates, and because section 988 applies to individual transactions while section 987 gain or loss is determined on a pooled basis by reference to the assets and liabilities of a section 987 QBU, achieving single entity treatment under § 1.1502–13 may be difficult. In other words, under current law, it may be difficult to ‘‘match’’ Lender’s section 987 gain or loss with Borrower’s section 988 gain or loss. Similar mismatches would occur with regard to transactions between section 987 QBUs of different consolidated group members. The proposed regulations would address the matching issue in this example by treating the loan as if it were made directly between Lender and Borrower. See proposed § 1.1502– 13(j)(9). Thus, when the loan is made, Lender QBU would be treated as transferring Ö100 to Lender, which in turn would be treated as lending Ö100 to Borrower in an intercompany transaction. The loan would be treated as a section 988 transaction with respect to both Lender and Borrower. When Borrower pays interest on the loan and repays the loan principal, Lender would be treated as transferring the interest or principal amount it receives from Borrower to Lender QBU. Lender’s interest income and Borrower’s interest expense, and their section 988 gain and loss with respect to principal and interest, would offset each other in amount, producing no net effect on CTI (thereby achieving single entity treatment). The group would report any foreign currency gain or loss (under section 987 or 988) on the transfers between Lender and Lender QBU (for example, when Lender QBU loans the Ö100 to Borrower, which is first treated as a remittance of the Ö100 from Lender QBU to Lender) on the group’s consolidated return. The proposed regulations also would replace Examples 4 and 15 in § 1.987– 2(c)(10) with new examples in § 1.1502– 13(j) to illustrate the application of the proposed rule. The new examples make clear that the proposed approach applies to reach single entity treatment E:\FR\FM\14NOP3.SGM 14NOP3 78154 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules for all consolidated groups, regardless of whether the taxpayer had a principal purpose of avoiding tax through the use of section 987. Cf. § 1.987–2(b)(3)(i) and (c)(10), Example 15 (providing that the IRS may reallocate a receivable from a section 987 QBU to its owner if a principal purpose of avoiding tax through the use of section 987 is present). khammond on DSKJM1Z7X2PROD with PROPOSALS3 B. Separate Return Limitation Years When a corporation joins a consolidated group, the regulations under section 1502 may limit the group’s ability to use the corporation’s preexisting tax attributes. For example, § 1.1502–21(c) generally restricts the group’s ability to use a member’s net operating loss (NOL) that arose in a year when the corporation was not a member of the group. In general, § 1.1502–21(c) allows the group to use only the portion of the NOL that does not exceed the member’s ‘‘cumulative register,’’ which reflects the member’s items of income, gain, deduction, and loss that have been included in the group’s CTI. See § 1.1502–21(c)(1)(i). Under the proposed regulations, a corporation that is the owner of a section 987 QBU may have suspended or deferred section 987 losses when it joins a consolidated group. The Treasury Department and the IRS request comments about how rules similar to the rules of § 1.1502–21(c) should apply to such losses. XV. Section 988 Transactions of a Section 987 QBU The temporary regulations provided special rules relating to section 988 transactions of a section 987 QBU, including transactions denominated in the owner’s functional currency. Although the temporary regulations have expired, the corresponding provisions of the 2016 proposed regulations remain outstanding. In general, under the 2016 proposed regulations, whether a transaction is a section 988 transaction is determined by reference to the section 987 QBU’s functional currency, but any section 988 gain or loss is determined in the owner’s functional currency. See § 1.987– 3(b)(4)(i) of the 2016 proposed regulations. In addition, certain section 988 transactions of a section 987 QBU that are denominated in, or determined by reference to, the owner’s functional currency (‘‘specified owner functional currency transactions’’) are not treated as section 988 transactions of the section 987 QBU. See § 1.987–3(b)(4)(ii) of the 2016 proposed regulations. The 2016 proposed regulations further provide that section 988 gain or loss VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 with respect to certain short-term section 988 transactions of a section 987 QBU (‘‘qualified short-term section 988 transactions’’) that are accounted for under a mark-to-market method of accounting is determined in the functional currency of the section 987 QBU, and not the functional currency of its owner. See § 1.987–3(b)(4)(iii) of the 2016 proposed regulations. Under the final regulations, a transaction denominated in a currency other than the section 987 QBU’s functional currency is a historic item. See § 1.987–1(d) and (e). However, the 2016 proposed regulations provide that a qualified short-term section 988 transaction for which section 988 gain or loss is determined by reference to the functional currency of the section 987 QBU is a marked item. See § 1.987– 1(d)(3) of the 2016 proposed regulations. The Treasury Department and the IRS understand that the rules of the 2016 proposed regulations relating to nonfunctional currency transactions of a section 987 QBU would increase the compliance burden on taxpayers in certain contexts (for example, where the section 987 QBU operates as a treasury center). This compliance burden could potentially be alleviated by treating all transactions (including specified owner functional currency transactions) denominated in a currency other than the functional currency of the section 987 QBU as marked items, determining whether those transactions are section 988 transactions by reference to the functional currency of the section 987 QBU, and determining the section 988 gain or loss with respect to those transactions in the functional currency of the section 987 QBU. However, the Treasury Department and the IRS are concerned that, under this approach, transactions denominated in the owner’s functional currency would be treated as section 988 transactions of a section 987 QBU. Therefore, these transactions would give rise to offsetting positions in that currency, enabling taxpayers to recognize losses while deferring the offsetting gains. For example, if a section 987 QBU held assets denominated in its owner’s functional currency, and the section 987 QBU’s functional currency weakened against that of its owner, the section 987 QBU would have section 988 gain and the owner would have an inverse amount of section 987 loss. The Treasury Department and the IRS request comments as to whether section 988 gain or loss on nonfunctional currency transactions (including specified owner functional currency transactions) of a section 987 QBU should be determined in the functional PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 currency of the section 987 QBU when a current rate election or annual recognition election is in effect and, if so, what limitations should be imposed to prevent abuse. Comments are also requested on whether the definition of qualified short-term section 988 transactions should be expanded or modified, and whether other exceptions or special rules should be provided for section 987 QBUs engaged in certain activities (for example, treasury centers). XVI. Definition of a Qualified Business Unit and an Eligible QBU Under section 985(b), the functional currency of a qualified business unit is generally either the dollar or the currency of the economic environment in which a significant part of its activities are conducted and in which its books and records are kept. Section 985(b); § 1.985–1(b) through (c). Under section 989, a ‘‘qualified business unit’’ means a ‘‘separate and clearly identified unit’’ of a trade or business of a taxpayer, provided that the unit maintains separate books and records. Section 989(a). The regulations describe two types of qualified business units. The activities of a person may be a qualified business unit if the activities constitute a trade or business and a separate set of books and records are maintained with respect to the activities. § 1.989(a)–1(b)(2)(ii). In addition, the so called ‘‘per se’’ qualified business units include any corporation, partnership (other than a section 987 aggregate partnership), trust, or estate. § 1.989(a)–1(b)(2)(i). A single qualified business unit may only have a single functional currency. Certain qualified business units, such as domestic corporations, are required to use the dollar as their functional currency unless otherwise provided by a ruling or administrative pronouncement. § 1.985–1(b)(1)(iii). No rulings or administrative pronouncements have been issued under this provision other than private letter rulings that can be relied on only by the specific taxpayer for whom they were issued. Accordingly, all domestic corporations are required to use the dollar as their functional currency unless they have obtained a private letter ruling specifically allowing that entity to use a different functional currency. The Treasury Department and the IRS have become aware of uncertainty regarding whether a per se qualified business unit, such as a corporation, that has only a single trade or business for which it keeps a single set of books and records is one qualified business unit (the corporation and its single trade E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules or business) or two qualified business units (the corporation itself being one and its single trade or business being the other). If a domestic corporation with a single trade or business for which it keeps a single set of books and records were a single qualified business unit, that would effectively mean that (absent a ruling) the functional currency of the trade or business would be required to be the dollar, even if the currency of the economic environment of the trade or business was the euro and books and records are maintained in euros; whereas another domestic corporation with an identical trade or business may be permitted to use the euro as the functional currency of the trade or business, as long as it had at least one other trade or business that uses the dollar. To clarify that a per se qualified business unit, such as a domestic corporation, is permitted to have a single trade or business that maintains a single set of books and records, and which uses a functional currency other than the dollar, the proposed regulations modify the definition of eligible QBU. The revised definition clarifies that, if a per se QBU has only a single trade or business for which only a single set of books and records are maintained, only the trade or business (and not the entity itself) would be an eligible QBU. Proposed § 1.987–1(b)(4). The entity itself would be the owner of the eligible QBU. Proposed § 1.987– 1(b)(5). As a result, if the eligible QBU has a functional currency other than the functional currency of the owner, the eligible QBU would be a section 987 QBU. The Treasury Department and the IRS request comments on whether a similar change should be made to § 1.989(a)– 1(b). Comments should also consider whether additional changes are needed in the regulations under section 985 regarding functional currency or in other provisions that reference the definition of a qualified business unit, such as § 1.904–4(f)(3)(vii). khammond on DSKJM1Z7X2PROD with PROPOSALS3 XVII. Other Changes and Revisions In addition to the provisions described in parts I through XVI of this Explanation of Provisions, the proposed regulations include other wording changes, additions, deletions, and organizational changes to the final regulations and the 2016 proposed regulations for purposes of clarifying, conforming, and making minor revisions. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Applicability Dates I. Applicability Dates of the Proposed Regulations Once finalized, the regulations (and the parts of the final regulations that are not replaced or modified by the proposed regulations) would apply to taxable years beginning after December 31, 2024. Proposed § 1.987–14(a)(1). A taxpayer may also choose to apply the final version of the proposed regulations and the parts of the final regulations that are not replaced or modified by the proposed regulations (the ‘‘new final regulations’’), once published in the Federal Register, for taxable years ending after the date these regulations are published as final in the Federal Register. Proposed § 1.987– 14(b). To choose to apply the new final regulations, the taxpayer and each member of its consolidated group and section 987 electing group must consistently apply the new final regulations in their entirety to the taxable year and all subsequent taxable years beginning on or before December 31, 2024. Id. The Treasury Department and the IRS are concerned that taxpayers may terminate certain QBUs before the general applicability date of the proposed regulations to avoid the application of these rules. Accordingly, the proposed regulations would also provide an earlier applicability date for terminating QBUs to prevent taxpayers from avoiding these rules. Specifically, the new final regulations are proposed to apply to a terminating QBU on the day the section 987 QBU terminates. Proposed § 1.987–14(a)(2). The proposed regulations would define a terminating QBU as a section 987 QBU if both (1) the section 987 QBU terminates on or after November 9, 2023, or as a result of an entity classification election filed on or after November 9, 2023 and effective before November 9, 2023, and (2) neither the new final regulations nor the 2016 and 2019 section 987 regulations would apply to the section 987 QBU when it terminates but for the anti-avoidance rule in proposed § 1.987–14(a)(2). Proposed § 1.987–1(h). In addition, if the section 987 regulations apply to a taxable year of a partnership and would not otherwise apply to the taxable year of a partner in which or with which the partnership’s taxable year ends, then the section 987 regulations apply to that taxable year of the partner solely with respect to the partner’s interest in the partnership and its section 987 gain or loss attributable to an eligible QBU held by the partnership. PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 78155 II. Applicability Dates of the 2016 and 2019 Section 987 Regulations The proposed regulations also provide rules regarding the applicability dates of the final regulations and temporary regulations. Section 1.987–11(a) of the 2016 final regulations generally provides that the 2016 final regulations apply to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. However, taxpayers could choose to apply them to an earlier taxable year as provided in § 1.987–11(b). The 2019 final regulations (other than § 1.987–12) have the same applicability date as the 2016 final regulations. As described in part V of the Background section, following the publication of the 2016 final regulations, the Treasury Department and the IRS have issued several notices stating that future guidance would defer the applicability dates of most provisions of the final regulations and the temporary regulations. Because certain provisions that were originally deferred have since been revoked or expired, those provisions are no longer subject to deferral; other provisions were finalized in 2019 and deferral began at that time. The provisions deferred by the notices (and the respective periods for deferral) are as follows (collectively, the ‘‘2016 and 2019 section 987 regulations’’): (i) Sections 1.861–9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985–5; 1.987–1 through 1.987–10; 1.988–1(a)(4), (a)(10)(ii), and (i); 1.988–4(b)(2); and 1.989(a)–1(b)(2)(i), (b)(4), (d)(3), and (d)(4), as contained in 26 CFR in part 1 in effect on April 1, 2017. (ii) Sections 1.987–2T(c)(9), 1.987– 4T(c)(2) and (f), and 1.987–7T, as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they were revoked on May 13, 2019). (iii) Sections 1.987–2(c)(9) and 1.987– 4(c)(2) and (f), as contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on May 13, 2019). (iv) Sections 1.987–1T (other than §§ 1.987–1T(g)(2)(i)(B) and (g)(3)(i)(H)), 1.987–3T, 1.987–6T, 1.988–1T, and 1.988–2T(i), as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they expired on December 6, 2019). Pursuant to the most recent notice, the 2016 and 2019 section 987 regulations would first apply to taxable years beginning after December 7, 2023. Notice 2022–34, 2022–34 I.R.B. 150. The deferral notices also allow taxpayers to rely on the provisions of the notices before the section 987 regulations are amended. See id. Because the proposed regulations would replace or modify parts of the E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78156 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules final regulations, the final regulations are not expected to become applicable in their current form. However, some taxpayers have chosen to apply the 2016 and 2019 section 987 regulations in accordance with § 1.987–11(b) and the deferral notices. The proposed regulations would provide rules for taxpayers who chose to apply the 2016 and 2019 section 987 regulations before the applicability date of those regulations. Proposed § 1.987–14(c)(1) would provide that a taxpayer may choose to apply the 2016 and 2019 section 987 regulations to a taxable year beginning after December 7, 2016, and beginning on or before December 31, 2024, in certain circumstances. Specifically, the taxpayer and each member of its consolidated group and section 987 electing group would be required to first apply the 2016 and 2019 section 987 regulations to a taxable year ending before November 9, 2023. Proposed § 1.987–14(c)(1)(i). In addition, the taxpayer and each member of its consolidated group and section 987 electing group would be required to consistently apply the 2016 and 2019 section 987 regulations in their entirety to all section 987 QBUs directly or indirectly owned by the taxpayer and each member of its consolidated group and section 987 electing group on the transition date for the taxable year that includes the transition date and all subsequent taxable years before the taxable year in which the taxpayer and each member of its consolidated group and section 987 electing group rely on the proposed regulations or apply the new final regulations. Proposed § 1.987– 14(c)(1)(ii). For purposes of proposed § 1.987–14(c), the term section 987 electing group does not include foreign partnerships, foreign non-grantor trusts, or foreign estates. Proposed § 1.987– 14(c)(3)(ii). If a taxpayer and each member of its consolidated group and section 987 electing group first apply the 2016 and 2019 section 987 regulations on their returns filed on or after November 9, 2023, they would be required to apply proposed § 1.987–10 in lieu of § 1.987– 10 of the final regulations. Proposed § 1.987–14(c)(1)(iii)(B). For these taxpayers, proposed § 1.987– 14(c)(1)(iii)(B) would provide that a taxpayer and each member of its consolidated group and section 987 electing group must transition from the previous method used to comply with section 987 using the transition rule in proposed § 1.987–10. In other words, these taxpayers would not be permitted to apply the fresh start method VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 described in § 1.987–10 of the final regulations. The Treasury Department and the IRS are concerned that, if the new proposed transition rule applied solely with respect to taxable years ending on or after November 9, 2023, taxpayers would effectively have the option to choose between two alternative transition methods. Taxpayers with pretransition loss could apply the transition rule of proposed § 1.987–10 (which preserves the pretransition loss), while taxpayers with pretransition gain could choose to apply the 2016 and 2109 section 987 regulations before the applicability date of the proposed regulations to take advantage of the fresh start transition method (which could eliminate the pretransition gain). Therefore, the proposed transition rule would apply to taxpayers who choose to apply the 2016 and 2019 section 987 regulations on their returns filed on or after November 9, 2023 with respect to a taxable year ending before November 9, 2023. Proposed § 1.987–14(c)(2) describes the applicability of the 2016 and 2019 section 987 regulations to section 987 QBUs that were not directly or indirectly owned by the taxpayer on the taxpayer’s transition date. Specifically, a taxpayer that is applying the 2016 and 2019 section 987 regulations to other section 987 QBUs may choose to apply the 2016 and 2019 section 987 regulations to any section 987 QBU that it did not directly or indirectly own on the transition date, provided the taxpayer applies those regulations consistently to that QBU for that taxable year and all subsequent taxable years before the taxable year in which the taxpayer relies on the proposed regulations or applies the new final regulations. III. Applicability Dates of § 1.987–12 Section 1.987–12T was issued as part of the temporary regulations and generally applied to any deferral event (as defined in § 1.987–12T(b)(2)) or outbound loss event (as defined in § 1.987–12T(d)(2)) that occurred on or after January 6, 2017. The 2019 final regulations withdrew § 1.987–12T and finalized the proposed regulations under § 1.987–12 that cross-referenced § 1.987–12T. See § 1.987–12. The deferral notices did not defer the applicability dates of § 1.987–12T or § 1.987–12, nor would the proposed regulations. Accordingly, all taxpayers to whom section 987(3) applies are currently subject to § 1.987–12. The proposed regulations would replace § 1.987–12 with certain deferral provisions generally included in PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 proposed §§ 1.987–11 through 1.987–13. Accordingly, the proposed regulations would provide that taxpayers continue to apply § 1.987–12 until the first taxable year to which they apply the new final regulations. IV. Reliance on the Proposed Regulations and 2016 Proposed Regulations Taxpayers may rely on the proposed regulations (and so much of the final regulations as would not be modified by the proposed regulations) for taxable years ending after November 9, 2023, provided the taxpayer and each member of its consolidated group and section 987 electing group consistently follow the proposed regulations in their entirety and in a consistent manner. In addition, taxpayers may rely on the parts of the 2016 proposed regulations that remain outstanding for taxable years ending after November 9, 2023, provided that both (i) the taxpayer and each member of its consolidated group and section 987 electing group consistently follow these parts in their entirety and in a consistent manner; and (ii) in that taxable year, the taxpayer follows the proposed regulations. For the avoidance of doubt, any person relying on the proposed regulations is treated as applying them for purposes of any provision that refers to the application of the proposed regulations or any part thereof (for example, for purposes of proposed § 1.987–10(b)). Special Analyses I. Regulatory Planning and Review— Economic Analysis Pursuant to the Memorandum of Agreement, Review of Treasury Regulations under Executive Order 12866 (June 9, 2023), tax regulatory actions issued by the IRS are not subject to the requirements of section 6 of Executive Order 12866, as amended. Therefore, a regulatory impact assessment is not required. II. Paperwork Reduction Act The collections of information in the proposed regulations with respect to section 987 are in proposed §§ 1.987– 1(g), 1.987–9, and 1.987–10(k). The likely respondents are individuals who file a Form 1040 and businesses that file a Form 1065, 1066, or 1120. Additionally, there is a possibility that a trust or estate that files a Form 1041 could be affected by the requirements of the proposed regulations. The IRS anticipates that the total number of E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 respondents could be 500,8 and that less than 1% of the total respondents would be a trust or estate filer. The collection of information provided by proposed § 1.987–1(g) is required only when a taxpayer makes or revokes certain elections for purposes of calculating its section 987 taxable income or loss and section 987 gain or loss with respect to a section 987 QBU. In the first year to which the section 987 regulations apply to the taxpayer, or the taxpayer or a member of its consolidated group or section 987 electing group is the owner of a section 987 QBU, the taxpayer may make any section 987 election. Thereafter, the taxpayer may make or revoke a current rate election or annual recognition election only every five years and may make or revoke other elections only with the consent of the Commissioner, which may be granted with a private letter ruling. When a taxpayer makes or revokes an election, the collection of information is mandatory. The collection of information required by proposed § 1.987–1(g) will be used by the IRS for tax compliance purposes. Proposed § 1.987–9 is intended to specify how a taxpayer satisfies its recordkeeping obligations under section 6001 with respect to section 987. The recordkeeping requirements under proposed § 1.987–9 are considered general tax records under § 1.6001–1(e). For Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (‘‘PRA’’) purposes, general tax records are already approved by OMB under 1545–0074 for individuals and under 1545–0123 for business entities, and will be approved under 1545–NEW for trust and estate filers. The IRS intends that the information collection requirements pursuant to proposed § 1.987–9 will be satisfied by the taxpayer maintaining permanent books and records that are adequate to verify its section 987 gain or loss and section 987 taxable income or loss with respect to its section 987 QBU. Specifically, with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU for a taxable year, as applicable, proposed § 1.987–9 requires taxpayers to maintain books and records related to the amount of the items of income, gain, deduction, or loss attributed to the 8 The estimated number of respondents is based on the number of taxpayers who filed a Form 8858 in 2021 that showed that the filer: (1) owned at least one disregarded entity or branch with a functional currency different from the functional currency of the owner, and (2) indicated that the disregarded entity was a section 989 QBU. Although these estimates are likely to increase once these proposed regulations are effective, the Treasury Department and the IRS do not have data that would allow for an accurate estimate of these increases. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 section 987 QBU in the functional currency of the section 987 QBU and its owner; the adjusted balance sheet of the section 987 QBU in the functional currency of the section 987 QBU and its owner; the exchange rates used to translate items of income, gain, deduction, or loss of the section 987 QBU into the owner’s functional currency and, if a spot rate convention is used, the manner in which the convention is determined; the exchange rates used to translate the assets and liabilities of the section 987 QBU into the owner’s functional currency and, if a spot rate convention is used, the manner in which the convention is determined; the amount of assets and liabilities transferred by the section 987 QBU to the owner determined in the functional currency of the owner; the amount of the unrecognized section 987 gain or loss for the taxable year; the amount of the net accumulated unrecognized section 987 gain or loss at the close of the taxable year; the amount of a remittance and the remittance proportion for the taxable year; the computations required under proposed §§ 1.861–9(g) and 1.861–9T(g) for purposes of sourcing and characterizing section 987 gain or loss, deferred section 987 gain or loss, or suspended section 987 loss under proposed § 1.987–6; the cumulative suspended section 987 loss in each recognition grouping; the outstanding deferred section 987 gain or loss in each recognition grouping; and the transition information required to be determined under proposed § 1.987– 10(k). These records are required for the IRS to validate that section 987 gain or loss and section 987 taxable income or loss have been properly determined. The collection of information in proposed § 1.987–10(k) is mandatory. Specifically, proposed § 1.987–10(k) would require a taxpayer to file a ‘‘Section 987 Transition Information’’ statement with its return for the taxable year beginning on the transition date (as defined in proposed § 1.987–10(c)). The statement would contain information that is necessary for a taxpayer to transition to the proposed section 987 regulations. Specifically, the statement requires a taxpayer to provide information that is relevant to determining the taxpayer’s pretransition gain or loss with respect to its section 987 QBUs. The collection of information required by proposed § 1.987–10(k) will be used by the IRS for tax compliance purposes. The IRS intends that the information described in proposed § 1.987–1(g) will be collected by attaching a statement to a taxpayer’s return (such as the appropriate Form 1040, Form 1120, PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 78157 Form 1065, or other appropriate form). With respect to proposed § 1.987–10(k), the IRS also intends that the collection of information will be conducted by attaching a ‘‘Section 987 Transition Information’’ statement to a return. For purposes of the PRA, the reporting burden associated with those collections of information with respect to proposed §§ 1.987–1(g) and 1.987–10(k) will be reflected in the Paperwork Reduction Act Submissions associated with those forms. The OMB Control Numbers for the forms will be approved under 1545– 0074 for individuals, under 1545–0123 for business entities, and under 1545– NEW for trust and estate filers. To the extent that a taxpayer makes or revokes an election by obtaining a private letter ruling, the reporting burden associated with those collections of information will be reflected in the Paperwork Reduction Act Submissions associated with Revenue Procedure 2023–1, IRB 2023–1 (or future revenue procedures governing private letter rulings). The OMB Control Number for the collection of information for Revenue Procedure 2023–1 is control number 1545–1522. The proposed regulation would only require taxpayers to follow the procedures under Revenue Procedure 2023–1 (or future revenue procedure governing private letter rulings) and would not change the collection requirements of the Revenue Procedure. The attachment to a return used for making elections with respect to these proposed regulations will be used by those taxpayers making or revoking an election for the taxable year. The ‘‘Section 987 Transition Information’’ statement attached to a return will be used by all taxpayers, but generally only with respect to the taxable year in which the taxpayer transitions to these proposed regulations. In certain cases, if the taxpayer owns a QBU that terminates after November 9, 2023 and before the taxable year in which the taxpayer transitions to the proposed regulations, the ‘‘Section 987 Transition Information’’ statement must be filed for that taxable year too, but the statement would only contain information with respect to the terminating QBU. The Treasury Department and the IRS request comments on all aspects of information collection burdens related to these proposed regulations. If the IRS releases a form for the purposes of collecting this information, drafts of IRS forms will be posted for comment at https://www.irs.gov/draftforms. The burden will be accounted for in 1545–0074 for individuals and in 1545– 0123 for businesses. The IRS is requesting a new OMB control number E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78158 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules to account for trust and estate filers’ burden, as reflected below. A summary of paperwork burden estimates for the elections as provided in proposed § 1.987–1(g) is as follows: Estimated number of respondents: 5. Estimated burden per response: 1.95 hours. Estimated frequency of response: 1 for the first year in which a taxpayer applies these regulations. After the first year, the current rate election and the annual recognition election can generally be changed only once every five years and other elections can be changed with the consent of the Commissioner. Estimated total burden hours: 9.75 burden hours. A summary of paperwork burden estimates for the ‘‘section 987 transition information’’ statement as provided in proposed § 1.987–10(k) is as follows: Estimated number of respondents: 5. Estimated burden per response: 1.95 hours. Estimated frequency of response: 1 for the initial transition year. Estimated total burden hours: 9.75 burden hours. 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. Commenters are strongly encouraged to submit public comments electronically. Written comments and recommendations for the proposed information collection should be sent to www.reginfo.gov/public/do/ PRAMain, with copies to the Internal Revenue Service. Find this particular information collection by selecting ‘‘Currently under Review—Open for Public Comments’’ then by using the search function. Submit electronic submissions for the proposed information collection to the IRS via email at pra.comments@irs.gov (indicate REG–132422–17 on the subject line). Comments on the collection of information should be received by February 12, 2024. 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 (including underlying assumptions and methodology); 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 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 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. 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. III. Regulatory Flexibility Act Generally, the proposed regulations affect U.S. corporations that have foreign operations. The number of small entities potentially affected by the proposed regulations is unknown; however, it is unlikely to be a substantial number because taxpayers with foreign operations are typically larger businesses. In accordance with the Regulatory Flexibility Act (5 U.S.C. 601 et seq.) the Secretary hereby certifies that these proposed regulations will not have a significant economic impact on a substantial number of small entities. IV. Section 7805(f) Pursuant to section 7805(f), this proposed regulation will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business. V. Unfunded Mandates Reform Act Section 202 of the Unfunded Mandates Reform Act of 1995 requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a State, local, or Tribal government, in the aggregate, or by the private sector, of $100 million in 1995 dollars, updated annually for inflation. The proposed regulations do not include any Federal mandate that may result in expenditures by State, local, or Tribal governments, or by the private sector in excess of that threshold. VI. Executive Order 13132: Federalism Executive Order 13132 (entitled ‘‘Federalism’’) prohibits an agency from PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 publishing any rule that has federalism implications if the rule either imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or preempts State law, unless the agency meets the consultation and funding requirements of section 6 of the Executive order. The proposed regulations do not have federalism implications and do not impose substantial direct compliance costs on State and local governments or preempt State law within the meaning of the Executive order. Comments and Request for Public Hearing Before these proposed amendments to the final regulations are adopted as final regulations, consideration will be given to comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES heading. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. Any comments submitted will be made available at https://www.regulations.gov or upon request. A public hearing will be scheduled if requested in writing by any person who timely submits written comments. Requests for a public hearing are also encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register. Drafting Information The principal authors of the proposed regulations are Raphael J. Cohen, D. Peter Merkel, Jack Zhou, and Azeka J. Abramoff of the Office of Associate Chief Counsel (International); and Jeremy Aron-Dine and Julie Wang of the Office of Associate Chief Counsel (Corporate). However, other personnel from the Treasury Department and the IRS participated in their development. Statement of Availability of IRS Documents IRS Revenue Procedures, Revenue Rulings, Notices, and other guidance cited in this document are published in the Internal Revenue Bulletin or Cumulative Bulletin and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov. Partial Withdrawal of Proposed Regulations Under the authority of 26 U.S.C. 7805, proposed §§ 1.987–1(g)(2)(i)(B) and (C) and (g)(3)(i)(G) and (H), 1.987–3(d), 1.987–7, and 1.987–8, contained in the E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules notice of proposed rulemaking that was published in the Federal Register on December 8, 2016 (81 FR 88882) is withdrawn. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Proposed Amendments to the Regulations Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows: 1. The authority citation for part 1 is amended by: ■ a. Removing the entry for §§ 1.861–9 and 1.861–9T and §§ 1.861–8T through 1.861–14T; ■ b. Adding entries for §§ 1.861–8T, 1.861–9, 1.861–9T, 1.861–10T, 1.861– 11T, 1.861–12T, 1.861–13T, and 1.861– 14T in numerical order; ■ c. Removing the entry for §§ 1.985–0 through 1.985–5; ■ d. Adding entries for §§ 1.985–0 through 1.985–5 in numerical order; ■ e. Removing the entry for §§ 1.987–1 through 1.987–5; ■ f. Adding entries for §§ 1.987–1 through 1.987–6, 1.987–7A, 1.987–7B, 1.987–7C, and 1.987–8 through 1.987– 11 in numerical order; ■ g. Revising the entry for § 1.987–12; ■ h. Adding entries for §§ 1.987–13 and 1.987–14 in numerical order; ■ i. Removing the entry for §§ 1.988–0 through 1.988–5; ■ j. Adding entries for §§ 1.988–0 through 1.988–5 and 1.989(a)–1 in numerical order. ■ k. Revising the entry for § 1.1502–13. The revisions and additions read as follows: ■ Authority: 26 U.S.C. 7805 * * * * * * * Section 1.861–8T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). Section 1.861–9 also issued under 26 U.S.C. 861, 863(a), 864(e), 864(e)(7), 865(i), 987, and 989(c), and 7701(f). Section 1.861–9T also issued under 26 U.S.C. 861, 863(a), 864(e), 864(e)(7), 865(i), and 7701(f). * * * * * khammond on DSKJM1Z7X2PROD with PROPOSALS3 Section 1.861–10T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). * * * * * Section 1.861–11T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). * * * * * Section 1.861–12T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). * * * * * Section 1.861–13T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). * * * VerDate Sep<11>2014 * * 17:12 Nov 13, 2023 * Jkt 262001 * * * * Section 1.985–0 also issued under 26 U.S.C. 985. Section 1.985–1 also issued under 26 U.S.C. 985. Section 1.985–2 also issued under 26 U.S.C. 985. Section 1.985–3 also issued under 26 U.S.C. 985. Section 1.985–4 also issued under 26 U.S.C. 985. Section 1.985–5 also issued under 26 U.S.C. 985, 987, and 989(c). * PART 1—INCOME TAXES * Section 1.861–14T also issued under 26 U.S.C. 863(a), 864(e), 865(i), and 7701(f). * * * * Section 1.987–1 also issued under 26 U.S.C. 987, 989(c), and 1502. Section 1.987–2 also issued under 26 U.S.C. 987, 989(c), and 1502. Section 1.987–3 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–4 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–5 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–6 also issued under 26 U.S.C. 904, 987, and 989(c). Section 1.987–7A also issued under 26 U.S.C. 987 and 989(c). Section 1.987–7B also issued under 26 U.S.C. 987 and 989(c). Section 1.987–7C also issued under 26 U.S.C. 987 and 989(c). Section 1.987–8 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–9 also issued under 26 U.S.C. 987, 989(c), and 6001. Section 1.987–10 also issued under 26 U.S.C. 987, 989(c), and 6001. Section 1.987–11 also issued under 26 U.S.C. 987, 989(c), and 1502. Section 1.987–12 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–13 also issued under 26 U.S.C. 987 and 989(c). Section 1.987–14 also issued under 26 U.S.C. 987 and 989(c). Section 1.988–0 also issued under 26 U.S.C. 988. Section 1.988–1 also issued under 26 U.S.C. 988 and 989(c). Section 1.988–2 also issued under 26 U.S.C. 988. Section 1.988–3 also issued under 26 U.S.C. 988. Section 1.988–4 also issued under 26 U.S.C. 988 and 989(c). Section 1.988–5 also issued under 26 U.S.C. 988. * * * * * Section 1.989(a)–1 also issued under 26 U.S.C. 989 and 989(c). * * * * * Section 1.1502–13 also issued under 26 U.S.C. 250(c), 987, 989(c), and 1502. * * * * * 2. Section 1.861–9 is amended by: a. Revising paragraphs (g)(2)(ii)(A) introductory text, (g)(2)(ii)(A)(1), and (g)(2)(ii)(B). ■ b. Adding paragraph (g)(2)(v). The revisions and addition read as follows: ■ ■ PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 78159 § 1.861–9 Allocation and apportionment of interest expense and rules for asset-based apportionment. * * * * * (g) * * * (2) * * * (ii) * * * (A) Tax book value method. In the case of taxpayers using the tax book value method of apportionment, the following rules apply to determine the value of the assets of a qualified business unit (as defined in section 989(a)) of a domestic corporation with a functional currency other than the dollar. (1) Section 987 QBU. In the case of a section 987 QBU (as defined in § 1.987– 1(b)(3)), the tax book value is determined by applying the rules of paragraph (g)(2)(i) of this section and § 1.861–9T(g)(3) to the beginning-of-year and end-of-year owner functional currency amount of assets. The beginning-of-year owner functional currency amount of assets is determined by reference to the owner functional currency amount of assets computed under § 1.987–4(d)(1)(i)(B) and (e) on the last day of the preceding taxable year. The end-of-year owner functional currency amount of assets is determined by reference to the owner functional currency amount of assets computed under § 1.987–4(d)(1)(i)(A) and (e) on the last day of the current taxable year. The beginning-of-year and end-of-year owner functional currency amount of assets, as so determined within each grouping, are then averaged as provided in paragraph (g)(2)(i) of this section. * * * * * (B) Fair market value method. In the case of taxpayers using the fair market value method of apportionment, the beginning-of-year and end-of-year fair market values of branch assets within each grouping is computed in dollars and averaged as provided in this paragraph (g)(2) and § 1.861–9T(g)(2). * * * * * (v) Applicability date. Generally, paragraph (g)(2)(ii)(A)(1) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987–14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987– 14(a)(1), then paragraph (g)(2)(ii)(A)(1) of this section applies to that taxable year and subsequent years. * * * * * § 1.861–9T [Amended] 3. Section 1.861–9T is amended by removing and reserving paragraph (g)(2)(ii) and removing paragraph (g)(2)(vi). ■ E:\FR\FM\14NOP3.SGM 14NOP3 78160 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules 4. Section 1.904–4 is amended by revising paragraph (c)(5)(iii)(B) to read as follows: ■ § 1.904–4 Separate application of section 904 with respect to certain categories of income. * * * * * (c) * * * (5) * * * (iii) * * * (B) Section 987. For special rules relating to the allocation and apportionment of foreign income taxes to section 987 items, see § 1.987– 6(b)(3)(iii). * * * * * ■ 5. Section 1.985–5 is amended by: ■ a. In paragraph (a) removing the language ‘‘§ 1.987–1(b)(2)’’ and adding the language ‘‘§ 1.987–1(b)(3)’’ in its place. ■ b. In paragraph (d)(1)(i) removing the language ‘‘1.987–11’’ and adding the language ‘‘1.987–14’’ in its place. ■ c. Revising the last sentence of paragraph (d)(2). d. Removing the second sentence of paragraph (e)(1). ■ e. In paragraph (e)(4)(i) removing the language ‘‘1.987–11’’ and adding the language ‘‘1.987–14’’ in its place. ■ f. In paragraph (e)(4)(i)(C) adding the language ‘‘, cumulative suspended section 987 loss determined under § 1.987–11(b), and deferred section 987 gain or loss determined under § 1.987– 12’’ after ‘‘§ 1.987–4’’. ■ g. In paragraph (e)(4)(ii) removing the language ‘‘subsequent years’’ and adding the language ‘‘subsequent taxable years’’ in its place. ■ h. Revising the last sentence of paragraph (e)(4)(iii). ■ i. Revising paragraphs (f) through (g). The revisions read as follows: ■ § 1.985–5 Adjustments required upon change in functional currency. * * * * * (d) * * * (2) * * * See §§ 1.987–5, 1.987–8, 1.987–12, and 1.987–13 for the effect of a termination of a section 987 QBU that is subject to §§ 1.987–1 through 1.987– 14. (e) * * * (4) * * * (iii) * * * See §§ 1.987–5, 1.987–8, 1.987–12, and 1.987–13 for the consequences of a termination of a section 987 QBU that is subject to §§ 1.987–1 through 1.987–14. (f) Example. The provisions of this section are illustrated by the following example: (1) Facts. FC, a foreign corporation, is wholly owned by DC, a domestic corporation. The Commissioner granted permission to change FC’s functional currency from the British pound to the euro beginning January 1, year 2. The EUR/GBP exchange rate on December 31, year 1, is Ö1:£0.50. (2) Analysis—(i) Determining new functional currency basis of property and liabilities. The following table shows how FC must convert the items on its balance sheet from the British pound to the euro on December 31, year 1. TABLE 1 TO PARAGRAPH (f)(2)(i)—CONVERSION OF FC’S BALANCE SHEET ITEMS GBP khammond on DSKJM1Z7X2PROD with PROPOSALS3 Assets: Cash on hand ....................................................................................................................................... Accounts Receivable ............................................................................................................................ Inventory ............................................................................................................................................... Ö100,000 Euro Bond (£100,000 historical basis) ................................................................................. Fixed assets: Property ................................................................................................................................................ Plant ...................................................................................................................................................... Accumulated Depreciation ............................................................................................................ Equipment ............................................................................................................................................. Accumulated Depreciation ............................................................................................................ EUR £40,000 £10,000 £100,000 £50,000 Ö80,000 Ö20,000 Ö200,000 Ö100,000 £200,000 £500,000 (£200,000) £1,000,000 (£400,000) Ö400,000 Ö1,000,000 (Ö400,000) Ö2,000,000 (Ö800,000) Total Assets ........................................................................................................................... Liabilities and Equity: Accounts Payable ................................................................................................................................. Long-term Liabilities ............................................................................................................................. Paid-in-Capital ...................................................................................................................................... Retained Earnings ................................................................................................................................ £1,300,000 Ö2,600,000 £50,000 £400,000 £800,000 £50,000 Ö100,000 Ö800,000 Ö1,600,000 Ö100,000 Total Liabilities and Equity ............................................................................................................ £1,300,000 Ö2,600,000 (ii) Exchange gain or loss on section 988 transactions. Under paragraph (b) of this section, FC will recognize a £50,000 loss (£50,000 current value minus £100,000 historical basis) on the Euro Bond resulting from the change in functional currency because, after the change, the Euro Bond will no longer be an asset denominated in a nonfunctional currency. The amount of FC’s retained earnings on its December 31, year 1, balance sheet reflects the £50,000 loss on the Euro Bond. (g) Applicability date. Generally, this regulation applies to taxable years beginning after December 31, 2024. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 However, if pursuant to § 1.987–14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987–14(a)(1), then this section applies to that taxable year and subsequent years. ■ 6. Section 1.987–1, as proposed to be amended by 81 FR 88882 (December 8, 2016), is further amended by: ■ a. Revising paragraph (a); ■ b. Revising the paragraph (b) heading, paragraph (b)(1) heading, paragraphs (b)(1)(i) and (ii), (2) through (5) and (7); ■ c. Revising paragraphs (c) introductory text, (c)(1)(i) and PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 (c)(1)(ii)(A) and removing paragraph (c)(1)(iii); ■ d. Revising paragraphs (c)(2), (c)(3)(i) introductory text, (c)(3)(i)(A) through (D) and adding paragraph (c)(3)(i)(F); ■ g. Revising paragraphs (c)(3)(ii) through (iv); ■ h. Removing the introductory text in paragraph (d); ■ i. Redesignating paragraphs (d)(1) through (3) as paragraphs (d)(1)(i) through (iii); ■ j. Adding paragraph (d)(1) introductory text; ■ k. Revising newly redesignated paragraphs (d)(1)(i) and (ii); ■ l. Adding paragraph (d)(2); E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules m. Revising paragraph (e); n. Adding paragraph (g) introductory text; ■ o. Revising paragraphs (g)(1) and (2); ■ p. Revising paragraph (g)(3) heading and adding (g)(3) introductory text; ■ q. Revising paragraph (g)(3)(i) heading and introductory text; ■ r. Revising paragraphs (g)(3)(i)(A) through (D), (G), and (H); ■ s. Adding paragraphs (g)(3)(i)(I) and (J); ■ t. Revising paragraph (g)(3)(ii); ■ u. Adding paragraph (g)(3)(iii); ■ v. Revising paragraphs (g)(4) and (5); and ■ w. Adding paragraph (h). The revisions and additions read as follows: ■ ■ khammond on DSKJM1Z7X2PROD with PROPOSALS3 § 1.987–1 rules. Scope, definitions, and special (a) In general. Sections 1.987–1 through 1.987–14 (the section 987 regulations) provide rules for determining the taxable income or loss and earnings and profits of a taxpayer with respect to a section 987 QBU. Further, the section 987 regulations provide rules for determining the timing, amount, character, and source of section 987 gain or loss recognized with respect to a section 987 QBU. This section addresses the scope of the section 987 regulations and provides certain definitions, special rules, and procedures for making elections. Section 1.987–2 provides rules for attributing assets and liabilities and items of income, gain, deduction, and loss to an eligible QBU. It also provides rules regarding the translation of items transferred to a section 987 QBU. Section 1.987–3 provides rules for determining and translating the taxable income or loss of a taxpayer with respect to a section 987 QBU. Section 1.987–4 provides rules for determining net unrecognized section 987 gain or loss. Section 1.987–5 provides rules regarding the recognition of section 987 gain or loss. It also provides rules regarding the translation of items transferred from a section 987 QBU to its owner. Section 1.987–6 provides rules regarding the character and source of section 987 gain or loss. Section 1.987–7A provides rules regarding partnerships (other than section 987 aggregate partnerships) and S corporations that own section 987 QBUs and their partners and shareholders. Section 1.987–7B provides rules regarding section 987 aggregate partnerships. Section 1.987–7C provides transition rules that apply when a partnership becomes, or ceases to be, a section 987 aggregate partnership. Section 1.987–8 provides rules VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 regarding the termination of a section 987 QBU. Section 1.987–9 provides rules regarding the recordkeeping required under section 987. Section 1.987–10 provides transition rules. Section 1.987–11 provides rules relating to suspended losses in connection with certain elections and the loss-to-theextent-of-gain rule. Section 1.987–12 provides rules regarding when section 987 gain or loss is deferred, as well as when such amounts are recognized. Section 1.987–13 provides rules relating to suspended section 987 loss of an owner with respect to a section 987 QBU that terminates. Section 1.987–14 provides the applicability date of the section 987 regulations. (b) Scope of section 987 and certain rules relating to QBUs—(1) Persons subject to section 987—(i) In general. Except as provided in paragraphs (b)(1)(ii) and (b)(6) of this section, any person (including an individual, corporation, partnership, S corporation, non-grantor trust, or estate) is subject to the section 987 regulations. (ii) Inapplicability to certain entities— (A) In general. Except as otherwise provided in paragraph (b)(1)(iii) of this section, section 987(3) and the section 987 regulations do not apply to foreign corporations that either are not controlled foreign corporations or that are controlled foreign corporations in which no United States shareholders own (within the meaning of section 958(a)) stock; foreign non-grantor trusts, foreign estates, or foreign partnerships (other than section 987 aggregate partnerships) if the aggregate beneficial interest or partnership interest of all U.S. persons that are beneficiaries or partners in the non-grantor trust, estate, or partnership is de minimis under paragraph (b)(1)(ii)(B) of this section; and individuals who are not United States persons. (B) De minimis interest in a foreign non-grantor trust, foreign estate, or foreign partnership—(1) General rules. The total partnership interests of all U.S. persons that own (within the meaning of section 958(a)) an interest in a partnership is de minimis if their aggregate partnership interests represent less than ten percent of the capital and less than ten percent of the profits of the partnership at all times during the partnership’s taxable year. The aggregate beneficial interests of all U.S. persons in a foreign non-grantor trust or foreign estate is de minimis if it constitutes less than ten percent of all of the beneficial interests. For purposes of this paragraph, a partner’s interest in a partnership or partnership item and a beneficiary’s interest in a non-grantor trust or estate is treated as including the PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 78161 interests of the partner or beneficiary and any related party (determined under section 267(b) or 707(b)). (2) Foreign partnerships. For purposes of this paragraph (b)(1)(ii)(B), a partner’s interest in the profits of a partnership is determined in accordance with the rules and principles of § 1.706–1(b)(4)(ii), and a partner’s interest in the capital of a partnership is determined in accordance with the rules and principles of § 1.706– 1(b)(4)(iii). (3) Foreign trusts and estates. For purposes of this paragraph (b)(1)(ii)(B), a person holds a beneficial interest in a foreign trust or in a foreign estate if the person has the right to receive directly or indirectly (for example, through a nominee) a mandatory distribution from the foreign trust or estate, or may receive, directly or indirectly, a discretionary distribution from the foreign trust. For purposes of this section, a mandatory distribution means a distribution that is required to be made pursuant to the terms of the trust’s or estate’s governing documents. A discretionary distribution means a distribution that is made to a person at the discretion of the trustee or a person with a limited power of appointment of such trust. The aggregate beneficial interests of all U.S. persons in a foreign non-grantor trust or foreign estate will be treated as equaling 10 percent or more of the beneficial interest in a foreign trust or a foreign estate if— (i) The beneficiaries receive, directly or indirectly, only discretionary distributions from the trust and the fair market value of the currency or other property distributed, directly or indirectly, from the trust to such beneficiaries during the prior calendar year exceeds, in the aggregate, 10 percent of the value of either all of the distributions made by the trust during that year or all of the assets held by the trust at the end of that year; (ii) The beneficiaries are entitled to receive, directly or indirectly, mandatory distributions from the trust or estate and the value of the beneficiaries’ aggregate interest in the trust or estate, as determined under section 7520, exceeds 10 percent of the value of all the assets held by the trust; or (iii) The beneficiaries are entitled to receive, directly or indirectly, mandatory distributions and may receive, directly or indirectly, discretionary distributions from the trust, and the value of the beneficiaries’ aggregate interest in the trust (determined as the sum of the fair market value of all of the currency or other property distributed from the trust at the discretion of the trustee during E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78162 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules the prior calendar year to the beneficiaries and the value of the beneficiaries’ interest in the trust as determined under section 7520 at the end of that year) exceeds either 10 percent of the value of all distributions made by such trust during the prior calendar year or 10 percent of the value of all the assets held by the trust at the end of that year. * * * * * (2) Application of the section 987 regulations to earnings and profits—(i) In general. The rules and principles of the section 987 regulations also apply to the determination of earnings and profits, and any elections that apply pursuant to the section 987 regulations also apply for purposes of determining earnings and profits. (ii) Timing. Earnings and profits are increased when section 987 gain is recognized and decreased when section 987 loss is recognized. As a result, converting net unrecognized section 987 gain or loss to deferred section 987 gain or loss or suspended section 987 loss does not affect earnings and profits because the amounts have not yet been recognized. (3) Definition of a section 987 QBU— (i) In general. For purposes of section 987, a section 987 QBU is an eligible QBU that has a functional currency different from its owner. A section 987 QBU also includes the assets and liabilities of an eligible QBU that are considered under paragraph (b)(5)(ii) of this section to be a section 987 QBU of a partner in a section 987 aggregate partnership. A section 987 QBU will continue to be treated as a section 987 QBU of the owner until a sale or other termination of the section 987 QBU as described in § 1.987–8(b) and (c). See § 1.985–1 for rules determining the functional currency of an eligible QBU. (ii) Section 987 QBU grouping election—(A) In general. Solely for purposes of section 987, an owner may elect to treat all section 987 QBUs with the same functional currency as a single section 987 QBU except to the extent provided in paragraph (b)(2)(ii)(B) of this section. (B) Special grouping rules for section 987 QBUs owned indirectly through a section 987 aggregate partnership. An owner making the section 987 QBU grouping election treats all section 987 QBUs with the same functional currency owned indirectly through a single section 987 aggregate partnership as a single section 987 QBU. However, an owner may not treat section 987 QBUs as a single section 987 QBU if such QBUs are owned indirectly through different section 987 aggregate VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 partnerships. Additionally, an owner may not treat section 987 QBUs that are owned both directly and indirectly through a section 987 aggregate partnership as a single section 987 QBU. (4) Definition of an eligible QBU—(i) In general. For purposes of section 987, an eligible QBU means a qualified business unit that is not subject to the United States dollar approximate separate transactions method rules of § 1.985–3. (ii) Qualified business unit. For purposes of this paragraph (b)(4), a qualified business unit is defined in § 1.989(a)–1(b), except that a corporation, partnership, section 987 aggregate partnership, trust, estate, or DE is not itself a qualified business unit, but the activities of such entity may be a qualified business unit if they meet the requirements of § 1.989(a)–1(b)(1) and (b)(2)(ii). For example, if a corporation is solely engaged in activities that constitute a trade or business within the meaning of § 1.989(a)–1(b)(2)(ii)(A), and the corporation maintains only one set of books and records, the activities (but not the corporation) are a qualified business unit. (5) Definition of an owner. For purposes of section 987, an owner is any person having direct or indirect ownership in an eligible QBU (including ownership through DEs). The term owner does not include an eligible QBU. For example, a section 987 QBU (QBU1) is not an owner of another section 987 QBU (QBU2) even if QBU1 wholly owns the DE that owns QBU2. A person that is not subject to the section 987 regulations under paragraph (b)(1)(ii) of this section can meet the definition of an owner under this paragraph (b)(5) for purposes of applying the section 987 regulations to other persons. (i) Direct ownership. A person is a direct owner of an eligible QBU if the person is the owner for Federal income tax purposes of the assets and liabilities of the eligible QBU. (ii) Indirect ownership. A person that is a partner in a section 987 aggregate partnership and is allocated, under § 1.987–7B, all or a portion of the assets and liabilities of an eligible QBU of such partnership is an indirect owner of the eligible QBU. * * * * * (7) Examples illustrating paragraph (b) of this section. The following examples illustrate the principles of this paragraph (b). The following facts are assumed for purposes of the examples. U.S. Corp is a domestic corporation, has the U.S. dollar as its functional PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 currency, and uses the calendar year as its taxable year. Except as otherwise provided: Business A and Business B are eligible QBUs and have the euro and the Japanese yen, respectively, as their functional currencies; and DE1 and DE2 are DEs, have no assets or liabilities, and conduct no activities. (i) Example 1—(A) Facts. U.S. Corp owns Business A and all of the interests in DE1. DE1 maintains a separate set of books and records that are kept in British pounds. DE1 owns pounds and all of the stock of a foreign corporation, FC. DE1 is liable to a lender on a pounddenominated obligation that was incurred to acquire the stock of FC. The FC stock, the pounds, and the liability incurred to acquire the FC stock are recorded on DE1’s separate books and records. DE1 has no other assets or liabilities and conducts no activities (other than holding the FC stock and pounds and servicing its liability). (B) Analysis—(1) Pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of Business A because it has direct ownership of Business A, an eligible QBU. Because Business A is an eligible QBU with a functional currency that is different from the functional currency of its owner, U.S. Corp, Business A is a section 987 QBU under paragraph (b)(3)(i) of this section. As a result, U.S. Corp and its section 987 QBU, Business A, are subject to section 987. (2) Holding the stock of FC and pounds and servicing a liability does not constitute a trade or business within the meaning of § 1.989(a)–1(c). Because the activities of DE1 do not constitute a trade or business within the meaning of § 1.989(a)–1(c), such activities are not an eligible QBU. In addition, pursuant to paragraph (b)(4)(ii) of this section, DE1 itself is not an eligible QBU. As a result, neither DE1 nor its activities qualify as a section 987 QBU of U.S. Corp. Therefore, neither the activities of DE1 nor DE1 itself is subject to section 987. For the foreign currency treatment of payments on DE1’s pound-denominated liability, see § 1.988–2(b). (ii) Example 2—(A) Facts. U.S. Corp owns all of the interests in DE1. DE1 owns Business A and all of the interests in DE2. The only activities of DE1 are Business A activities and holding the interests in DE2. DE2 owns Business B and Business C. For purposes of this example, Business B does not maintain books and records that are separate from DE2. Instead, the activities of Business B are reflected on the books and records of DE2, which are maintained in Japanese yen. In addition, Business C has the U.S. dollar as its functional currency, maintains books and records E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules that are separate from the books and records of DE2, and is an eligible QBU. (B) Analysis—(1) Pursuant to paragraph (b)(4)(ii) of this section, DE1 and DE2 are not eligible QBUs. Moreover, pursuant to paragraph (b)(5) of this section, DE1 is not the owner of the Business A, Business B, or Business C eligible QBUs, and DE2 is not the owner of the Business B or Business C eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of the Business A, Business B, and Business C eligible QBUs. (2) Because Business A and Business B are eligible QBUs with functional currencies that are different than the functional currency of U.S. Corp, Business A and Business B are section 987 QBUs under paragraph (b)(3)(i) of this section. (3) The Business C eligible QBU has the same functional currency as U.S. Corp, the U.S. dollar. Therefore, the Business C eligible QBU is not a section 987 QBU under paragraph (b)(3)(i) of this section. (iii) Example 3—(A) Facts. U.S. Corp owns all of the interests in DE1. DE1 owns Business A and Business B. For purposes of this example, assume Business B has the euro as its functional currency. (B) Analysis—(1) Pursuant to paragraph (b)(4)(ii) of this section, DE1 is not an eligible QBU. Moreover, pursuant to paragraph (b)(5) of this section, DE1 is not the owner of the Business A or Business B eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of the Business A and Business B eligible QBUs. (2) Business A and Business B constitute two separate eligible QBUs, each with the euro as its functional currency. Accordingly, Business A and Business B are section 987 QBUs of U.S. Corp under paragraph (b)(3)(i) of this section. U.S. Corp may elect to treat Business A and Business B as a single section 987 QBU pursuant to paragraph (b)(3)(ii) of this section. If such election is made, pursuant to paragraph (b)(5) of this section, U.S. Corp would be the owner of the Business AB section 987 QBU that would include the activities of both the Business A section 987 QBU and the Business B section 987 QBU. In addition, pursuant to paragraph (b)(5) of this section, DE1 would not be treated as the owner of the Business AB section 987 QBU. (iv) Example 4—(A) Facts. U.S. Corp and FC, an unrelated foreign corporation, are the only partners in P, a foreign partnership with the euro as its VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 functional currency. P owns DE1 and Business A. DE1 owns Business B. (B) Analysis—(1) P is not a section 987 aggregate partnership under paragraph (h) of this section because its partners are not related to each other within the meaning of sections 267(b) and 707(b). Therefore, pursuant to paragraph (b)(5) of this section and § 1.987–7A(b), P is the owner of Business A because it is the owner of the assets and liabilities of Business A. Because Business A is an eligible QBU with the same functional currency as its owner, P (the euro), Business A is not a section 987 QBU under paragraph (b)(3)(i) of this section. (2) Pursuant to paragraph (b)(4)(ii) of this section, DE1 is not an eligible QBU. Moreover, pursuant to paragraph (b)(5) of this section and § 1.987–7A(b), P (rather than DE1) is the owner of the Business B eligible QBU. The Business B eligible QBU has a different functional currency than P. Therefore, the Business B eligible QBU is a section 987 QBU under paragraph (b)(3)(i) of this section. As a result, P and its section 987 QBU, Business B, are subject to section 987. (v) Example 5—(A) Facts. U.S. Corp owns all of the interests in DE1. DE1 owns Business A and all of the interests in DE2. DE2 owns Business B and all of the interests in DE3, a DE. DE3 owns Business C, which is an eligible QBU with the Mexican peso as its functional currency. (B) Analysis. Pursuant to paragraph (b)(4)(ii) of this section, DE1, DE2, and DE3 are not eligible QBUs. Pursuant to paragraph (b)(5) of this section, an eligible QBU is not an owner of another eligible QBU. Accordingly, the Business A eligible QBU is not the owner of the Business B eligible QBU or the Business C eligible QBU, and the Business B eligible QBU is not the owner of the Business C eligible QBU. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of the Business A, Business B, and Business C eligible QBUs. Because each of the Business A, Business B, and Business C eligible QBUs has a different functional currency than U.S. Corp, such eligible QBUs are section 987 QBUs of U.S. Corp under paragraph (b)(3)(i) of this section. (c) Exchange rates. Solely for purposes of section 987, the spot rate, the yearly average exchange rate, and the historic rate are determined as provided in paragraphs (c)(1) through (3) of this section. (1) Spot rate—(i) In general. Except as otherwise provided in this section, the spot rate means the rate determined under the rules of § 1.988–1(d)(1), (2), and (4) on the relevant date. PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 78163 (ii) Election to use a spot rate convention—(A) In general—spot rate convention. An owner may elect to use a spot rate convention that reasonably approximates the spot rate determined in paragraph (c)(1)(i) of this section. A spot rate convention may be based on the spot rate at the beginning of a reasonable period, the spot rate at the end of a reasonable period, the average of spot rates for a reasonable period, or spot and forward rates for a reasonable period. For this purpose, a reasonable period may not exceed three months. For example, in lieu of the spot rate determined in paragraph (c)(1)(i) of this section, the spot rate for all transactions during a monthly period may be determined pursuant to one of the following conventions: the spot rate at the beginning of the current month or at the end of the preceding month; the monthly average of daily spot rates for the current or preceding month; or an average of the beginning and ending spot rates for the current or preceding month. Similarly, in lieu of the spot rate determined in paragraph (c)(1)(i) of this section, the spot rate may be determined pursuant to an average of the spot rate and the 30-day forward rate on a day of the preceding month. Use of a spot rate convention that is consistent with the convention used for financial accounting purposes is generally presumed to reasonably approximate the rate in paragraph (c)(1)(i) of this section. However, the Commissioner may prescribe the spot rate as determined in paragraph (c)(1)(i) of this section or an appropriate spot rate pursuant to this paragraph (c)(1)(ii) if the Commissioner determines that the use of the convention would not clearly reflect income based on the facts and circumstances available at the time of the election. The election or revocation of a spot rate convention does not change the spot rate with respect to any day of a taxable year before the election or revocation becomes effective. See paragraph (g) of this section for rules relating to section 987 elections. * * * * * (2) Yearly average exchange rate. For purposes of section 987, the yearly average exchange rate is a rate that represents an average exchange rate for the taxable year (or, if the section 987 QBU existed for less than the full taxable year, the portion of the year during which the 987 QBU existed) computed under any reasonable method. For example, an owner may determine the yearly average exchange rate based on a daily, monthly, or quarterly averaging convention, whether weighted or unweighted, and may take E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78164 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules into account forward rates for a period not to exceed three months. Use of an averaging convention that is consistent with the convention used for financial accounting purposes is generally presumed to be a reasonable method. However, the Commissioner may prescribe an appropriate yearly average exchange rate if the Commissioner determines that the use of the convention would not have been expected to clearly reflect income based on the facts and circumstances available at the time of the election. (3) Historic rate—(i) In general. Except as otherwise provided in the section 987 regulations, the historic rate is determined as described in paragraphs (c)(3)(i)(A) through (F) of this section. In a taxable year in which an annual recognition election is in effect (and a current rate election is not in effect), paragraphs (c)(3)(i)(B) and (C) of this section are applied as if § 1.987– 3(c)(2)(iv)(A) and (B) were applicable. (A) Assets generally. In the case of an asset other than inventory that is acquired by a section 987 QBU (including through a transfer), the historic rate is the yearly average exchange rate applicable to the year of acquisition. (B) Inventory under the simplified inventory method. In the case of inventory with respect to which a taxpayer uses the simplified inventory method described in § 1.987– 3(c)(2)(iv)(A), the historic rate for inventory accounted for under the lastin, first-out (LIFO) method of accounting is the yearly average exchange rate applicable to the year in which the inventory’s LIFO layer arose. The historic rate for all other inventory of such a taxpayer is the yearly average exchange rate for the taxable year for which the determination of the historic rate for such inventory is relevant. (C) Inventory under the historic inventory method. In the case of inventory with respect to which a taxpayer has elected under § 1.987– 3(c)(2)(iv)(B) to use the historic inventory method, each inventoriable cost with respect to such inventory may have a different historic rate. The historic rate for each inventoriable cost is the exchange rate at which such item would be translated under § 1.987–3 if it were not an inventoriable cost. (D) Liabilities generally. In the case of a liability that is incurred or assumed by a section 987 QBU, the historic rate is the yearly average exchange rate applicable to the year the liability is incurred or assumed. * * * * * (F) Determination of historic rates after revocation of current rate election. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Except as provided in paragraph (c)(3)(i)(B) of this section with respect to non-LIFO inventory subject to the simplified inventory method, if a current rate election is revoked or otherwise ceases to be in effect, the historic rate of all historic items that were properly reflected on the books and records of a section 987 QBU under § 1.987–2(b) on the last day of the last taxable year to which the current rate election was in effect is the spot rate applicable to that day. (ii) [Reserved] (iii) Date placed in service for depreciable or amortizable property. In the case of depreciable or amortizable property, an owner may determine the historic rate by reference to the date such property is placed in service by the section 987 QBU rather than the date the property was acquired, provided that this convention is consistently applied for all such property attributable to that section 987 QBU. (iv) Changed functional currency. In the case of a section 987 QBU or an owner of a section 987 QBU that previously changed its functional currency, § 1.985–5(d)(1)(ii)(A) and (e)(4)(i)(A), respectively, are taken into account in determining the historic rate for an item reflected on the balance sheet of the section 987 QBU immediately before the year of change. (d) Marked item—(1) In general. Except as provided in paragraph (d)(2) of this section, a marked item is an asset (marked asset) or liability (marked liability) that is properly reflected on the books and records of a section 987 QBU under § 1.987–2(b) and that— (i) Is denominated in, or determined by reference to, the functional currency of the section 987 QBU, is not a section 988 transaction of the section 987 QBU, and would be a section 988 transaction if such item were held or entered into directly by the owner of the section 987 QBU; or (ii) Is a prepaid expense or a liability for an advance payment of unearned income, in either case having an original term of one year or less on the date the prepaid expense or liability for an advance payment of unearned income arises. * * * * * (2) Current rate election. A taxpayer may elect to treat all assets and liabilities that are properly reflected on the books and records of a section 987 QBU under § 1.987–2(b) as marked items (a current rate election). See § 1.987–11(c) for rules suspending section 987 loss if a current rate election is in effect. (e) Historic item. A historic item is an asset (historic asset) or liability (historic PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 liability) that is properly reflected on the books and records of a section 987 QBU under § 1.987–2(b) and that is not a marked item. * * * * * (g) Elections. This paragraph (g) provides rules for making and revoking elections under the section 987 regulations (the section 987 elections). A section 987 election is made for the owner and for a taxable year and applies to every section 987 QBU owned by the owner while the election is in effect. Once made, a section 987 election remains in effect until revoked. (1) Persons making the election. A section 987 election is made or revoked by the authorized person. The authorized person is described in paragraph (g)(1)(i), (ii), (iii), or (iv) of this section. If there are multiple controlling domestic shareholders, references to ‘‘the authorized person’’ refer to all authorized persons. (i) United States persons. Except as provided in paragraph (g)(1)(iii) or (iv) of this section, if the owner of a section 987 QBU is a United States person, the election is made or revoked by the owner. (ii) CFCs and other foreign entities— (A) In general. Except as provided in paragraph (g)(1)(iv) of this section, if the owner of a section 987 QBU is a controlled foreign corporation or other foreign entity, the election is made or revoked by the controlling domestic shareholders of the controlled foreign corporation or other foreign entity. (B) Controlling domestic shareholders. For purposes of this paragraph (g), the controlling domestic shareholders of a controlled foreign corporation are determined under § 1.964–1(c)(5)(i) and the controlling domestic shareholders of a foreign entity other than a controlled foreign corporation are determined by applying the rules and principles of § 1.964–1(c)(5)(i) as if the foreign entity were a controlled foreign corporation and, if the entity is a trust or estate, the beneficial interests in the entity were stock. (iii) Consolidated groups. If the owner is a member of a consolidated group, see § 1.1502–77. (iv) Partnerships. If the owner of a section 987 QBU is a partnership, the election is made or revoked by the partnership. For a partnership that is not otherwise required to file a partnership return, see § 1.6031(a)– 1(b)(5) for elections that can only be made by a partnership under section 703. (2) Consistency rules—(i) Consolidated groups. A section 987 election is made or revoked by a E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules consolidated group and applies to all members of the group. Therefore, the same section 987 elections will be in effect for all members of a consolidated group at all times. If a corporation becomes a member of a consolidated group, it is deemed to make or revoke any section 987 election as necessary to be consistent with the consolidated group. If a corporation ceases to be a member of a consolidated group and does not join another group, its section 987 elections are unaffected by its departure from the group. (ii) United States shareholders, CFCs, foreign partnerships, foreign nongrantor trusts, and foreign estates. If the authorized person makes or revokes an election on behalf of any person (including the authorized person) described in paragraphs (g)(2)(ii)(A) through (D) of this section (the section 987 electing group), then the election must be made or revoked on behalf of all members of the section 987 electing group for the first taxable year of each entity that ends with or within the taxable year of the United States person described in paragraph (g)(2)(ii)(A) of this section in which the election or revocation became effective. If an entity that was not previously a member of the section 987 electing group becomes a member (for example, upon formation or acquisition), it is deemed to make or revoke any section 987 election as necessary to be consistent with the other members (without regard to the requirements of paragraph (g)(3)(ii) of this section). The following persons are described in this paragraph (g)(2)(ii): (A) A United States person (the relevant United States person). (B) Each controlled foreign corporation in which the relevant United States person owns (within the meaning of section 958(a)) more than fifty percent (by vote or value). (C) Each foreign partnership in which the relevant United States person owns (directly or indirectly) more than fifty percent of the capital and profits interest. (D) Each foreign non-grantor trust or estate in which the relevant United States person’s beneficial interests in the trust or estate exceed fifty percent. (iii) Section 381(a) transactions. If a corporation (acquiring corporation) acquires the assets of another corporation in a transaction described in section 381(a), the acquiring corporation’s election status applies to all section 987 QBUs owned by the acquiring corporation after the transaction. (3) Manner of making or revoking elections. The section 987 elections must be made in accordance with this VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 paragraph (g)(3), except as provided in forms and instructions or other guidance as provided by the Secretary. (i) Statement must be attached to a return. An authorized person that makes or revokes a section 987 election in accordance with this paragraph (g) must attach to its return the statement described in this paragraph (g)(3)(i). Each statement must include an identification of the election that is made or revoked; the name, address, and functional currency of each owner (or if the owner is a member of a consolidated group, the common parent of the consolidated group) for which the election is made or revoked; and the name, address, functional currency, and owner of each section 987 QBU owned by each owner. (A) Section 987 grouping election. The election provided in paragraph (b)(3)(ii) of this section is titled ‘‘Section 987 Grouping Election Under § 1.987– 1(b)(3)(ii)’’ and must provide the name, address, and functional currency of each section 987 QBU of each owner that is being grouped together. (B) Election to use a spot rate convention. An election under paragraph (c)(1)(ii) of this section to use a spot rate convention is titled ‘‘Section 987 Election to Use a Spot Rate Convention Under § 1.987–1(c)(1)(ii)’’ and must describe the convention. (C) [Reserved] (D) Election to use the historic inventory method. An election under § 1.987–3(c)(2)(iv)(B) to use the historic inventory method is titled ‘‘Section 987 Election to Use the Historic Inventory Method Under § 1.987–3(c)(2)(iv)(B).’’ * * * * * (G) Annual recognition election. An annual recognition election under § 1.987–5(b)(2) is titled ‘‘Section 987 Election for Annual Recognition Under § 1.987–5(b)(2).’’ (H) Current rate election. A current rate election under paragraph (d)(2) of this section is titled ‘‘Section 987 Election to Use Current Rates Under § 1.987–1(d)(2).’’ (I) [Reserved] (J) Elections related to the transition rules. The elections provided in § 1.987–10 are made by reporting the election on the statement described in § 1.987–10(k). (ii) Election requirements—(A) Consent required. Except as provided in paragraph (g)(3)(ii)(B) or (C) of this section, a section 987 election may not be made or revoked without the consent of the Commissioner. A copy of the consent must be attached to the statement described in paragraph (g)(3)(i) of this section. For purposes of PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 78165 this paragraph (g)(3)(ii), the Commissioner’s consent may be obtained only with a ruling or administrative pronouncement. See Revenue Procedure 2023–1, I.R.B. 2023– 1 (or superseding guidance). (B) Current rate election and annual recognition election. Except as provided in paragraph (g)(3)(ii)(C) of this section, the authorized person may make a current rate election or an annual recognition election without the Commissioner’s consent by filing the statement prescribed in paragraph (g)(3)(i) of this section with the Internal Revenue Service in accordance with the prescribed form or its instructions (or other guidance) on or before the first day of the taxable year to which the election applies, and attaching a copy of the statement to its return. Once made, a current rate election or annual recognition election may not be revoked without the Commissioner’s consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was made. Once revoked, a new current rate election or annual recognition election may not be made without the Commissioner’s consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was revoked. (C) First year to which the section 987 regulations apply. The authorized person may make a section 987 election without the consent of the Commissioner on its original, timely filed (including extensions) return for the first taxable year of the owner in which both— (1) The section 987 regulations apply (other than by applying solely to one or more terminating QBUs pursuant to § 1.987–14(a)(2)); and (2) Either the owner or any member of its consolidated group or section 987 electing group is the owner of a section 987 QBU. (iii) Elections made under the 2016 and 2019 section 987 regulations. Each section 987 election must be made by the authorized person under the rules of this section without regard to whether the election was in effect under the 2016 and 2019 final regulations or under prior § 1.987–8T. In the first taxable year in which the section 987 regulations apply, any elections made under the 2016 and 2019 final regulations cease to be effective. (4) No change in method of accounting. An election under section 987 is not governed by the general rules concerning changes in methods of accounting. (5) Principles of § 1.964–1(c)(3) applicable to section 987 elections. Except as otherwise provided in this E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78166 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules paragraph (g), if the authorized person makes or revokes a section 987 election on behalf of a controlled foreign corporation or other foreign entity, the authorized person must make or revoke the section 987 election in accordance with the rules and principles of § 1.964– 1(c)(3) (determined by treating the foreign entity as a foreign corporation if it is not one). (h) Definitions. The definitions in this paragraph (h) apply for purposes of the section 987 regulations. 1991 proposed regulations. The term 1991 proposed regulations means proposed sections 1.987–1 through 1.987–3 as contained in 56 FR 48457– 01 (September 25, 1991). 2006 proposed regulations. The term 2006 proposed regulations means: proposed sections 1.861– 9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985–5; 1.987–1 through 1.987–11; 1.988– 1(a)(3), (a)(4), (a)(10)(ii), and (i); 1.988– 4(b)(2); and 1.989(a)–1(b)(2)(i), and (b)(4) as contained in 71 FR 52876–01 (September 7, 2006). 2016 and 2019 section 987 regulations. The term 2016 and 2019 section 987 regulations means the following regulations: (i) Sections 1.861–9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985–5; 1.987–1 through 1.987–10; 1.988–1(a)(4), (a)(10)(ii), and (i); 1.988–4(b)(2); and 1.989(a)–1(b)(2)(i), (b)(4), (d)(3), and (d)(4), as contained in 26 CFR in part 1 in effect on April 1, 2017. (ii) Sections 1.987–2T(c)(9), 1.987– 4T(c)(2) and (f), and 1.987–7T, as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they were revoked on May 13, 2019). (iii) Sections 1.987–2(c)(9) and 1.987– 4(c)(2) and (f), as contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on May 13, 2019). (iv) Sections 1.987–1T (other than §§ 1.987–1T(g)(2)(i)(B) and (g)(3)(i)(H)), 1.987–3T, 1.987–6T, 1.988–1T, and 1.988–2T(i), as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they expired on December 6, 2019). Adjusted balance sheet. The term adjusted balance sheet means a tax basis balance sheet in the functional currency of the eligible QBU, determined by— (i) Preparing a balance sheet for the relevant date from the eligible QBU’s books and records (within the meaning of § 1.989(a)–1(d)) recorded in the eligible QBU’s functional currency and showing all assets and liabilities attributable to the eligible QBU as provided in § 1.987–2(b) (the preliminary balance sheet); and (ii) Making adjustments necessary to conform the items reflected on the VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 preliminary balance sheet to United States tax accounting principles. Annual recognition election. The term annual recognition election has the meaning provided in § 1.987–5(b)(2). Authorized person. The term authorized person has the meaning provided in paragraph (g)(1) of this section. Combination. The term combination has the meaning provided in § 1.987– 2(c)(9)(i). Combined QBU. The term combined QBU has the meaning provided in § 1.987–2(c)(9)(i). Combining QBU. The term combining QBU has the meaning provided in § 1.987–2(c)(9)(i). Consolidated group. The term consolidated group has the meaning provided in § 1.1502–1(h). Controlled group. A controlled group means all persons with the relationships to each other specified in sections 267(b) or 707(b). Controlled foreign corporation. The term controlled foreign corporation (or CFC) has the meaning provided in section 957. Cumulative suspended section 987 loss. The term cumulative suspended section 987 loss has the meaning provided in § 1.987–11(b). Current rate election. The term current rate election has the meaning provided in § 1.987–1(d)(2). Deferral event. The term deferral event has the meaning provided in § 1.987–12(g)(1). Deferred section 987 gain or loss. The term deferred section 987 gain or loss has the meaning provided in § 1.987– 12(b)(2). Disregarded entity. The term disregarded entity (or DE) means an entity disregarded as an entity separate from its owner for Federal income tax purposes, including an entity described in § 301.7701–2(c)(2), a qualified subchapter S subsidiary under section 1361(b)(3), a qualified REIT subsidiary within the meaning of section 856(i)(2), and a wholly-owned grantor trust. Disregarded transactions. The term disregarded transactions has the meaning provided in § 1.987–2(c)(2)(ii). ECI. The term ECI means income that is effectively connected with the conduct of a trade or business within the United States. Eligible pretransition method. The term eligible pretransition method has the meaning provided in § 1.987– 10(e)(4). Eligible QBU. The term eligible QBU has the meaning provided in paragraph (b)(4) of this section. Historic asset. The term historic asset has the meaning provided in paragraph (e) of this section. PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 Historic item. The term historic item has the meaning provided in paragraph (e) of this section. Historic liability. The term historic liability has the meaning provided in paragraph (e) of this section. Historic rate. The term historic rate has the meaning provided in paragraph (c)(3) of this section. Liability. The term liability means the amount of a liability on the adjusted balance sheet (or the amount that would be on the adjusted balance sheet if an adjusted balance sheet were prepared for that day). Loss-to-the-extent-of-gain rule. The term loss-to-the-extent-of-gain rule has the meaning provided in § 1.987– 11(e)(1). Marked asset. The term marked asset has the meaning provided in paragraph (d) of this section. Marked item. The term marked item has the meaning provided in paragraph (d) of this section. Marked liability. The term marked liability has the meaning provided in paragraph (d) of this section. Net accumulated unrecognized section 987 gain or loss. The term net accumulated unrecognized section 987 gain or loss has the meaning provided in § 1.987–4(c). Net unrecognized section 987 gain or loss. The term net unrecognized section 987 gain or loss has the meaning provided in § 1.987–4(b). Non-grantor trust. The term nongrantor trust means a trust (or the portion of a trust) that is not a grantor trust. A grantor trust is a trust with respect to which one or more persons are treated as owners of all or a portion of the trust under sections 671 through 679. If only a portion of a trust is treated as owned by a person, that portion is a grantor trust with respect to that person. Original deferral QBU. The term original deferral QBU has the meaning provided in § 1.987–12(b). Original deferral QBU owner. The term original deferral QBU owner has the meaning provided in § 1.987– 12(g)(3). Original suspended loss QBU owner. The term original suspended loss QBU owner has the meaning provided in § 1.987–13(l)(1). Outbound loss event. The term outbound loss event has the meaning provided in § 1.987–13(h)(2). Outbound loss QBU. The term outbound loss QBU has the meaning provided in § 1.987–13(h)(1). Outbound section 987 loss. The term outbound section 987 loss has the meaning provided in § 1.987–13(h)(4). Owner. The term owner has the meaning provided in paragraph (b)(5) of this section. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules Prior § 1.987–1. The term prior § 1.987–1 means § 1.987–1, as contained in 26 CFR in part 1 in effect on April 1, 2017. Prior § 1.987–4. The term prior § 1.987–4 means § 1.987–4, as contained in 26 CFR in part 1 in effect on April 1, 2017. Prior § 1.987–5. The term prior § 1.987–5 means § 1.987–5, as contained in 26 CFR in part 1 in effect on April 1, 2017. Prior § 1.987–8T. The term prior § 1.987–8T means § 1.987–8T, as contained in 26 CFR in part 1 in effect on April 1, 2017. Prior § 1.987–10. The term prior § 1.987–10 means § 1.987–10, as contained in 26 CFR in part 1 in effect on April 1, 2017. Prior § 1.987–12. The term prior § 1.987–12 means § 1.987–12, as contained in 26 CFR in part 1 in effect on April 1, 2020. Prior § 1.987–12T. The term prior § 1.987–12T means § 1.987–12T, as contained in 26 CFR in part 1 in effect on April 1, 2017. Recognition grouping. The term recognition grouping has the meaning provided in § 1.987–11(f). Remittance. The term remittance has the meaning provided in § 1.987–5(c). S corporation. The term S corporation has the meaning provided in section 1361(a)(1). Section 904 category. The term section 904 category means a separate category of income described in § 1.904– 5(a)(4)(v). Section 987 aggregate partnership—(i) In general. The term section 987 aggregate partnership means a partnership if both: (A) All of the interests in partnership capital and profits are owned, directly or indirectly, by persons related to each other within the meaning of sections 267(b) or 707(b). For this purpose, ownership of an interest in partnership capital or profits is determined in accordance with the rules for constructive ownership provided in section 267(c), other than section 267(c)(3). (B) The partnership has one or more eligible QBUs, at least one of which would be a section 987 QBU with respect to a partner if the partner owned the eligible QBU directly. (ii) Section 987 QBU of a partner. The assets and liabilities of an eligible QBU owned through a section 987 aggregate partnership and allocated to a partner under the principles of § 1.987–7B are considered to be a section 987 QBU of such partner if the partner has a functional currency different from that of the eligible QBU. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (iii) Certain unrelated partners disregarded. In determining whether a partnership is a section 987 aggregate partnership, the interest of an unrelated partner is disregarded if the acquisition of such interest has as a principal purpose the avoidance of treatment as a section 987 aggregate partnership. (iv) Cross-reference. See § 1.987– 7A(a)(2) for a rule providing that references to ‘‘partnerships’’ in the section 987 regulations are treated as references to partnerships that are not section 987 aggregate partnerships, except where the context otherwise requires. Section 987 electing group. The term section 987 electing group has the meaning provided in paragraph (g)(2)(ii) of this section. Section 987 elections. The term section 987 elections has the meaning provided in paragraph (g) of this section. Section 987 QBU. The term section 987 QBU has the meaning provided in paragraph (b)(3) of this section. Section 987 regulations. The term section 987 regulations has the meaning provided in paragraph (a) of this section. Section 987 taxable income or loss. The term section 987 taxable income or loss has the meaning provided in § 1.987–3(a). Separated QBU. The term separated QBU has the meaning provided in § 1.987–2(c)(9)(iii). Separation. The term separation has the meaning provided in § 1.987– 2(c)(9)(iii). Separation fraction. In the case of a separated QBU, the term separation fraction means a fraction, the numerator of which is the aggregate adjusted basis of the gross assets properly reflected on the books and records of the separated QBU immediately after the separation, and the denominator of which is the aggregate adjusted basis of the gross assets properly reflected on the books and records of all separated QBUs immediately after the separation. Separating QBU. The term separating QBU has the meaning provided in § 1.987–2(c)(9)(iii). Spot rate. The term spot rate has the meaning provided in paragraph (c)(1) of this section. Successor deferral QBU. The term successor deferral QBU has the meaning provided in § 1.987–12(g)(2). Successor deferral QBU owner. The term successor deferral QBU owner has the meaning provided in § 1.987– 12(c)(1). Successor suspended loss QBU. The term successor suspended loss QBU has PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 78167 the meaning provided in § 1.987– 13(l)(2). Successor suspended loss QBU owner. The term successor suspended loss QBU owner has the meaning provided in § 1.987–13(l)(3). Suspended section 987 loss. The term suspended section 987 loss means section 987 loss that is subject to the limitations on recognition described in § 1.987–11(e). See §§ 1.987–10(e)(5), 1.987–11(c) and (d), 1.987–12(c), and 1.987–13(h) for rules regarding when net unrecognized section 987 loss or deferred section 987 loss becomes suspended section 987 loss. Tentative tested income group. The term tentative tested income group has the meaning provided in § 1.987– 6(b)(2)(i)(D)(1). Terminating QBU. The term terminating QBU means a section 987 QBU, if both—(i) The section 987 QBU terminates on any date on or after November 9, 2023, or the section 987 QBU terminates as a result of an entity classification election made under § 301.7701–3 that is filed on or after November 9, 2023, and that is effective before November 9, 2023; and (ii) When the section 987 QBU terminates, neither the section 987 regulations nor the 2016 and 2019 section 987 regulations would apply with respect to the section 987 QBU but for § 1.987–14(a)(2). Termination. With respect to a section 987 QBU, the term termination has the meaning provided in § 1.987–8(b) and (c). With respect to a successor suspended loss QBU, the term termination has the meaning provided in § 1.987–13(j). Transfer. The term transfer has the meaning provided in § 1.987–2(c). Transition date. The term transition date has the meaning provided in § 1.987–10(b). United States person. The term United States person (or U.S. person) has the meaning provided in section 7701(a)(30). United States shareholder. The term United States shareholder (or U.S. shareholder) has the meaning provided in section 951(b) (or, if applicable, section 953(c)(1)(A)). Yearly average exchange rate. The term yearly average exchange rate has the meaning provided in paragraph (c)(2) of this section. ■ 7. Section 1.987–2 is revised to read as follows: § 1.987–2 Attribution of items to eligible QBUs; definition of a transfer and related rules. (a) Scope. This section provides rules regarding when items are attributed to E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78168 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules eligible QBUs and when they are treated as transferred to or from section 987 QBUs. Paragraph (b) of this section provides rules for attributing assets and liabilities, and items of income, gain, deduction, and loss, to an eligible QBU. Paragraph (c) of this section defines a transfer to or from a section 987 QBU. Paragraph (d) of this section provides translation rules for transfers to a section 987 QBU. Paragraph (e) of this section provides a cross-reference relating to the treatment of section 987 QBUs owned by consolidated groups. (b) Attribution of items to an eligible QBU—(1) General rules. Except as provided in paragraphs (b)(2) and (3) of this section, items are attributable to an eligible QBU to the extent they are reflected on the separate set of books and records, as defined in § 1.989(a)– 1(d)(1) and (2), of the eligible QBU. In the case of a section 987 aggregate partnership, items reflected on the books and records of the partnership and deemed allocated to an eligible QBU of such partnership are considered to be reflected on the books and records of such eligible QBU. For purposes of this section, the term item refers to any asset or liability, and any item of income, gain, deduction, or loss. Items that are attributed to an eligible QBU pursuant to this section must be adjusted to conform to Federal income tax principles. Except as provided in § 1.989(a)–1(d)(3), these attribution rules apply solely for purposes of section 987. For example, the allocation and apportionment of interest expense under section 864(e) is independent of these rules. (2) Exceptions for non-portfolio stock, interests in partnerships, and certain acquisition indebtedness. The following items are not considered to be on the books and records of an eligible QBU: (i) Stock of a corporation (whether domestic or foreign), other than stock of a corporation if the owner of the eligible QBU owns less than 10 percent of the total combined voting power of all classes of stock entitled to vote and less than 10 percent of the total value of all classes of stock of such corporation. For this purpose, section 958 (other than section 958(b)(1)) applies in determining ownership of a controlled foreign corporation and section 318(a) applies in determining ownership of other corporations, except that in applying section 318(a)(2)(C), the phrase ‘‘10 percent’’ is used instead of the phrase ‘‘50 percent.’’ (ii) An interest in a partnership (whether domestic or foreign). (iii) A liability that was incurred to acquire stock described in paragraph (b)(2)(i) of this section or that was VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 incurred to acquire a partnership interest described in paragraph (b)(2)(ii) of this section. (iv) Income, gain, deduction, or loss arising from the items described in paragraphs (b)(2)(i) through (iii) of this section. For example, if a dividend is received with respect to stock of a corporation described in paragraph (b)(2)(i) of this section, the dividend is excluded from the income of the eligible QBU. See also paragraph (c)(2)(ii) of this section, treating the payment as received by the owner and contributed to the eligible QBU. (3) Adjustments to items reflected on the books and records—(i) General rule. If a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU is the avoidance of Federal income tax under, or through the use of, section 987, the item must be allocated between or among the eligible QBU, the owner of such eligible QBU, and any other persons, entities (including DEs), or other QBUs within the meaning of § 1.989(a)–1(b) (including eligible QBUs) in a manner that reflects the substance of the transaction. For purposes of this paragraph (b)(3)(i), relevant factors for determining whether such Federal income tax avoidance is a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU include the factors set forth in paragraphs (b)(3)(ii) and (iii) of this section. The presence or absence of any factor or factors is not determinative. The weight given to any factor (whether or not set forth in paragraphs (b)(3)(ii) and (iii) of this section) depends on the facts and circumstances. (ii) Factors indicating no tax avoidance. For purposes of paragraph (b)(3)(i) of this section, factors that may indicate that recording (or not recording) an item on the books and records of an eligible QBU did not have as a principal purpose the avoidance of Federal income tax under, or through the use of, section 987 include the recording (or not recording) of an item: (A) For a significant and bona fide business purpose; (B) In a manner that is consistent with the economics of the underlying transaction; (C) In accordance with generally accepted accounting principles (or similar comprehensive accounting standard); (D) In a manner that is consistent with the treatment of similar items from year to year; (E) In accordance with accepted conditions or practices in the particular trade or business of the eligible QBU; PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 (F) In a manner that is consistent with an explanation of existing internal accounting policies that is evidenced by documentation contemporaneous with the timely filing of a return for the taxable year; and (G) As a result of a transaction between legal entities (for example, the transfer of an asset or the assumption of a liability), even if such transaction is not regarded for Federal income tax purposes (for example, a transaction between a DE and its owner). (iii) Factors indicating tax avoidance. For purposes of paragraph (b)(3)(i) of this section, factors that may indicate that a principal purpose of recording (or not recording) an item on the books and records of an eligible QBU is the avoidance of Federal income tax under, or through the use of, section 987 include: (A) The presence or absence of an item on the books and records that is the result of one or more transactions that are transitory, for example, due to a circular flow of cash or other property; (B) The presence or absence of an item on the books and records that is the result of one or more transactions that do not have substance; and (C) The presence or absence of an item on the books and records that results in the taxpayer (or a person related to the taxpayer within the meaning of section 267(b) or section 707(b)) having offsetting positions with respect to the functional currency of a section 987 QBU. (4) Assets and liabilities of a section 987 aggregate partnership or DE that are not attributed to an eligible QBU. Neither a section 987 aggregate partnership nor a DE is an eligible QBU and, thus, neither entity can be a section 987 QBU. See § 1.987–1(b)(4). As a result, a section 987 aggregate partnership or DE may have assets and liabilities that are not attributed to an eligible QBU as provided under this paragraph (b) and, therefore, are not subject to section 987. For the foreign currency treatment of such assets or liabilities, see § 1.988–1(a)(4). (5) Special types of basis. Any type of basis that does not affect the income or loss of the section 987 QBU is not considered to be on the books and records of the section 987 QBU. Thus, for example, section 743(b) basis is not considered to be on the books and records of the section 987 QBU. (c) Transfers to and from section 987 QBUs—(1) In general. The following rules apply for purposes of determining whether there is a transfer of an asset or a liability from an owner to a section 987 QBU, or from a section 987 QBU to E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules an owner. These rules apply solely for purposes of section 987. (2) Disregarded transactions—(i) General rule. An asset or liability is treated as transferred to a section 987 QBU from its owner if, as a result of a disregarded transaction, such asset or liability is reflected on the books and records of (or attributed to) the section 987 QBU within the meaning of paragraph (b) of this section. Similarly, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of a disregarded transaction, such asset or liability is no longer reflected on the books and records of (or attributed to) the section 987 QBU within the meaning of paragraph (b) of this section. (ii) Definition of a disregarded transaction. For purposes of this section, a disregarded transaction means a transaction that is not regarded for Federal income tax purposes (for example, any transaction between separate section 987 QBUs of the same owner). For purposes of this paragraph (c), a disregarded transaction is treated as including events described in paragraphs (c)(2)(ii)(A) through (E) of this section. (A) If the recording (or not recording) of an asset or liability on the books and records of a section 987 QBU of an owner is the result of such asset or liability being removed from (or included on) the books and records of the owner or another eligible QBU of the owner, the asset or liability is treated as transferred from (or to) the owner or other eligible QBU to (or from) the section 987 QBU in a disregarded transaction (including through a DE or a section 987 aggregate partnership). (B) If an asset or liability that was previously treated as being on the books and records of a section 987 QBU of an owner begins to be treated as being on the books and records of the owner or a separate eligible QBU of the owner as a result of the application of paragraph (b)(2) or (3) of this section, the asset or liability is treated as having been transferred from the section 987 QBU to the owner or separate eligible QBU in a disregarded transaction. If an asset or liability that was previously treated as being on the books and records of the owner or a separate eligible QBU of the same owner begins to be treated as being on the books and records of the section 987 QBU as a result of the application of paragraph (b)(2) or (3) of this section, the asset or liability is treated as transferred from the owner or separate eligible QBU to the section 987 QBU in a disregarded transaction. (C) If an asset or liability that is attributable to a section 987 QBU within VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 the meaning of paragraph (b) of this section is sold or exchanged (including in a nonrecognition transaction, such as an exchange under section 351) for an asset or liability that is not attributable to the section 987 QBU immediately after the sale or exchange, the sold or exchanged asset or liability that was attributable to the section 987 QBU immediately before the transaction is treated as transferred from the section 987 QBU to its owner in a disregarded transaction immediately before the sale or exchange for purposes of section 987 (including for purposes of recognizing section 987 gain or loss under § 1.987– 5) and subsequently sold or exchanged by the owner. (D) If an asset or liability of an owner of a section 987 QBU that is not attributable to a section 987 QBU within the meaning of paragraph (b) of this section is sold or exchanged (including in a nonrecognition transaction, such as an exchange under section 351) for an asset or liability that is attributable to the section 987 QBU immediately after the sale or exchange, the asset or liability that is attributable to the section 987 QBU immediately after the transaction is treated as received or assumed by the owner and transferred from the owner to the section 987 QBU in a disregarded transaction immediately after the sale or exchange for purposes of section 987 (including for purposes of recognizing section 987 gain or loss under § 1.987–5). (E) If an asset or liability that is properly attributable to a section 987 QBU was received, assumed, or accrued in a regarded transaction (including the making or receiving of a payment) in which the related item of income, gain, deduction, or loss is not attributable to the section 987 QBU, the asset or liability is treated as though it was received, assumed, or accrued by the owner or another eligible QBU and transferred to the section 987 QBU in a disregarded transaction. Similarly, if an asset or liability that is not properly attributable to a section 987 QBU was received, assumed, or accrued in a regarded transaction (including the making or receiving of a payment) in which the related item of income, gain, deduction, or loss is attributable to the section 987 QBU, the asset or liability is treated as though it was received, assumed, or accrued by the section 987 QBU and transferred to the owner or another eligible QBU in a disregarded transaction. For example, if a section 987 QBU receives a dividend on an interest in stock that would be attributable to the section 987 QBU but for paragraph (b)(2)(i) of this section, or pays interest on a liability that would be PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 78169 attributable to the section 987 QBU but for paragraph (b)(2)(iii) of this section, the owner would be treated as receiving the dividend and transferring to the section 987 QBU the amount of the dividend, or the section 987 QBU would be treated as transferring to the owner the amount of the interest expense and the owner would be treated as paying the interest expense. See also paragraph (c)(7) of this section (application of general tax law principles). (iii) Items derived from disregarded transactions ignored. For purposes of section 987, disregarded transactions do not give rise to items of income, gain, deduction, or loss that are taken into account in determining section 987 taxable income or loss under § 1.987–3. (3) Transfers of assets to and from section 987 QBUs owned through section 987 aggregate partnerships—(i) Contributions to section 987 aggregate partnerships. Solely for purposes of section 987, an asset is treated as transferred by an indirect owner to a section 987 QBU of a partner to the extent the indirect owner contributes the asset to the section 987 aggregate partnership that carries on the activities of the section 987 QBU, provided that, immediately before the contribution, the asset is not reflected on the books and records of the section 987 QBU within the meaning of paragraph (b) of this section and the asset is reflected on the books and records of the section 987 QBU immediately after the contribution. For purposes of this paragraph (c)(3)(i), deemed contributions of money described under section 752 are disregarded. See paragraph (c)(4)(ii) of this section for rules governing the assumption by a partner of liabilities of a section 987 aggregate partnership. (ii) Distributions from section 987 aggregate partnerships. Solely for purposes of section 987, an asset is treated as transferred from a section 987 QBU of a partner to its indirect owner to the extent the section 987 aggregate partnership that carries on the activities of the section 987 QBU distributes the asset to the indirect owner, provided that, immediately before the distribution, the asset is reflected on the books and records of the section 987 QBU within the meaning of paragraph (b) of this section, and the asset is not reflected on the books and records of the section 987 QBU immediately after the distribution. For purposes of this paragraph (c)(3)(ii), deemed distributions of money described under section 752 are disregarded. See paragraph (c)(4)(i) of this section for rules governing the assumption by a section 987 aggregate partnership of liabilities of a partner. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78170 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (4) Transfers of liabilities to and from section 987 QBUs owned through section 987 aggregate partnerships—(i) Assumptions of partner liabilities. Solely for purposes of section 987, a liability of the owner of a section 987 aggregate partnership is treated as transferred to a section 987 QBU of a partner if, and to the extent, the section 987 aggregate partnership assumes the liability, provided that, immediately before the transfer, the liability is not reflected on the books and records of the section 987 QBU within the meaning of paragraph (b) of this section, and the liability is reflected on the books and records of the section 987 QBU immediately after the transfer. (ii) Assumptions of section 987 aggregate partnership liabilities. Solely for purposes of section 987, a liability of a section 987 aggregate partnership is treated as transferred from a section 987 QBU of a partner to its indirect owner if, and to the extent, the indirect owner assumes the liability of the section 987 aggregate partnership, provided that, immediately before the assumption, the liability is reflected on the books and records of the section 987 QBU within the meaning of paragraph (b) of this section, and the liability is not reflected on the books and records of the section 987 QBU immediately after the transfer. (5) Acquisitions and dispositions of interests in DEs and section 987 aggregate partnerships. Solely for purposes of section 987, an asset or liability is treated as transferred to a section 987 QBU from its owner if, as a result of an acquisition (including by contribution) or disposition of an interest in a section 987 aggregate partnership or DE, the asset or liability is reflected on the books and records of the section 987 QBU. Similarly, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of an acquisition or disposition of an interest in a section 987 aggregate partnership or DE, the asset or liability is not reflected on the books and records of the section 987 QBU. See paragraph (c)(10)(xviii) of this section (Example 18) for an illustration of this rule. (6) Changes in form of ownership treated as terminations. See §§ 1.987– 8(b)(6) (treating a change in the form of ownership of an eligible QBU from direct ownership to indirect ownership or from indirect ownership to direct ownership as a termination) and 1.987– 12(g)(1)(i)(A) (subjecting the termination to the deferral rules). (7) Application of general tax law principles. General tax law principles, including the circular cash flow, steptransaction, economic substance, and substance-over-form doctrines, apply for VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 purposes of determining whether there is a transfer of an asset or liability under this paragraph (c), including a transfer of an asset or liability pursuant to a disregarded transaction. (8) Interaction with § 1.988–1(a)(10). See § 1.988–1(a)(10) for rules regarding the treatment of an intra-taxpayer transfer of a section 988 transaction. (9) Certain disregarded transactions not treated as transfers—(i) Combinations of section 987 QBUs. The combination (a combination) of two or more separate section 987 QBUs (combining QBUs) that are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, into one section 987 QBU (combined QBU) does not give rise to a transfer of any combining QBU’s assets or liabilities to the owner under § 1.987– 2(c). In addition, transactions between the combining QBUs occurring in the taxable year of the combination do not result in a transfer of the combining QBUs’ assets or liabilities to the owner under § 1.987–2(c). For this purpose, a combination occurs when the assets and liabilities that are properly reflected on the books and records of two or more combining QBUs begin to be properly reflected on the books and records of a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which the combining QBUs become a combined QBU. A combination may also result when an owner of two or more section 987 QBUs with the same functional currency becomes subject to a grouping election under § 1.987– 1(b)(3)(ii) or when a section 987 QBU of an owner subject to a grouping election changes its functional currency to that of another section 987 QBU of the same owner. For purposes of determining net unrecognized section 987 gain or loss, deferred section 987 gain or loss, and cumulative suspended section 987 loss of a combined QBU, the combining QBUs are treated as having combined immediately before the beginning of the taxable year of combination. See §§ 1.987–4(f)(1), 1.987–11(b)(2), and 1.987–12(f)(1). (ii) Change in functional currency from a combination. If, following a combination of section 987 QBUs described in paragraph (c)(9)(i) of this section, the combined section 987 QBU has a different functional currency than one or more of the combining section 987 QBUs, any such combining section 987 QBU is treated as changing its functional currency and the owner of the combined section 987 QBU must comply with the regulations under PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 section 985 regarding the change in functional currency. See §§ 1.985– 1(c)(6) and 1.985–5. (iii) Separation of section 987 QBUs. The separation (a separation) of a section 987 QBU (separating QBU) into two or more section 987 QBUs (separated QBUs) that, after the separation, are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, does not result in a transfer of the separating QBU’s assets or liabilities to the owner under § 1.987–2(c). Additionally, transactions that occurred between the separating QBUs in the taxable year of the separation before the completion of the separation do not result in transfers for purposes of section 987. For this purpose, a separation occurs when the assets and liabilities that are properly reflected on the books and records of a separating QBU begin to be properly reflected on the books and records of two or more separated QBUs and each of the separated QBUs continues to perform a significant portion of the separating QBU’s activities immediately after the separation. A separation may result from any transaction or series of transactions in which a separating QBU becomes two or more separated QBUs described in the preceding sentence. A separation may also result when a section 987 QBU that is subject to a grouping election under § 1.987– 1(b)(3)(ii) changes its functional currency or when the grouping election is revoked. For purposes of determining net unrecognized section 987 gain or loss, deferred section 987 gain or loss, or cumulative suspended section 987 loss of a separated QBU, the separating QBU is treated as having separated immediately before the beginning of the taxable year of separation. See §§ 1.987– 4(f)(2), 1.987–11(b)(3), and 1.987– 12(f)(2). (iv) Special rules for successor suspended loss QBUs. For purposes of determining whether a combination or separation has occurred with respect to a successor suspended loss QBU, the rules of paragraphs (c)(9)(i) and (iii) of this section are applied without regard to whether any of the combining QBUs, the combined QBU, the separating QBU, or the separated QBUs are section 987 QBUs. A combined QBU is a successor suspended loss QBU if either combining QBU was a successor suspended loss QBU, and a separated QBU is a successor suspended loss QBU if the separating QBU was a successor suspended loss QBU. (10) Examples. The following examples illustrate the principles of this E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules paragraph (c). For purposes of the examples, X and Y are domestic corporations, have the U.S. dollar as their functional currencies, and use the calendar year as their taxable years. Furthermore, except as otherwise provided, Business A and Business B are eligible QBUs that have the euro and the Japanese yen, respectively, as their functional currencies, and DE1 and DE2 are DEs. For purposes of determining whether any of the transfers in these examples result in remittances, see § 1.987–5. (i) Example 1. Transfer to a directly owned section 987 QBU—(A) Facts. X owns all of the interests in DE1. DE1 owns Business A, which is a section 987 QBU of X. X owns Ö100 that are not reflected on the books and records of Business A. Business A is in need of additional capital and, as a result, X lends the Ö100 to DE1 for use in Business A in exchange for a note. (B) Analysis—(1) The loan from X to DE1 is not regarded for Federal income tax purposes (because it is an interbranch transaction) and therefore is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Because DE1 is a DE, the DE1 note held by X and the liability of DE1 under the note are not taken into account under this section. (2) As a result of the disregarded transaction, the Ö100 is reflected on the books and records of Business A. Therefore, X is treated as transferring Ö100 to its Business A section 987 QBU for purposes of section 987. This transfer is taken into account in determining the amount of any remittance for the taxable year under § 1.987–5(c). See § 1.988–1(a)(10)(ii) for the application of section 988 to X as a result of the transfer of nonfunctional currency to its section 987 QBU. (ii) Example 2. Transfer to a directly owned section 987 QBU—(A) Facts. X owns Business A and Business B, both of which are section 987 QBUs of X. X owns equipment that is used in Business A and is reflected on the books and records of Business A. Because Business A has excess manufacturing capacity and X intends to expand the manufacturing capacity of Business B, the equipment formerly used in Business A is transferred to Business B for use by Business B. As a result of the transfer, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B. (B) Analysis. The transfer of the equipment from the books and records of Business A to the books and records of Business B is not regarded for Federal income tax purposes (because it is an VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 interbranch transaction) and therefore is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Therefore, for purposes of section 987, the Business A section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring the equipment to the Business B section 987 QBU. These transfers are taken into account in determining the amount of any remittance for the taxable year under § 1.987–5(c). (iii) Example 3. Intracompany sale of property between two section 987 QBUs— (A) Facts. X owns all of the interests in DE1 and DE2. DE1 and DE2 own Business A and Business B, respectively, both of which are section 987 QBUs of X. DE1 owns equipment that is used in Business A and is reflected on the books and records of Business A. For business reasons, DE1 sells a portion of the equipment used in Business A to DE2 in exchange for a fair market value amount of Japanese yen. The yen used by DE2 to acquire the equipment was generated by Business B and was reflected on Business B’s books and records. Following the sale, the yen and the equipment will be used in Business A and Business B, respectively. As a result of such sale, the equipment is removed from the books and records of Business A and is recorded on the books and records of Business B. Similarly, as a result of the sale, the yen is removed from the books and records of Business B and is recorded on the books and records of Business A. (B) Analysis—(1) The sale of equipment between DE1 and DE2 is a transaction that is not regarded for Federal income tax purposes (because it is an interbranch transaction) and therefore the transaction is a disregarded transaction (as defined in paragraph (c)(2)(ii) of this section). Pursuant to paragraph (c)(2)(iii) of this section, the sale does not give rise to an item of income, gain, deduction, or loss for purposes of determining section 987 taxable income or loss under § 1.987–3. However, the yen and equipment exchanged by DE1 and DE2 in connection with the sale must be taken into account as a transfer under paragraph (c)(2)(i) of this section. (2) As a result of the disregarded transaction, the equipment ceases to be reflected on the books and records of Business A and becomes reflected on the books and records of Business B. Therefore, the Business A section 987 QBU is treated as transferring the equipment to X, and X is subsequently treated as transferring the equipment to the Business B section 987 QBU. PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 78171 (3) Additionally, as a result of the disregarded transaction, the yen currency ceases to be reflected on the books and records of Business B and becomes reflected on the books and records of Business A. Therefore, the Business B section 987 QBU is treated as transferring the yen to X, and X is subsequently treated as transferring the yen from X to the Business A section 987 QBU. The transfers among Business A, Business B and X are taken into account in determining the amount of any remittance for the taxable year under § 1.987–5(c). (iv) through (ix) [Reserved] (x) Example 10. Contribution of assets to a corporation—(A) Facts. X owns Business A. X forms Z, a domestic corporation, contributing 50 percent of its Business A assets and liabilities to Z in exchange for all of the stock of Z. X and Z do not file a consolidated tax return. (B) Analysis. Pursuant to paragraph (b)(2) of this section, the Z stock received in exchange for 50 percent of Business A’s assets and liabilities is not reflected on the books and records of, and therefore is not attributable to, Business A for purposes of section 987 immediately after the exchange. As a result, pursuant to paragraphs (c)(2)(i) and (ii) of this section, 50 percent of the assets and liabilities of Business A are treated as transferred from Business A to X in a disregarded transaction immediately before the exchange. See § 1.1502–13(j)(9) if X and Z file a consolidated return. (xi) Example 11. Circular transfers— (A) Facts. X owns Business A. On December 30, year 1, Business A purports to transfer Ö100 to X. On January 2, year 2, X purports to transfer Ö50 to Business A. On January 4, year 2, X purports to transfer another Ö50 to Business A. As of the end of year 1, X has an unrecognized section 987 loss with respect to Business A, such that a remittance, if respected, would result in recognition of a foreign currency loss under section 987. (B) Analysis. Because the transfer by Business A to X is offset by the transfers from X to Business A that occurred in close temporal proximity, the Internal Revenue Service may disregard the purported transfers to and from Business A for purposes of section 987 pursuant to general tax principles under paragraph (c)(7) of this section. (xii) Example 12. Transfers without substance—(A) Facts. X owns Business A and Business B. On January 1, year 1, Business A purports to transfer Ö100 to X. On January 4, year 1, X purports to transfer Ö100 to Business B. The account in which Business B deposited E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78172 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules the Ö100 is used to pay the operating expenses and other costs of Business A. As of the end of year 1, X has an unrecognized section 987 loss with respect to Business A, such that a remittance, if respected, would result in recognition of a foreign currency loss under section 987. (B) Analysis. Because Business A continues to have use of the transferred property, the IRS may disregard the Ö100 purported transfer from Business A to X for purposes of section 987 pursuant to general tax principles under paragraph (c)(7) of this section. (xiii) Example 13. Offsetting positions in section 987 QBUs—(A) Facts. X owns Business A and Business B. Business A and Business B each have the euro as its functional currency. X has not made a grouping election under § 1.987– 1(b)(3)(ii). On January 1, year 1, X borrows Ö1,000 from a third-party lender, records the liability with respect to the borrowing on the books and records of Business A, and records the borrowed Ö1,000 on the books and records of Business B. On December 31, year 2, when Business A has $100 of net unrecognized section 987 loss and Business B has $100 of net unrecognized section 987 gain resulting from the change in exchange rates with respect to the liability and the Ö1,000, X terminates the Business A section 987 QBU. (B) Analysis. Because Business A and Business B have offsetting positions in the euro, the IRS will scrutinize the transaction under paragraph (b)(3) of this section to determine if a principal purpose of recording the eurodenominated liability on the books and records of Business A and the borrowed euros on the books and records of Business B was the avoidance of tax under section 987. If such a principal purpose is present, the items must be reallocated (that is, the euros and the euro-denominated liability) between Business A, Business B, and X, under paragraph (b)(3) of this section to reflect the substance of the transaction. (xiv) Example 14. Offsetting positions with respect to a section 987 QBU and a section 988 transaction—(A) Facts. X owns all of the interests in DE1, and DE1 owns Business A. On January 1, year 1, X borrows Ö1,000 from a thirdparty lender and records the liability with respect to the borrowing on its books and records. X contributes the Ö1,000 loan proceeds to DE1 and the Ö1,000 are reflected on the books and records of Business A. On December 31, year 2, when Business A has $100 of net unrecognized section 987 loss resulting from the change in exchange rates with respect to the Ö1,000 received from the VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 borrowing, and when the eurodenominated borrowing, if repaid, would result in $100 of gain under section 988, X terminates the Business A section 987 QBU. (B) Analysis. Because X and Business A have offsetting positions in the euro, the IRS will scrutinize the transaction under paragraph (b)(3) of this section to determine whether a principal purpose of recording the borrowed euros on the books and records of Business A, or not recording the corresponding eurodenominated liability on the books and records of Business A, was the avoidance of tax under section 987. If such a principal purpose is present, the items (that is, the euros and the eurodenominated liability) must be reallocated between Business A and X under paragraph (b)(3) of this section to reflect the substance of the transaction. (xv) Example 15. Offsetting positions with respect to a section 987 QBU and a section 988 transaction—(A) Facts. X owns all of the stock of Y and all of the interests in DE1. DE1 owns Business A. X and Y do not file a consolidated return. On January 1, year 1, DE1 lends Ö1,000 to Y. X records the receivable with respect to the loan on Business A’s books and records. On December 31, year 2, when Business A has $100 of net unrecognized section 987 gain resulting from the loan, Y repays the Ö1,000 liability. The repayment of the eurodenominated borrowing results in $100 of loss to Y under section 988. X claims a $100 loss on its consolidated return under section 988. Business A does not make any remittances to X in year 2, so the offsetting gain with respect to the loan receivable has not been recognized by X. (B) Analysis. Y, a related party to X, and Business A have offsetting positions in the euro. The IRS will scrutinize the transaction under paragraph (b)(3) of this section to determine whether a principal purpose of recording the eurodenominated receivable on the books and records of Business A, rather than on the books and records of X, was to avoid Federal income tax under, or through the use of, section 987. If such a principal purpose is present, the eurodenominated receivable must be reallocated between Business A and X under paragraph (b)(3) of this section to reflect the substance of the transaction. Other provisions may also apply to defer or disallow the loss. See e.g., § 1.1502–13(j)(9) if X and Y file a consolidated return. (xvi) Example 16. Loan by section 987 QBU followed by immediate distribution to owner—(A) Facts. X owns all of the interests in DE1. DE1 owns Business A. On January 1, year 1, Business A PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 borrows Ö1,000 from a bank. On January 2, year 1, Business A distributes the Ö1,000 it received from the bank to X. There are no other transfers between X and Business A during the year. At the end of the year, X has net unrecognized section 987 loss with respect to Business A such that a remittance would result in the recognition of foreign currency loss under section 987. (B) Analysis. Because the proceeds from the loan to Business A are immediately transferred to X and the distribution from Business A to X could result in the recognition of section 987 loss, the IRS will scrutinize the transaction under paragraph (b)(3) of this section to determine whether a principal purpose of recording of the loan on the books and records of Business A, rather than on the books and records of X, was to avoid Federal income tax under, or through the use of, section 987. If such a principal purpose is present, the items must be reallocated to reflect the substance of the transaction, potentially including by moving the loan onto the books of X, resulting in the transfer not being taken into account for purposes of section 987 under paragraph (b)(3) of this section. (xvii) Example 17. Payment of interest by section 987 QBU on obligation of owner—(A) Facts. X owns all of the interests in DE1. DE1 owns Business A. On January 1, X borrows Ö1,000 from a bank. On July 1, DE1 pays Ö20 in interest on X’s Ö1,000 obligation to the bank, which is treated as a payment by Business A. (B) Analysis. Under general tax law principles as provided in paragraph (c)(7) of this section, on July 1, year 1, Business A is treated for purposes of section 987 as making a transfer of Ö20 to X, and X is treated as making a Ö20 interest payment to the bank. See also paragraph (c)(2)(ii)(E) for interest payments on loans that are not attributable to a section 987 QBU pursuant to paragraph (b)(2) or (3) of this section. (xviii) Example 18. Sale of the interests in a DE—(A) Facts. X owns all of the interests in DE1, a disregarded entity. DE1 owns Business A, which is a section 987 QBU of X. X has made a current rate election under § 1.987– 1(d)(2) but not an annual recognition election under § 1.987–5(b)(2). On December 31, year 1, X sells all of the interests in DE1 to FC, an unrelated foreign corporation, for $150,000, when the exchange rate is Ö1=$1.2. At the time of the sale, all of DE1’s assets are used in Business A and are reflected on the books and records of Business A. The assets have a basis of Ö100,000 and Business A has no liabilities. In year 1, E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules X has net unrecognized section 987 gain with respect to Business A of $20,000. (B) Analysis—(1) Under paragraph (c)(5) of this section, solely for purposes of section 987, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of a disposition of an interest in a DE, the asset or liability is not reflected on the books and records of the section 987 QBU. As a result of the sale of DE1, the assets of Business A are no longer reflected on the books and records of the Business A section 987 QBU. Therefore, the assets of Business A are treated as transferred from the Business A section 987 QBU to X in connection with the sale of X’s interests in DE1. (2) The transfer of all of Business A’s assets to X under paragraph (c)(5) of this section results in a termination of the Business A section 987 QBU under § 1.987–8(b)(2) (substantially all assets transferred). Under § 1.987–5(c)(3) and § 1.987–8(e), a termination of a section 987 QBU is treated as a remittance of all the gross assets of the section 987 QBU to the owner on the date of the termination. Therefore, the owner’s remittance proportion is one, and X recognizes all of its net unrecognized section 987 gain with respect to Business A, or $20,000. (3) Because a current rate election was in effect, all of the assets of Business A are marked items. Therefore, under § 1.987–5(f)(2), X’s basis in the assets transferred from Business A is determined by translating Business A’s functional currency basis in the assets into X’s functional currency at the spot rate applicable to the date of the transfer, Ö1=$1.2. Consequently, immediately before the sale of the interests in DE1, X’s functional currency basis in Business A’s assets (which Business A held with a basis of Ö100,000) is $120,000. X recognizes $30,000 of gain under section 1001(a) on the sale of DE1. (d) Translation of items transferred to a section 987 QBU—(1) Marked items. The adjusted basis of a marked asset, or the amount of a marked liability, transferred to a section 987 QBU is translated into the section 987 QBU’s functional currency at the spot rate applicable to the date of transfer. If, and to the extent that, exchange gain or loss is recognized on the asset or liability transferred under § 1.988–1(a)(10)(ii), the adjusted basis of the marked asset, or the amount of the marked liability, is adjusted to take into account the exchange gain or loss recognized. (2) Historic items. The adjusted basis of a historic asset, or the amount of a historic liability, transferred to a section 987 QBU is translated into the section VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 987 QBU’s functional currency at the rate provided in § 1.987–1(c)(3). If, and to the extent that, exchange gain or loss is recognized on the asset or liability transferred under § 1.988–1(a)(10)(ii), the adjusted basis of the historic asset, or the amount of the historic liability, is adjusted to take into account the exchange gain or loss recognized. (e) Cross-reference. See also § 1.1502– 13(j)(9) regarding the treatment of intercompany transactions involving section 987 QBUs owned by a member of a consolidated group. ■ 8. Section 1.987–3, as proposed to be amended by 81 FR 88882 (December 8, 2016), is further amended by: ■ a. Revising paragraphs (a), (b)(1), (b)(2)(i), (b)(3) and (c)(1); ■ b. Adding paragraph (c)(2) introductory text. ■ c. Revising paragraphs (c)(2)(i), (c)(2)(iii) and (iv), (c)(3), (d) and (e). The revisions and addition read as follows: § 1.987–3 Determination of section 987 taxable income or loss of an owner of a section 987 QBU. (a) In general. This section provides rules for determining the taxable income or loss of an owner of a section 987 QBU (section 987 taxable income or loss). Paragraph (b) of this section provides rules for determining items of income, gain, deduction, and loss, which generally are determined in the section 987 QBU’s functional currency. Paragraph (c) of this section provides rules for translating each item determined under paragraph (b) of this section into the functional currency of the owner of the section 987 QBU, if necessary. Paragraph (d) of this section is reserved. Paragraph (e) of this section provides examples illustrating the application of the rules of this section. (b) * * * (1) In general. Except as otherwise provided in this paragraph (b), a section 987 QBU must determine each item of income, gain, deduction, or loss of such section 987 QBU in its functional currency under Federal income tax principles. (2) * * * (i) In general. Except as otherwise provided in paragraphs (b)(2)(ii) and (b)(4) of this section, an item of income, gain, deduction, or loss (or the item’s components and related items, such as gross receipts and amount realized) that is denominated in (or determined by reference to) a nonfunctional currency (including the functional currency of the owner) is translated into the section 987 QBU’s functional currency at the spot rate on the date such item is properly taken into account, subject to PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 78173 the limitation under § 1.987– 1(c)(1)(ii)(B) regarding the use of a spot rate convention. Paragraphs (e)(1) and (2) of this section (Examples 1 and 2) illustrate the application of this paragraph (b)(2)(i). * * * * * (3) Determination in the case of a section 987 QBU owned through a section 987 aggregate partnership—(i) In general. Except as otherwise provided in this paragraph (b)(3), the taxable income or loss of a section 987 aggregate partnership, and the distributive share of any owner that is a partner in such partnership, are determined in accordance with the provisions of subchapter K of the Internal Revenue Code. (ii) Determination of each item of income, gain, deduction, or loss in the eligible QBU’s functional currency. A section 987 aggregate partnership generally must determine each item of income, gain, deduction, or loss reflected on the books and records of each of its eligible QBUs under § 1.987– 2(b) in the functional currency of each such QBU. (iii) Allocation of items of income, gain, deduction, or loss of an eligible QBU. A section 987 aggregate partnership must allocate the items of income, gain, deduction, or loss of each eligible QBU among its partners in accordance with each partner’s distributive share of such income, gain, deduction, or loss as determined under subchapter K of the Internal Revenue Code. (iv) Translation of items into the owner’s functional currency. To the extent the items referred to in paragraph (b)(3)(iii) of this section are allocated to a partner, the partner must adjust the items to conform to Federal income tax principles and translate the items into the partner’s functional currency, if necessary, as provided in paragraph (c) of this section. * * * * * (c) * * * (1) In general. Except as otherwise provided in this section, the exchange rate to be used by an owner in translating an item of income, gain, deduction, or loss attributable to a section 987 QBU (or the item’s components and related items, such as gross receipts, amount realized, basis, and cost of goods sold) into the owner’s functional currency, if necessary, is the yearly average exchange rate for the taxable year. (2) Exceptions. This paragraph (c)(2) applies to taxable years for which neither the annual recognition election nor the current rate election is in effect. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78174 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (i) Recovery of basis with respect to historic assets. Except as otherwise provided in this paragraph (c)(2), the exchange rate to be used by the owner in translating any recovery of basis (whether through a sale or exchange; deemed sale or exchange; cost recovery deduction such as depreciation, depletion or amortization; or otherwise) with respect to a historic asset is the historic rate for the property to which such recovery of basis is attributable. * * * * * (iii) [Reserved] (iv) Cost of goods sold computation— (A) General rule—simplified inventory method. Except as otherwise provided in paragraph (c)(2)(iv)(B) of this section, cost of goods sold (COGS) for a taxable year is translated into the functional currency of the owner at the yearly average exchange rate for the taxable year in which the sale occurred (or the COGS was otherwise taken into account in computing taxable income) and adjusted as provided in paragraph (c)(3) of this section. (B) Election to use the historic inventory method. In lieu of using the simplified inventory method described in paragraph (c)(2)(iv)(A) of this section, the owner of a section 987 QBU may elect under this paragraph (c)(2)(iv)(B) to translate inventoriable costs (including current-year inventoriable costs and costs that were capitalized into inventory in prior years) that are included in COGS at the historic rate for each such cost. * * * * * (3) Adjustments to COGS required under the simplified inventory method. This paragraph (c)(3) applies to taxable years for which neither the annual recognition election nor the current rate election is in effect. (i) In general. An owner of a section 987 QBU that uses the simplified inventory method described in paragraph (c)(2)(iv)(A) of this section must make the adjustment described in paragraph (c)(3)(ii) of this section. In addition, the owner must make the adjustment described in paragraph (c)(3)(iii) of this section with respect to any inventory for which the section 987 QBU does not use the LIFO inventory method (as described in section 472) and must make the adjustment described in paragraph (c)(3)(iv) of this section with respect to any inventory for which the section 987 QBU uses the LIFO inventory method. An owner of a section 987 QBU that uses the simplified inventory method must make all of the applicable adjustments described in paragraphs (c)(3)(ii) through (iv) of this section with respect VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 to the section 987 QBU even in taxable years in which the amount of COGS is zero. (ii) Adjustment for cost recovery deductions included in inventoriable costs. The translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) to reflect the difference between the historic rates appropriate for translating cost recovery deductions attributable to other historic assets and the exchange rate used to translate COGS under paragraph (c)(2)(iv)(A) of this section, to the extent any such cost recovery deductions are included in inventoriable costs for the taxable year. The adjustment is included as an adjustment to translated COGS computed under paragraph (c)(2)(iv)(A) of this section in full in the year to which the adjustment relates and is not allocated between COGS and ending inventory. The adjustment for each cost recovery deduction is computed as the product of: (A) The cost recovery deduction, expressed in the functional currency of the section 987 QBU; and (B) The exchange rate specified in paragraph (c)(2)(i) of this section for translating the cost recovery deduction (that is, the historic rate for the property to which such deduction is attributable) less the exchange rate used to translate COGS under the simplified inventory method described in paragraph (c)(2)(iv)(A) of this section (that is, the yearly average exchange rate for the taxable year). (iii) Adjustment to beginning inventory for non-LIFO inventory. In the case of inventory with respect to which a section 987 QBU does not use the LIFO inventory method (non-LIFO inventory), the translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) by the product of: (A) The ending non-LIFO inventory included on the closing balance sheet for the preceding year, expressed in the functional currency of the section 987 QBU; and (B) The exchange rate described in §§ 1.987–4(e)(2)(ii) and 1.987– 1(c)(3)(i)(B) that is used for translating ending inventory on the closing balance sheet for the preceding year (which is generally the yearly average exchange rate for the preceding year) less the exchange rate used to translate COGS under paragraph (c)(2)(iv)(A) of this section (that is, the yearly average exchange rate for the taxable year). For purposes of this paragraph (c)(3)(iii)(B), in the first taxable year in which a current rate election is revoked or otherwise ceases to be in effect, the PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 exchange rate that is used for translating ending inventory on the closing balance sheet for the preceding year is deemed to be equal to the spot rate applicable to the last day of the preceding taxable year. (iv) Adjustment for year of LIFO liquidation. In the case of inventory with respect to which a section 987 QBU uses the LIFO inventory method, for each LIFO layer liquidated in whole or in part during the taxable year, the translated COGS amount computed under paragraph (c)(2)(iv)(A) of this section is increased or decreased (as appropriate) by the product of: (A) The amount of the LIFO layer liquidated during the taxable year, expressed in the functional currency of the section 987 QBU; and (B) The exchange rate described in §§ 1.987–4(e)(2)(ii) and 1.987– 1(c)(3)(i)(B) or (F) that is used for translating such LIFO layer (which is generally the yearly average exchange rate for the year such LIFO layer arose) less the exchange rate used to translate COGS under paragraph (c)(2)(iv)(A) of this section (that is, the yearly average exchange rate for the taxable year). (d) [Reserved] (e) Examples. The following examples illustrate the application of this section. For purposes of the examples, U.S. Corp is a domestic corporation that uses the calendar year as its taxable year and has the U.S. dollar as its functional currency. Except as otherwise indicated, U.S. Corp is the owner of Business A, a section 987 QBU with the euro as its functional currency, and elects under paragraph (c)(2)(iv)(B) of this section to use the historic inventory method with respect to Business A but does not make any other elections under section 987. Exchange rates used in these examples are selected for the purpose of illustrating the principles of this section. No inference (for example, whether a currency is hyperinflationary or not) is intended by their use. (1) Example 1. Business A accrues £100 of income from the provision of services. Under paragraph (b)(2)(i) of this section, the £100 is translated into Ö90 at the spot rate on the date of accrual, without the use of a spot rate convention. In determining U.S. Corp’s taxable income, the Ö90 of income is translated into dollars at the rate provided in paragraph (c)(1) of this section. (2) Example 2. Business A sells a historic asset consisting of noninventory property for £100. Under paragraph (b)(2)(i) of this section, the £100 amount realized is translated into Ö85 at the spot rate on the sale date without the use of a spot rate E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules convention. In determining U.S. Corp’s taxable income, the Ö85 is translated into dollars at the rate provided in paragraph (c)(1) of this section. The euro basis of the property is translated into dollars at the rate provided in paragraph (c)(2)(i) of this section (that is, the historic rate). (3) Example 3—(i) Facts. Business A uses a first-in, first-out (FIFO) method of accounting for inventory. Business A sells 1,200 units of inventory in year 2 for Ö3 per unit. Business A’s gross sales are translated under paragraph (c)(1) of 78175 this section at the yearly average exchange rate for the year of the sale. The yearly average exchange rate is Ö1 = $1.02 for year 1 and Ö1 = $1.05 for year 2. (ii) Analysis—(A) Business A’s dollar gross sales will be computed as follows: TABLE 1 TO PARAGRAPH (e)(3)(ii)(A)—GROSS SALES [Year 2] Number of units Month Jan .................................................................. Feb .................................................................. March .............................................................. April ................................................................. May ................................................................. June ................................................................ July .................................................................. Aug .................................................................. Sept ................................................................. Oct ................................................................... Nov .................................................................. Dec .................................................................. (B) The purchase price for each inventory unit was Ö1.50. Under § 1.987–1(c)(3)(i) and paragraph Amount in Ö 100 200 0 200 100 0 100 100 0 0 100 300 300 600 0 600 300 0 300 300 0 0 300 900 1,200 ........................ Ö/$ yearly average rate Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 Ö1 = = = = = = = = = = = = $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 $1.05 Amount in $ ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... ...................................................... 315.00 630.00 0.00 630.00 315.00 0.00 315.00 315.00 0.00 0.00 315.00 945.00 ......................................................................... $3,780.00 (c)(2)(iv)(B) of this section, the basis of each item of inventory is translated into dollars at the yearly average exchange rate for the year the inventory was acquired. TABLE 2 TO PARAGRAPH (e)(3)(ii)(B)—OPENING INVENTORY AND PURCHASES [Year 2] Number of units Month khammond on DSKJM1Z7X2PROD with PROPOSALS3 Opening inventory (purchased in Dec. year 1) Purchases in year 2 Jan ........................................................... Feb ........................................................... March ....................................................... April .......................................................... May .......................................................... June ......................................................... July ........................................................... Aug ........................................................... Sept .......................................................... Oct ........................................................... Nov ........................................................... Dec ........................................................... (C) Because Business A uses a FIFO method for inventory, Business A is considered to have sold in year 2 the 100 units of opening inventory purchased in year 1 ($153.00), the 300 units purchased in January year 2 ($472.50), the 300 units purchased in April year 2 ($472.50), the 300 units purchased in July year 2 ($472.50), and 200 of the 300 units purchased in November year 2 ($315.00). Accordingly, Business A’s translated dollar COGS for year 2 is $1,885.50. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Amount in Ö Ö/$ yearly average rate 100 150 Ö1 = $1.02 ...................................................... 153.00 300 0 0 300 0 0 300 0 0 0 300 0 1,200 450 0 0 450 0 0 450 0 0 0 450 0 ........................ Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... Ö1 = $1.05 ...................................................... ......................................................................... 472.50 0 0 472.50 0 0 472.50 0 0 0 472.50 0 1,890.00 Business A’s opening inventory for year 3 is 100 units of inventory with a translated dollar basis of $157.50. (D) Accordingly, for purposes of section 987, Business A has gross income in dollars of $1,894.50 ($3,780.00—$1,885.50) for year 2. (4) [Reserved] (5) Example 5. The facts are the same as in paragraph (e)(3) of this section (Example 3) except that during year 2, Business A incurred Ö100 of depreciation expense with respect to a truck. No portion of the depreciation PO 00000 Amount in $ Frm 00043 Fmt 4701 Sfmt 4702 expense is an inventoriable cost. The truck was purchased on January 15, year 1. The yearly average exchange rate for year 1 was Ö1 = $1.02. Under paragraph (c)(2)(i) of this section, the Ö100 of depreciation is translated into dollars at the historic rate. The historic rate is the yearly average exchange rate for year 1. Accordingly, U.S. Corp takes into account depreciation of $102 with respect to Business A in year 2. (6) Example 6. The facts are the same as in paragraph (e)(5) of this section E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78176 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (Example 5) except that the Ö100 of depreciation expense incurred during year 2 with respect to the truck is an inventoriable cost. As a result, the depreciation expense is capitalized into the 1,200 units of inventory purchased by Business A in year 2. Of those 1,200 units, 1,100 units are sold during the year, and 100 units become ending inventory. The portion of depreciation expense capitalized into inventory that is sold during year 2 is reflected in Business A’s euro COGS and is translated at the Ö1 = $1.02 yearly average exchange rate for year 1, the year in which the truck was purchased. The portion of the depreciation expense capitalized into the 100 units of ending inventory is not taken into account in year 2 but rather, will be taken into account in the year the ending inventory is sold, translated at the Ö1 = $1.02 yearly average exchange rate for year 1. (7) Example 7. Business A purchased raw land on October 16, year 1, for Ö8,000 and sold the land on November 1, year 2, for Ö10,000. The yearly average exchange rate was Ö1 = $1.02 for year 1 and Ö1 = $1.05 for year 2. Under paragraph (c)(1) of this section, the amount realized is translated into dollars at the yearly average exchange rate for year 2 (Ö10,000 × $1.05 = $10,500). Under paragraph (c)(2)(i) of this section, the basis is determined at the historic rate for year 1, which is the yearly average exchange rate under section § 1.987–1(c)(3)(i) for such year (Ö8,000 × $1.02 = $8,160). Accordingly, the amount of gain reported by U.S. Corp on the sale of the land is $2,340 ($10,500—$8,160). (8) Example 8. The facts are the same as in paragraph (e)(7) of this section (Example 7), except that U.S. Corp makes a current rate election under § 1.987–1(d)(2). Under paragraph (c)(2) of this section, none of the exceptions to paragraph (c)(1) of this section apply in a taxable year for which an annual recognition election or a current rate election is in effect. As a result, all items of income, gain, deduction, and loss with respect to Business A are translated into U.S Corp’s functional currency at the yearly average exchange rate under paragraph (c)(1) of this section. Business A’s gain on the sale of the land is determined in its functional currency and is equal to Ö2,000 (amount realized of Ö10,000 less basis of Ö8,000). This gain is translated at the yearly average exchange rate for year 2 of Ö1 = $1.05, and the amount of gain reported by U.S. Corp on the sale of the land is $2,100. The result would be the same if U.S. Corp made an annual recognition election under § 1.987– 5(b)(2). VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 9. Section 1.987–4 is revised to read as follows: ■ § 1.987–4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU. (a) In general. The net unrecognized section 987 gain or loss of a section 987 QBU is determined by the owner annually as provided in paragraph (b) of this section in the owner’s functional currency. Only assets and liabilities reflected on the books and records of the section 987 QBU under § 1.987–2(b) are taken into account. (b) Calculation of net unrecognized section 987 gain or loss. Net unrecognized section 987 gain or loss of a section 987 QBU for a taxable year equals the sum of: (1) The section 987 QBU’s net accumulated unrecognized section 987 gain or loss for all prior taxable years as determined in paragraph (c) of this section; and (2) The section 987 QBU’s unrecognized section 987 gain or loss for the current taxable year as determined in paragraph (d) of this section. (c) Net accumulated unrecognized section 987 gain or loss for all prior taxable years—(1) In general. A section 987 QBU’s net accumulated unrecognized section 987 gain or loss for all prior taxable years is the aggregate of the amounts determined under § 1.987–4(d) for all prior taxable years to which this section applies, reduced (without duplication) by amounts recognized under § 1.987–5(a), amounts treated as deferred section 987 gain or loss, and amounts treated as suspended section 987 loss for all prior taxable years to which this section applies. (2) Additional adjustments for certain taxable years beginning on or before December 31, 2024. For any section 987 QBU in existence before the transition date, see § 1.987–10(e)(5) and (f)(2) for additional adjustments to the section 987 QBU’s net accumulated unrecognized section 987 gain or loss. (d) Calculation of unrecognized section 987 gain or loss for a taxable year. The unrecognized section 987 gain or loss of a section 987 QBU for a taxable year is generally determined under paragraphs (d)(1) through (10) of this section. However, for taxable years in which a current rate election or an annual recognition election is in effect, the unrecognized section 987 gain or loss of a section 987 QBU for a taxable year is determined by only applying paragraphs (d)(1) through (5) and (10) of this section. PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 (1) Step 1: Determine the change in the owner functional currency net value of the section 987 QBU for the taxable year—(i) In general. The change in the owner functional currency net value of the section 987 QBU for the taxable year equals— (A) The owner functional currency net value of the section 987 QBU, determined in the functional currency of the owner under paragraph (e) of this section, on the last day of the taxable year; less (B) The owner functional currency net value of the section 987 QBU, determined in the functional currency of the owner under paragraph (e) of this section, on the last day of the preceding taxable year. (ii) Year section 987 QBU is terminated. If a section 987 QBU is terminated within the meaning of § 1.987–8 during an owner’s taxable year, the owner functional currency net value of the section 987 QBU described in paragraph (d)(1)(i)(A) of this section is determined on the date the section 987 QBU is terminated. (iii) First taxable year of a section 987 QBU. If the owner’s taxable year is the first taxable year of a section 987 QBU, the owner functional currency net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of this section is zero. (iv) First year in which an election is in effect or ceases to be in effect. Except as otherwise provided, the owner functional currency net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of this section is determined based on the elections that were (or were not) in effect on the last day of the preceding taxable year. (2) Step 2: Increase the amount determined in step 1 by the amount of assets transferred from the section 987 QBU to the owner—(i) In general. The amount determined in paragraph (d)(1) of this section is increased by the total amount of assets transferred from the section 987 QBU to the owner during the taxable year translated into the functional currency of the owner as provided in paragraph (d)(2)(ii) of this section. (ii) Assets transferred from the section 987 QBU to the owner during the taxable year. The total amount of assets transferred from the section 987 QBU to the owner for the taxable year translated into the functional currency of the owner equals the sum of: (A) The amount of the functional currency of the section 987 QBU and the aggregate adjusted basis of all marked assets, after taking into account § 1.988– 1(a)(10), transferred to the owner during the taxable year determined in the E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules functional currency of the section 987 QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and (B) The aggregate adjusted basis of all historic assets, after taking into account § 1.988–1(a)(10), transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the historic rate for each such asset. (3) Step 3: Decrease the amount determined in steps 1 and 2 by the amount of assets transferred from the owner to the section 987 QBU—(i) In general. The aggregate amount determined in paragraphs (d)(1) and (2) of this section is decreased by the total amount of assets transferred from the owner to the section 987 QBU during the taxable year determined in the functional currency of the owner as provided in paragraph (d)(3)(ii) of this section. (ii) Assets transferred from the owner to the section 987 QBU during the taxable year. The total amount of assets transferred from the owner to the section 987 QBU for the taxable year equals the sum of: (A) The amount of functional currency of the owner transferred to the section 987 QBU during the taxable year; and (B) The aggregate adjusted basis of all assets, after taking into account § 1.988– 1(a)(10), transferred to the section 987 QBU during the taxable year determined in the functional currency of the owner immediately before the transfer. (4) Step 4: Decrease the amount determined in steps 1 through 3 by the amount of liabilities transferred from the section 987 QBU to the owner—(i) In general. The aggregate amount determined in paragraphs (d)(1) through (3) of this section is decreased by the total amount of liabilities transferred from the section 987 QBU to the owner during the taxable year translated into the functional currency of the owner as provided in paragraph (d)(4)(ii) of this section. (ii) Liabilities transferred from the section 987 QBU to the owner during the taxable year. The total amount of liabilities transferred from the section 987 QBU to the owner for the taxable year equals the sum of: (A) The amount of marked liabilities transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the spot rate applicable to the date of transfer; and VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (B) The amount of historic liabilities, after taking into account § 1.988– 1(a)(10), transferred to the owner during the taxable year determined in the functional currency of the section 987 QBU and translated into the functional currency of the owner at the historic rate for each such liability. (5) Step 5: Increase the amount determined in steps 1 through 4 by the amount of liabilities transferred from the owner to the section 987 QBU. The aggregate amount determined in paragraphs (d)(1) through (4) of this section is increased by the total amount of liabilities, after taking into account § 1.988–1(a)(10), transferred from the owner to the section 987 QBU during the taxable year determined in the functional currency of the owner immediately before the transfer. (6) Step 6: Decrease or increase the amount determined in steps 1 through 5 by the section 987 taxable income or loss, respectively, of the section 987 QBU for the taxable year. The aggregate amount determined in paragraphs (d)(1) through (5) of this section is decreased or increased by the section 987 taxable income or loss, respectively, computed under § 1.987–3 for the taxable year. (7) Step 7: Increase the amount determined in steps 1 through 6 by any expenses or losses that are not deductible in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year. The aggregate amount determined under paragraphs (d)(1) through (6) of this section is increased by the amount of any expense or loss that reduces the basis of assets or increases the amount of liabilities on the adjusted balance sheet of the section 987 QBU for the taxable year but is not deductible in computing the section 987 QBU’s taxable income or loss for the taxable year (such as business interest expense that is not deductible under section 163(j)). Items of expense or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under § 1.987–3(c) if they were deductible in computing the section 987 QBU’s taxable income or loss for the taxable year. However, any foreign income taxes incurred by the section 987 QBU with respect to which the owner claims a credit are translated at the same rate at which such taxes were translated under section 986(a). (8) Step 8: Decrease the amount determined in steps 1 through 7 by the amount of any income or gain that is not included in taxable income in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year. The aggregate amount determined under paragraphs PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 78177 (d)(1) through (7) of this section is decreased by the amount of any income or gain that increases the basis of assets or reduces the amount of liabilities on the adjusted balance sheet of the section 987 QBU for the taxable year but is not included in taxable income in computing the section 987 QBU’s taxable income or loss for the taxable year. Items of income or gain described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that would apply under § 1.987–3(c) if they were included in taxable income in computing the section 987 QBU’s taxable income or loss for the taxable year. (9) Step 9: Increase or decrease the amount determined in steps 1 through 8 by any income or gain, or any deduction or loss, respectively, that does not impact the adjusted balance sheet. The aggregate amount determined under paragraphs (d)(1) through (8) of this section is increased by any items of income or gain taken into account in step 6 that do not increase the basis of assets or reduce the amount of liabilities on the adjusted balance sheet of the section 987 QBU for the taxable year, and decreased by any items of deduction or loss taken into account in step 6 that do not reduce the basis of assets or increase the amount of liabilities on the adjusted balance sheet of the section 987 QBU for the taxable year. Items of income, gain, deduction, or loss described in the preceding sentence are translated into the functional currency of the owner using the exchange rate that applied under § 1.987–3(c) in computing the section 987 QBU’s taxable income or loss for the taxable year. (10) Step 10: Decrease or increase the amount determined in steps 1 through 9 by any increase or decrease, respectively, to the adjusted balance sheet that is not previously taken into account under steps 2 through 9—(i) In general. Except as provided in paragraph (d)(10)(iii) of this section, the aggregate amount determined under paragraphs (d)(1) through (9) of this section is— (A) Decreased by the residual increase to the adjusted balance sheet (as defined in paragraph (d)(10)(ii) of this section), translated into the owner’s functional currency at the yearly average exchange rate for the taxable year; or (B) Increased by the residual decrease to the adjusted balance sheet (as defined in paragraph (d)(10)(ii) of this section), translated into the owner’s functional currency at the yearly average exchange rate for the taxable year. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78178 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (ii) Determining the residual increase or decrease to the adjusted balance sheet. The residual increase to the adjusted balance sheet is the positive amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU. The residual decrease to the adjusted balance sheet is the negative amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU. (iii) Modifications for taxable years to which a current rate election or an annual recognition election applies. For any taxable year to which a current rate election or an annual recognition election applies, paragraphs (d)(10)(i) and (ii) of this section are applied by replacing ‘‘paragraphs (d)(1) through (9)’’ with ‘‘paragraphs (d)(1) through (5).’’ (e) Determination of the owner functional currency net value of a section 987 QBU—(1) In general. The owner functional currency net value of a section 987 QBU on the last day of a taxable year is equal to the aggregate amount of functional currency and the adjusted basis of each other asset on the section 987 QBU’s adjusted balance sheet on that day, less the aggregate amount of each liability on the section 987 QBU’s adjusted balance sheet on that day, in each case translated into the owner’s functional currency as provided in paragraph (e)(2) of this section. (2) Translation of adjusted balance sheet items into the owner’s functional currency. The amount of the section 987 QBU’s functional currency, the basis of an asset, or the amount of a liability is translated as follows: (i) Marked item. A marked item is translated into the owner’s functional currency at the spot rate applicable to the last day of the relevant taxable year. (ii) Historic item. A historic item is translated into the owner’s functional currency at the historic rate. (f) Combinations and separations—(1) Combinations. The net accumulated unrecognized section 987 gain or loss of a combined QBU for a taxable year is equal to the sum of the combining QBUs’ net accumulated unrecognized section 987 gain or loss. See paragraph (f)(3)(i) of this section (Example 1) for an illustration of this rule. (2) Separations. The net accumulated unrecognized section 987 gain or loss of a separated QBU for a taxable year is VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 equal to the separating QBU’s net accumulated unrecognized section 987 gain or loss multiplied by the separation fraction. For purposes of determining the owner functional currency net value of the separated QBUs on the last day of the taxable year preceding the taxable year of separation under paragraphs (d)(1)(i)(B) and (e) of this section, the balance sheets of the separated QBUs on that day will be deemed to reflect the assets and liabilities reflected on the balance sheet of the separating QBU on that day, apportioned between the separated QBUs in a reasonable manner that takes into account the assets and liabilities reflected on the balance sheets of the separated QBUs immediately after the separation. See paragraph (f)(3)(ii) of this section (Example 2) for an illustration of this rule. (3) Examples. The following examples illustrate the rules of paragraphs (f)(1) and (2) of this section. For purposes of these examples, assume that no section 987 elections are in effect. (i) Example 1. Combination of two section 987 QBUs that have the same owner—(A) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a manufacturing business that constitutes a section 987 QBU (Manufacturing QBU) that has the euro as its functional currency. Manufacturing QBU has a net accumulated unrecognized section 987 loss of $100. DC1 also owns Entity B, a DE. Entity B conducts a sales business that constitutes a section 987 QBU (Sales QBU) that has the euro as its functional currency. Sales QBU has a net accumulated unrecognized section 987 gain of $110. During the taxable year, Entity A merges into Entity B under local law pursuant to which Entity A ceases to exist, Entity B survives, and Entity B acquires all the assets and liabilities of Entity A. As a result, the books and records of Manufacturing QBU and Sales QBU are combined into a new single set of books and records. The combined entity has the euro as its functional currency. (B) Analysis. Pursuant to § 1.987– 2(c)(9)(i), Manufacturing QBU and Sales QBU are combining QBUs, and their combination does not give rise to a transfer that is taken into account in determining the amount of a remittance (as defined in § 1.987–5(c)). For purposes of computing net unrecognized section 987 gain or loss under this section for the year of the combination, the combination is deemed to have occurred on the last day of the owner’s prior taxable year, such that the owner functional currency net value of the combined section 987 QBU at the end of that taxable year described PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 under paragraph (d)(1)(i)(B) of this section takes into account items reflected on the balance sheets of both Manufacturing QBU and Sales QBU at that time. Additionally, any transactions between Manufacturing QBU and Sales QBU occurring during the year of the merger will not result in transfers to or from a section 987 QBU. Pursuant to paragraph (f)(1) of this section, the combined QBU will have a net accumulated unrecognized section 987 gain of $10 (the $100 loss from Manufacturing QBU plus the $110 gain from Sales QBU). (ii) Example 2. Separation of two section 987 QBUs that have the same owner—(A) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in the Netherlands that constitutes a section 987 QBU (Dutch QBU) that has the euro as its functional currency. The business of Dutch QBU consists of manufacturing and selling bicycles and scooters and is recorded on a single set of books and records. On the last day of year 1, the adjusted basis of the gross assets of Dutch QBU is Ö1,000. In year 2, the net accumulated unrecognized section 987 loss of Dutch QBU from all prior taxable years is $200. During year 2, Entity A separates the bicycle and scooter business such that each business begins to have its own books and records and to meet the definition of a section 987 QBU under § 1.987–1(b)(3) (hereafter, ‘‘bicycle QBU’’ and ‘‘scooter QBU’’). There are no transfers between DC1 and Dutch QBU before the separation. After the separation, the aggregate adjusted basis of bicycle QBU’s assets is Ö600 and the aggregate adjusted basis of scooter QBU’s assets is Ö400. Each section 987 QBU continues to have the euro as its functional currency. (B) Analysis. Pursuant to § 1.987– 2(c)(9)(iii), bicycle QBU and scooter QBU are separated QBUs, and the separation of Dutch QBU, a separating QBU, does not give rise to a transfer taken into account in determining the amount of a remittance. For purposes of computing net unrecognized section 987 gain or loss under this section for year 2, the separation will be deemed to have occurred on the last day of the owner’s prior taxable year, year 1. Pursuant to paragraph (f)(2) of this section and § 1.987–1(h), bicycle QBU will have a separation fraction of Ö600/Ö1,000 and net accumulated unrecognized section 987 loss of $120 (Ö600/Ö1,000 × $200), and scooter QBU will have a separation fraction of Ö400/Ö1,000 and net accumulated unrecognized section 987 loss of $80 (Ö400/Ö1,000 × $200). (g) Examples. The following examples illustrate the provisions of this section. E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules For purposes of the examples, U.S. Corp is a domestic corporation that uses the calendar year as its taxable year and has the dollar as its functional currency. Except as otherwise indicated, no section 987 elections are in effect. Exchange rate assumptions used in these examples are selected for the purpose of illustrating the principles of this section, and no inference is intended by their use. Additionally, the examples are not intended to demonstrate when activities constitute a trade or business within the meaning of §§ 1.989(a)–1(b)(2)(ii)(A) and 1.989(a)– 1(c) and therefore whether a section 987 QBU is considered to exist. (1) Example 1—(i) Facts. On July 1, year 1, U.S. Corp establishes Japan Branch, a section 987 QBU that has the yen as its functional currency, and U.S. Corp transfers to Japan Branch ¥100,000 with a basis of $1,000 and raw land with a basis of $500. On the same day, Japan Branch borrows ¥10,000 from a bank. In year 1, Japan Branch earns ¥12,000 for providing services and incurs ¥2,000 of related expenses. Japan Branch thus earns ¥10,000 of net income in year 1. The spot rate on July 1, year 1, is $1 = ¥100; the spot rate on December 31, year 1, is $1 = ¥120; and the average rate for the period of July 1, year 1, to December 31, year 1, is $1 = ¥110. Thus, the ¥12,000 of services revenue when translated under § 1.987–3(c)(1) at the yearly average exchange rate equals $109.09 (¥12,000 × ($1/¥110)) = $109.09). The ¥2,000 of expenses translated at the same yearly average exchange rate equals $18.18 (¥2,000 × ($1/¥110) = $18.18). Thus, Japan Branch’s net income translated into dollars equals $90.91 ($109.09—$18.18 = $90.91). (ii) Analysis. Under paragraph (a) of this section, U.S. Corp must compute the net unrecognized section 987 gain or loss of Japan Branch for year 1. Because this is Japan Branch’s first taxable year, the net unrecognized section 987 gain or loss (as defined under paragraph (b) of this section) is the branch’s unrecognized section 987 gain or loss for year 1 as determined in paragraph (d) of this section. The calculations under paragraph (d) of this section are made as follows: (A) Step 1. Under paragraph (d)(1) of this section (Step 1), U.S. Corp must determine the change in the owner functional currency net value (OFCNV) of Japan Branch for year 1 in dollars. The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year. (1) The OFCNV of Japan Branch on December 31, year 1 is determined under paragraph (e) of this section as the sum of the basis of each asset on 78179 Japan Branch’s adjusted balance sheet on December 31, year 1, less the sum of each liability on Japan Branch’s adjusted balance sheet on that date, translated into dollars as provided in paragraph (e)(2) of this section. (2) For this purpose, Japan Branch will show the following assets and liabilities on its adjusted balance sheet for December 31, year 1: cash of ¥120,000; raw land with a basis of ¥55,000 ($500 translated under § 1.987– 2(d)(2) at the historic rate of $1 = ¥110); and liabilities of ¥10,000. (3) Under paragraph (e)(2) of this section, U.S. Corp will translate these items as follows. The ¥120,000 is a marked asset and the ¥10,000 liability is a marked liability. These items are translated into dollars on December 31, year 1, using the spot rate on December 31, year 1, of $1 = ¥120. The raw land is a historic asset and is translated into dollars under paragraph (e)(2)(ii) of this section at the historic rate, which under § 1.987–1(c)(3)(i)(A) is the yearly average exchange rate of $1 = ¥110 applicable to the year the land was transferred to the QBU. (4) The OFCNV of Japan Branch on December 31, year 1, in dollars is $1,416.67, determined below. The OFCNV of Japan Branch on December 31, year 1, is shown below in dollars (together with the corresponding amounts in yen). TABLE 1 TO PARAGRAPH (g)(1)(ii)(A)(4)—OFCNV—END OF YEAR 1 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Amount in ¥ Assets Yen ........................................................................ 120,000 Land ....................................................................... Translation rate Amount in $ 1,000.00 55,000 $1 = ¥120 (spot rate-12/31/year 1) .............................. $1 = ¥110 (historic rate-yearly average rate-year 1) ... ....................................................................................... Total assets ........................................................... Liabilities Bank loan .............................................................. 175,000 ....................................................................................... 1,500.00 10,000 $1 = ¥120 (spot rate-12/31/year 1) .............................. 83.33 Total liabilities ............................................................... Year 1 ending net value ............................................... 10,000 165,000 ....................................................................................... ....................................................................................... 83.33 1,416.67 (5) Under paragraph (d)(1) of this section, the change in OFCNV of Japan Branch for year 1 is equal to the OFCNV of the branch determined in dollars on December 31, year 1, (which is $1,416.67) less the OFCNV of the branch determined in dollars on the last day of the preceding taxable year. Because this is the first taxable year of Japan Branch, the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year is zero under paragraph (d)(1)(iii) of this section. Accordingly, the change in OFCNV of Japan Branch for year 1 is $1,416.67. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (B) Step 2 (no adjustment). No adjustment is made under paragraph (d)(2) of this section (Step 2) because no assets were transferred by Japan Branch to U.S. Corp during the taxable year. (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan Branch ¥100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ¥55,000, translated under § 1.987– 2(d)(2) at the historic rate of $1 = ¥110). The total amount of assets transferred from U.S. Corp to Japan Branch in dollars is $1,500, and the total amount of the transfer in yen is ¥155,000. PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 500.00 Therefore, under paragraph (d)(3) of this section (Step 3), the amount determined in previous steps is reduced by $1,500.00, from $1,416.67 to negative $83.33. (D) Steps 4 and 5 (no adjustment). No adjustment is made under paragraphs (d)(4) and (5) of this section (Steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year. (E) Step 6. Under paragraph (d)(6) of this section (Step 6), the amount determined in previous steps is E:\FR\FM\14NOP3.SGM 14NOP3 78180 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules decreased by the section 987 taxable income of Japan Branch of $90.91, from negative $83.33 to negative $174.24. (F) Steps 7 through 9 (no adjustment). No adjustment is made under paragraphs (d)(7) through (9) of this section (Steps 7 through 9) because all of Japan Branch’s items of income or deduction for the taxable year impact the adjusted balance sheet and are taken into account in computing taxable income. (G) Step 10 (no adjustment)—(1) Calculation of residual increase or decrease to the adjusted balance sheet. Under paragraph (d)(10)(ii) of this section, the residual increase (or decrease) to the adjusted balance sheet is the positive (or negative) amount, if any, that would be determined under paragraphs (d)(1) through (9) of this section (Steps 1 through 9) in the functional currency of the section 987 QBU if such amounts were determined in the functional currency of the section 987 QBU. In year 1, the relevant steps that must be applied in the functional currency of Japan Branch (the yen) are paragraphs (d)(1), (3), and (6) of this section (Steps 1, 3, and 6). For purposes of applying paragraph (d)(1) of this section (Step 1) in yen, the change in the net value of Japan Branch is ¥165,000. See paragraph (g)(1)(ii)(A)(4) of this section. For purposes of applying paragraph (d)(3) of this section (Step 3) in yen, the amount of assets transferred from U.S. Corp to Japan Branch is ¥155,000. See paragraph (g)(1)(ii)(C) of this section. For purposes of applying paragraph (d)(6) of this section (Step 6) in yen, Japan Branch earned ¥10,000 of net income in year 1. The application of these steps results in no residual increase or decrease to the adjusted balance sheet, as shown below: TABLE 2 TO PARAGRAPH (g)(1)(ii)(G)(1)—APPLICATION OF RELEVANT STEPS IN YEN Change in net value in yen (Step 1) ............................................................................................................................................. Subtract amount determined in yen under Step 3 (transfers from owner to section 987 QBU) .................................................. Subtract amount determined in yen under Step 6 (section 987 taxable income or loss) ............................................................ ¥165,000 (¥155,000) (¥10,000) Residual increase or decrease to the adjusted balance sheet .............................................................................................. ¥0 (2) No residual increase or decrease to the adjusted balance sheet. As explained in paragraph (g)(1)(ii)(G)(1) of this section, there is no residual increase or decrease to the adjusted balance sheet of Japan Branch in year 1. Therefore, no adjustment is made under paragraph (d)(10) of this section (Step 10). Accordingly, the unrecognized section 987 loss of Japan Branch for year 1 is $174.24. (2) Example 2—(i) Facts. The facts are the same as in paragraph (g)(1) of this section (Example 1), except that U.S. Corp makes a current rate election under § 1.987–1(d)(2) for year 1. (ii) Analysis. Because a current rate election is in effect for year 1, the unrecognized section 987 gain or loss for year 1 is determined by applying only paragraphs (d)(1) through (5) and (10) of this section (Steps 1 through 5 and Step 10). The calculations under paragraph (d) of this section are made as follows: (A) Step 1. The change in the OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 1, less the OFCNV of Japan Branch determined in dollars on the last day of the preceding taxable year. (1) For this purpose, Japan Branch will show the same assets and liabilities on its adjusted balance sheet for December 31, year 1 as are described in paragraph (g)(1)(ii)(A)(2) of this section (Example 1), but the land is treated as a marked asset as a result of the current rate election. The adjusted balance sheet reflects cash of ¥120,000, raw land with a basis of ¥50,000 ($500 translated under § 1.987–2(d)(1) at the July 1, year 1 spot rate of $1 = ¥100), and liabilities of ¥10,000. (2) Because of the current rate election, all of Japan Branch’s assets and liabilities are treated as marked items. Therefore, under paragraph (e)(2) of this section, these items are translated into dollars on December 31, year 1, using the spot rate on December 31, year 1, of $1 = ¥120. (3) The OFCNV of Japan Branch on December 31, year 1, and the change in OFCNV of Japan Branch for year 1, is $1,333.33, determined below. The OFCNV (and change in OFCNV) of Japan Branch is shown below (together with the corresponding amounts in yen). TABLE 3 TO PARAGRAPH (g)(2)(ii)(A)(3)—OFCNV AND CHANGE IN OFCNV—YEAR 1 Amount in ¥ khammond on DSKJM1Z7X2PROD with PROPOSALS3 Assets Yen ........................................................................ Land ....................................................................... Translation rate Amount in $ 120,000 50,000 $1 = ¥120 (spot rate-12/31/year 1) .............................. $1 = ¥120 (spot rate-12/31/year 1) .............................. 1,000.00 416.67 Total assets .................................................... Liabilities Bank loan .............................................................. 170,000 ....................................................................................... 1,416.67 10,000 $1 = ¥120 (spot rate-12/31/year 1) .............................. 83.33 Total liabilities ................................................. Year 1 ending net value ............................................... Net value on the last day of the preceding taxable year. 10,000 160,000 0 ....................................................................................... ....................................................................................... ....................................................................................... 83.33 1,333.33 0 Change in net value .............................................. 160,000 ....................................................................................... 1,333.33 (B) Step 2 (no adjustment). No adjustment is made under paragraph VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (d)(2) of this section (Step 2) because no PO 00000 Frm 00048 Fmt 4701 Sfmt 4702 assets were transferred by Japan Branch to U.S. Corp during the taxable year. E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan Branch ¥100,000 with a basis of $1,000.00 and raw land with a basis of $500.00 (equal to ¥50,000, translated under § 1.987– 2(d)(1) at the spot rate on July 31, year 1 of $1 = ¥100). The total amount of assets transferred in dollars is $1,500.00, and the amount of assets transferred in yen is ¥150,000. Therefore, under paragraph (d)(3) of this section (Step 3), the amount determined in previous steps is reduced by $1,500, from $1,333.33 to negative $166.67. (D) Steps 4 and 5 (no adjustment). No adjustment is made under paragraphs (d)(4) and (5) of this section (Steps 4 and 5) because no liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year. (E) Steps 6 through 9 do not apply. Under paragraph (d) of this section, paragraphs (d)(6) through (9) of this section (Steps 6 through 9) do not apply because a current rate election is in effect. (F) Step 10—(1) Application of relevant steps in Japan Branch’s functional currency. Under paragraph (d)(10)(iii) of this section, because a current rate election is in effect, the 78181 residual increase or decrease to the adjusted balance sheet is determined by applying paragraphs (d)(1) through (5) of this section (Steps 1 through 5) in the functional currency of the section 987 QBU. The relevant steps that must be applied under paragraph (d)(10) of this section in the functional currency of Japan Branch are paragraphs (d)(1) and (3) of this section (Steps 1 and 3). See paragraphs (g)(2)(ii)(A) and (C) of this section for amounts determined in yen. The residual increase to the adjusted balance sheet is determined as follows: TABLE 4 TO PARAGRAPH (g)(2)(ii)(F)(1)—APPLICATION OF RELEVANT STEPS IN YEN Step 1: Change in net value .......................................................................................................................................................... Step 3: Subtract amount of transfers from owner to section 987 QBU ........................................................................................ ¥160,000 (¥150,000) Residual increase or decrease to the adjusted balance sheet .............................................................................................. ¥10,000 (2) Residual increase or decrease to the adjusted balance sheet. As explained in paragraph (g)(2)(ii)(F)(1) of this section, the residual increase to Japan Branch’s adjusted balance sheet in year 1 is ¥10,000. This amount, translated at the yearly average exchange rate of $1 = ¥110, equals $90.91. Therefore, the amount determined in previous steps is reduced by $90.91, from negative $166.67 to negative $257.58. Accordingly, the unrecognized section 987 loss of Japan Branch for year 1 is $257.58. (3) Example 3—(i) Facts—(A) Background. The facts in year 1 are the same as in paragraph (g)(2) of this section (Example 2). In year 9, a current rate election remains in effect, U.S. Corp has net unrecognized section 987 loss of $1,000 with respect to Japan Branch, and Japan Branch does not make a remittance. On December 31, year 9, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ¥120,000; raw land with a basis of ¥50,000; and liabilities of ¥10,000. Effective for year 10, U.S. Corp revokes the current rate election. (B) Operations in year 10. In year 10, Japan Branch earns ¥12,000 for providing services and incurs ¥2,000 of related expenses. Japan Branch thus earns ¥10,000 of net income in year 10. On December 31, year 10, the adjusted balance sheet of Japan Branch shows the following assets and liabilities: cash of ¥130,000; raw land with a basis of ¥50,000; and liabilities of ¥10,000. Assume that the spot rate on December 31, year 9, is $1 = ¥120; the spot rate on December 31, year 10, is $1 = ¥130; and the yearly average exchange rate for year 10 is $1 = ¥125. Thus, the ¥12,000 of services revenue when properly translated under § 1.987–3(c)(1) at the yearly average exchange rate equals $96.00 (¥12,000 × ($1/¥125)) = $96.00). The ¥2,000 of expenses translated at the same yearly average exchange rate equals $16.00 (¥2,000 × ($1/¥125) = $16.00). Thus, Japan Branch’s net income translated into dollars equals $80. There are no transfers of assets or liabilities between U.S. Corp and Japan Branch in year 10. (ii) Analysis—(A) Determination of OFCNV for year 9. Under paragraph (d)(1)(iv) of this section, the OFCNV of a section 987 QBU on the last day of the preceding taxable year is determined based on the elections that were (or were not) in effect on the last day of that taxable year. In year 9, a current rate election was in effect. Therefore, in determining the OFCNV of Japan Branch for year 9, all assets and liabilities of Japan Branch (including the land) are treated as marked items. The OFCNV of Japan Branch for year 9, is $1,333.33, determined under paragraph (e) of this section as follows (together with the corresponding amounts in yen): TABLE 5 TO PARAGRAPH (g)(3)(ii)(A)—OFCNV—END OF YEAR 9 Amount in ¥ khammond on DSKJM1Z7X2PROD with PROPOSALS3 Assets Yen ........................................................................ Land ....................................................................... Translation rate Amount in $ 120,000 50,000 $1 = ¥120 (spot rate-12/31/year 9) .............................. $1 = ¥120 (spot rate-12/31/year 9) .............................. 1,000.00 416.67 Total assets .................................................... Liabilities Bank loan .............................................................. 170,000 ....................................................................................... 1,416.67 10,000 $1 = ¥120 (spot rate-12/31/year 9) .............................. 83.33 Total liabilities ................................................. Year 9 ending net value ............................................... 10,000 160,000 ....................................................................................... ....................................................................................... 83.33 1,333.33 (B) Determination of OFCNV for year 10. In year 10, a current rate election is not in effect. Therefore, in determining VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 the OFCNV of Japan Branch for year 10, the land owned by Japan Branch is treated as a historic item. Under PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 § 1.987–1(c)(3)(i)(F), the historic rate applicable to historic items that were properly reflected on the books and E:\FR\FM\14NOP3.SGM 14NOP3 78182 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules records of Japan Branch on the last day of the last taxable year in which a current rate election was in effect (December 31, year 9) generally is equal to the spot rate applicable to that day. Therefore, the historic rate applicable to the land is the spot rate on December 31, year 9. The OFCNV of Japan Branch for year 10 is $1,339.74, determined under paragraph (e) of this section as follows (together with the corresponding amounts in yen): TABLE 6 TO PARAGRAPH (g)(3)(ii)(B)—OFCNV—END OF YEAR 10 Amount in ¥ khammond on DSKJM1Z7X2PROD with PROPOSALS3 Assets Yen ........................................................................ Land ....................................................................... Translation rate Amount in $ 130,000 50,000 $1 = ¥130 (spot rate-12/31/year 10) ............................ $1 = ¥120 (historic rate-spot rate-12/31/year 9) .......... 1,000.00 416.67 Total assets .................................................... Liabilities Bank loan .............................................................. 180,000 ....................................................................................... 1,416.67 10,000 $1 = ¥130 (spot rate-12/31/year 10) ............................ 76.92 Total liabilities ................................................. Year 10 ending net value ............................................. 10,000 170,000 ....................................................................................... ....................................................................................... 76.92 1,339.74 (C) Determination of unrecognized section 987 gain or loss for year 10. The unrecognized section 987 gain or loss of Japan Branch for year 10 is determined under paragraph (d) of this section as follows: (1) Step 1. The change in the OFCNV of Japan Branch for year 10 is equal to the OFCNV of Japan Branch determined in dollars on the last day of year 10, less the OFCNV of Japan Branch determined in dollars on the last day of year 9. Therefore, the change in OFCNV is equal to $6.41 ($1,339.74 ¥ $1,333.33). (2) Steps 2 through 5 (no adjustment). No adjustment is made under paragraphs (d)(2) through (5) of this section (Steps 2 through 5) because no assets or liabilities were transferred by U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the taxable year. (3) Step 6. Under paragraph (d)(6) of this section (Step 6), the amount determined in previous steps is decreased by the section 987 taxable income of Japan Branch of $80.00, from $6.41 to negative $73.59. (4) Steps 7 through 10 (no adjustment). No adjustment is made under paragraphs (d)(7) through (10) of this section (Steps 7 through 10) because all of Japan Branch’s items of income or deduction for the taxable year impact the adjusted balance sheet and are taken into account in computing taxable income. In addition, Japan Branch does not have a residual increase or decrease to the adjusted balance sheet (because the change in net value of ¥10,000 is equal to the amount of Japan Branch’s net income in year 10). Accordingly, the unrecognized section 987 loss of Japan Branch for year 10 is negative $73.59. (D) Determination of net unrecognized section 987 gain or loss. In year 10, Japan Branch has net accumulated section 987 loss of $1,000. Because U.S. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Corp revoked the current rate election for year 10, the net accumulated section 987 loss of $1,000 becomes suspended section 987 loss under § 1.987–11(d)(2) and Japan Branch’s net accumulated section 987 loss is reduced to zero. Therefore, in year 10, Japan Branch’s net unrecognized section 987 loss is equal to $73.59, its unrecognized section 987 loss for year 10. ■ 10. Section 1.987–5 is revised to read as follows: § 1.987–5 or loss. Recognition of section 987 gain (a) Recognition of section 987 gain or loss by the owner of a section 987 QBU. The taxable income of an owner of a section 987 QBU includes the owner’s section 987 gain or loss recognized with respect to the section 987 QBU for the taxable year. Except as otherwise provided in § 1.987–7A(c)(4)(ii), 1.987– 11(c), 1.987–12(b) or (e), or 1.987–13(h) or (k), for any taxable year the owner’s section 987 gain or loss recognized with respect to a section 987 QBU is equal to: (1) The owner’s net unrecognized section 987 gain or loss with respect to the section 987 QBU determined under § 1.987–4 on the last day of such taxable year (or, if earlier, on the day the section 987 QBU is terminated under § 1.987– 8); multiplied by (2) The owner’s remittance proportion for the taxable year, as determined under paragraph (b) of this section. (b) Remittance proportion—(1) In general. Except as provided in paragraph (b)(2) of this section, the owner’s remittance proportion with respect to a section 987 QBU for a taxable year is equal to: (i) The amount of the remittance, as determined under paragraph (c) of this section, to the owner from the section 987 QBU for such taxable year; divided by (ii) The sum of: PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 (A) The aggregate adjusted basis of the gross assets of the section 987 QBU as of the end of the taxable year that are reflected on its year-end balance sheet translated into the owner’s functional currency as provided in § 1.987–4(e)(2); and (B) The amount of the remittance, as determined under paragraph (c) of this section. (2) Annual recognition election. A taxpayer may elect to recognize its net unrecognized section 987 gain or loss with respect to the section 987 QBU on an annual basis (annual recognition election). For any taxable year in which the annual recognition election is in effect, the owner’s remittance proportion with respect to a section 987 QBU is one. See paragraph (g) of this section for an example illustrating this rule. Additionally, for any taxable year of an original deferral QBU owner in which an annual recognition election is in effect, the remittance proportion with respect to any successor deferral QBU is one. (c) Remittance—(1) Definition. A remittance is determined in the owner’s functional currency and equals the excess, if any, of: (i) The aggregate of all amounts transferred from the section 987 QBU to the owner during the taxable year, as determined in paragraph (d) of this section; over (ii) The aggregate of all amounts transferred from the owner to the section 987 QBU during the taxable year, as determined in paragraph (e) of this section. (2) Day when a remittance is determined. An owner’s remittance from a section 987 QBU is determined on the last day of the owner’s taxable year (or, if earlier, on the day the section 987 QBU is terminated under § 1.987– 8). E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (3) Termination. A termination of a section 987 QBU as determined under § 1.987–8 is treated as a remittance of all the gross assets of the section 987 QBU to the owner on the date of such termination. See § 1.987–8(e). Accordingly, the remittance proportion in the case of a termination is one. (d) Aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year. For purposes of paragraph (c)(1)(i) of this section, the aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year is the aggregate amount of functional currency and the aggregate adjusted basis of the other assets transferred, as determined in the owner’s functional currency under § 1.987–4(d)(2). Solely for this purpose, the amount of liabilities transferred from the owner to the section 987 QBU, as determined in the owner’s functional currency under § 1.987–4(d)(5), is treated as a transfer of assets from the section 987 QBU to the owner with an adjusted basis equal to the amount of such liabilities. (e) Aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year. For purposes of paragraph (c)(1)(ii) of this section, the aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year is the aggregate amount of functional currency and the aggregate adjusted basis of the assets transferred, as determined in the owner’s functional currency under § 1.987–4(d)(3). Solely for this purpose, the amount of liabilities transferred from the section 987 QBU to the owner determined under § 1.987–4(d)(4) is treated as a transfer of assets from the owner to the section 987 QBU with an adjusted basis equal to the amount of such liabilities. (f) Determination of owner’s adjusted basis in transferred assets and amount of transferred liabilities—(1) In general. The owner’s adjusted basis in an asset or the amount of a liability received in a transfer from a section 987 QBU (whether or not such transfer is made in connection with a remittance) is determined in the owner’s functional currency under the rules prescribed in paragraphs (f)(2) and (3) of this section. (2) Marked items. The basis of a marked asset or amount of a marked liability is the amount determined by translating the section 987 QBU’s functional currency basis of the asset or amount of the liability, after taking into account § 1.988–1(a)(10), into the owner’s functional currency at the spot rate applicable to the date of transfer. (3) Historic items. The basis of a historic asset or amount of a historic VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 liability is the amount determined by translating the section 987 QBU’s functional currency basis of the asset or amount of the liability, after taking into account § 1.988–1(a)(10), into the owner’s functional currency at the historic rate for the asset or liability. (g) Example. The following example illustrates the calculation of section 987 gain or loss under this section. For purposes of this example, except as otherwise indicated, assume that no section 987 elections are in effect. (1) Facts—(i) U.S. Corp, a domestic corporation with the dollar as its functional currency, operates in the United Kingdom through Business A, a section 987 QBU with the pound as its functional currency. During year 2, the following transfers took place between U.S. Corp and Business A. On January 5, year 2, U.S. Corp transferred to Business A $300, which Business A used during the year to purchase services. On March 5, year 2, Business A transferred a machine to U.S. Corp. The pound adjusted basis of the machine when properly translated into dollars as described under § 1.987– 4(d)(2)(ii)(B) and paragraph (d) of this section is $500. On November 1, year 2, Business A transferred pounds to U.S. Corp. The dollar amount of the pounds when properly translated as described under § 1.987–4(d)(2)(ii)(A) and paragraph (d) of this section is $2,300. On December 7, year 2, U.S Corp transferred a truck to Business A with an adjusted basis of $2,000. (ii) At the end of year 2, Business A holds assets, properly translated into the owner’s functional currency pursuant to § 1.987–4(e)(2), consisting of a computer with a pound adjusted basis equivalent to $500, a truck with a pound adjusted basis equivalent to $2,000, and pounds equivalent to $2,850. In addition, Business A has a pound liability entered into in year 1 with Bank A. All such assets and liabilities are reflected on the books and records of Business A. Assume that the net unrecognized section 987 gain for Business A as determined under § 1.987–4 as of the last day of year 2 is $80. (2) Analysis. U.S. Corp’s section 987 gain with respect to Business A is determined as follows: (i) Computation of amount of remittance. Under paragraphs (c)(1) and (2) of this section, U.S. Corp must determine the amount of the remittance for year 2 in the owner’s functional currency (dollars) on the last day of year 2. The amount of the remittance for year 2 is $500, determined as follows: PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 78183 TABLE 1 TO PARAGRAPH (g)(2)(i) Transfers from Business A to U.S. Corp in dollars Machine ................................ Pounds .................................. $500 2,300 Aggregate transfers from Business A to U.S. Corp ........................... $2,800 Transfers from U.S. Corp to Business A in dollars U.S. dollars ........................... Truck ..................................... $300 2,000 Aggregate transfers from U.S. Corp to Business A ................................. $2,300 Computation of amount of remittance Aggregate transfers from Business A to U.S. Corp ... Less: aggregate transfers from U.S. Corp to Business A ............................... (2,300) Total remittance ............. $500 $2,800 (ii) Computation of section 987 QBU gross assets plus remittance. Under paragraph (b)(1)(ii) of this section, Business A must determine the aggregate basis of its gross assets that are reflected on its year-end balance sheet translated into the owner’s functional currency and must increase this amount by the amount of the remittance. TABLE 2 TO PARAGRAPH (g)(2)(ii) Computer ......................................... Pounds ............................................ Truck ............................................... $500 2,850 2,000 Aggregate gross assets ............... Remittance ...................................... Aggregate basis of Business A’s gross assets at end of year 2, increased by amount of remittance $5,350 $500 $5,850 (iii) Computation of remittance proportion. Under paragraph (b) of this section, Business A must compute the remittance proportion by dividing the $500 remittance amount by the $5,850 sum of the aggregate basis of Business A’s gross assets and the amount of the remittance. The resulting remittance proportion is 0.085. (iv) Computation of section 987 gain or loss. The amount of U.S. Corp’s section 987 gain or loss that is recognized with respect to Business A is determined under paragraph (a) of this section by multiplying the 0.085 remittance proportion by the $80 of net unrecognized section 987 gain. U.S. Corp’s resulting recognized section 987 gain for year 2 is $6.80. E:\FR\FM\14NOP3.SGM 14NOP3 78184 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (3) Annual recognition election. If an annual recognition election under paragraph (b)(2) of this section were in effect for year 2, U.S. Corp’s remittance proportion would be one. Accordingly, U.S. Corp would recognize all $80 of the net unrecognized section 987 gain with respect to Business A. ■ 11. Section 1.987–6, as proposed to be amended by 81 FR 88882 (December 8, 2016), is further amended by: ■ a. Revising paragraph (a). ■ b. Adding paragraph (b) introductory text. ■ c. Revising paragraphs (b)(1) through (3), and (c). The revisions and addition read as follows: khammond on DSKJM1Z7X2PROD with PROPOSALS3 § 1.987–6 Character and source of section 987 gain or loss. (a) Ordinary income or loss. Section 987 gain or loss is ordinary income or loss for Federal income tax purposes. (b) Character and source of section 987 gain or loss. With respect to each section 987 QBU, the character and source of section 987 gain or loss is determined under this paragraph (b) for all purposes of the Internal Revenue Code, including sections 904(d), 907, and 954. References to an owner in this paragraph (b) include a partner of a partnership (other than a section 987 aggregate partnership) or shareholder of an S corporation that has section 987 gain or loss attributable to a section 987 QBU owned by the partnership or S corporation. (1) Timing of character and source determination. The character and source of section 987 gain or loss is determined based on the initial assignment pursuant to paragraph (b)(2)(i) of this section and may be reassigned in the year in which the section 987 gain or loss is recognized pursuant to paragraph (b)(2)(ii) of this section. The initial assignment is made in the earliest of the taxable years described in paragraphs (b)(1)(i) through (iv) of this section. (i) The taxable year in which the net unrecognized section 987 gain or loss is recognized. (ii) The taxable year in which the net unrecognized section 987 loss becomes suspended section 987 loss. (iii) The taxable year in which the net unrecognized section 987 gain or loss becomes deferred section 987 gain or loss. (iv) In the case of pretransition gain or loss that is recognized ratably over the transition period pursuant to the election under § 1.987–10(e)(5)(ii), the taxable year that includes the transition date. (2) Method for determining the character and source of section 987 gain VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 or loss—(i) Initial assignment—(A) In general. In a taxable year of the initial assignment, determined under paragraph (b)(1) of this section, the owner assigns gross section 987 gain or loss to the statutory and residual groupings in the same proportions as the proportions in which the tax book value of the assets of the section 987 QBU are assigned to the groupings under the asset method in §§ 1.861–9(g) and 1.861–9T(g), as modified by this paragraph (b)(2)(i). For purposes of applying the asset method, the owner takes into account only the assets that are attributed to the section 987 QBU under § 1.987–2(b). (B) Special rules for applying the asset method to assign section 987 gain or loss. For purposes of assigning gross section 987 gain or loss to the statutory and residual groupings under paragraph (b)(2)(i)(A) of this section, the proportions in which the tax book value of the assets of the section 987 QBU are assigned to the groupings described in paragraph (b)(2)(i)(A) of this section are determined without regard to section 987 gain or loss. Further, the section 987 gain or loss is assigned after any reattribution of gross income required under § 1.904–4(f)(2)(vi) or 1.951A– 2(c)(7)(ii)(B)(2) (or the principles thereof, as applicable), but before the allocation and apportionment of expenses or the application of provisions that are based on a net income computation, such as the hightax exception to passive category income in § 1.904–4(c), the high-tax exception to foreign base company income in § 1.954–1(d), and the high-tax exclusion from tested income in § 1.951A–2(c)(7). (C) Section 987 gain or loss that is assigned to subpart F income groups treated as attributable to section 988 transactions. Section 987 gain or loss assigned under paragraphs (b)(2)(i)(A) and (B) of this section to a grouping described in § 1.960–1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups) is treated as foreign currency gain or foreign currency loss attributable to section 988 transactions not directly related to the business needs of the controlled foreign corporation and is taken into account for purposes of determining the excess of foreign currency gains over foreign currency losses characterized as foreign personal holding company income under section 954(c)(1)(D). (D) Section 987 gain or loss assigned to tentative tested income rather than tested income—(1) In general. In the case of a controlled foreign corporation, the initial assignment of section 987 gain or loss under paragraphs PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 (b)(2)(i)(A) and (B) of this section is made as though the election described in § 1.951A–2(c)(7)(viii) is in effect for the taxable year. As a result, section 987 gain or loss that would have initially been characterized as tested income in a section 904 category if no election under § 1.951A–2(c)(7) was in effect is initially characterized as tentative tested income in the section 904 category (a tentative tested income group). (2) For purposes of the GILTI high-tax exclusion, section 987 gain or loss is not attributable to any tested unit. In the case of a controlled foreign corporation, the initial assignment of section 987 gain or loss is made as though the section 987 gain or loss was not attributable to any tested unit for purposes of applying § 1.951A–2(c)(7) (GILTI high-tax exclusion). See paragraph (b)(2)(iii) of this section (applying the GILTI high-tax exclusion by treating all section 987 gain or loss in the same tentative tested income group as composing a single tentative tested income item). (E) Initial assignment applies for purposes of the loss-to-the-extent-ofgain rule. See § 1.987–11(e) and (f) (grouping of section 987 gain and loss and applying the loss-to-the-extent-ofgain rule on basis of the initial assignment of section 987 gain and loss under this paragraph (b)(2)(i)). (ii) Reassignment of section 987 gain or loss. In the taxable year in which section 987 gain or loss is recognized (determined by taking into account §§ 1.987–5, 1.987–11(e), 1.987–12(c), and 1.987–13(b) through (d), if applicable), the section 987 gain or loss is sourced and characterized based on the initial determination in paragraph (b)(2)(i)(B) of this section, but with appropriate changes to account for the application of provisions that are based on a net income computation such as the high-tax exception to passive category income in § 1.904–4(c), the high-tax exception to foreign base company income in § 1.954–1(d), and the high-tax exclusion to tested income in § 1.951A–2(c)(7). Thus, for example, if an election under § 1.951A– 2(c)(7)(viii) (GILTI high-tax exclusion) is in effect for the taxable year, section 987 gain or loss initially assigned to a tentative tested income group will be reassigned to a tested income group (as defined in § 1.960–1(d)(2)(ii)(C)) or to the residual income group (as defined in § 1.960–1(d)(2)(ii)(D)). If no election is made under § 1.951A–2(c)(7)(viii) for a taxable year, all of the section 987 gain or loss that is recognized in the taxable year that was initially assigned to tentative tested income under paragraph (b)(2)(i) of this section, is reassigned to E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules the appropriate tested income group (as defined in § 1.960–1(d)(2)(ii)(C)). (iii) Special rule for the application of the GILTI high-tax exclusion to section 987 gain or loss. Section 987 gain in a tentative tested income group that is recognized by a controlled foreign corporation in a taxable year comprises a single tentative gross tested income item (as if it were allocable to its own tested unit) within the meaning of § 1.951A–2(c)(7)(ii), and section 987 loss in a tentative tested income group that is recognized by a controlled foreign corporation in the taxable year is allocated and apportioned to the corresponding tentative gross tested income item for purposes of calculating the tentative tested income item within the meaning of § 1.951A–2(c)(7)(iii). Thus, for purposes of applying the hightax exclusion in § 1.951A–2(c)(7), all of the section 987 gain and loss in a tentative tested income group that is recognized by the controlled foreign corporation in a taxable year is a single tentative tested income item. (3) Allocation and apportionment of foreign income tax to section 987 items under section 861. For purposes of applying the definition of a corresponding U.S. item in § 1.861– 20(b), an item of foreign gross income and an item of section 987 gain or loss are treated as arising from the same transaction or other realization event only if the requirements in both paragraphs (b)(3)(i) and (ii) of this section are satisfied. (i) The foreign gross income is an item of foreign currency gain or loss. The owner of the section 987 QBU, original deferral QBU owner, or original suspended loss QBU owner includes the foreign gross income under the laws of the foreign country in which it is a tax resident because under that foreign law it is required to recognize foreign currency gain or loss with respect to its interest in the section 987 QBU or with respect to a successor deferral QBU or successor suspended loss QBU. (ii) The same event or events give rise to both the foreign gross income and the section 987 gain or loss. The remittance under § 1.987–5(c) that gave rise to the item of section 987 gain or loss comprises one or more of the events that gave rise to the item of foreign gross income described in paragraph (b)(3)(i) of this section. * * * * * (c) Examples. The following examples illustrate the application of this section. For purposes of the examples, assume that no section 987 elections are in effect. (1) Example 1. CFC is a controlled foreign corporation with the Swiss franc VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (Sf) as its functional currency. CFC is the owner of Business A, a section 987 QBU that has the euro as its functional currency. For year 1, CFC does not have an election described in § 1.951A– 2(c)(7)(viii) in effect, and CFC recognizes section 987 gain of Sf10,000 under § 1.987–5. Business A has average total assets of Sf1,000,000 in year 1, which generate income (other than section 987 gain) as follows: Sf750,000 of assets that produce gross income in the statutory grouping for general category tested income under sections 904(d)(1)(A) and 951A; and Sf250,000 of assets that produce foreign source passive gross income in one of the groupings described in § 1.960– 1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups). Under paragraphs (b)(2)(i)(A), (B), and (D) of this section, Sf7,500 (Sf750,000/Sf1,000,000 × Sf10,000) of the section 987 gain is initially assigned to the statutory grouping of foreign source general category tentative tested income. Because an election under § 1.951A– 2(c)(7)(viii) is not in effect for the taxable year in which the section 987 gain is recognized, the section 987 gain is reassigned under paragraph (b)(2)(ii) of this section to foreign source general category tested income. The remaining Sf2,500 (Sf250,000/Sf1,000,000 × Sf10,000) is characterized under paragraphs (b)(2)(i)(A) and (B) of this section by reference to assets that give rise to foreign source passive gross income in one of the groupings described in § 1.960–1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups) and is therefore treated under paragraph (b)(2)(i)(C) of this section as foreign source foreign currency gain taken into account for purpose of determining foreign personal holding company income under section 954(c)(1)(D). All of the section 987 gain is treated as ordinary income. (2) Example 2. The facts are the same as in paragraph (c)(1) of this section (Example 1) except that: CFC recognizes section 987 loss of Sf40,000, Sf10,000 of which is characterized under paragraphs (b)(2)(i)(A) and (B) of this section by reference to assets that give rise to foreign source passive gross income in one of the groupings described in § 1.960–1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups); and CFC otherwise has Sf12,000 of net foreign currency gain determined under § 1.954–2(g) that is taken into account in determining the excess of foreign currency gain over foreign currency losses characterized as foreign personal holding company income under section 954(c)(1)(D). Under paragraph PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 78185 (b)(2)(i)(C) of this section, the Sf10,000 section 987 loss characterized by reference to assets that give rise to foreign source passive gross income in one of the groupings described in § 1.960–1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups) is treated as foreign currency loss taken into account under section 954(c)(1)(D) for purposes of computing foreign personal holding company income. Accordingly, CFC will aggregate the Sf10,000 section 987 loss with the Sf12,000 net foreign currency gain and will have Sf2,000 of net foreign currency gain characterized as passive foreign personal holding company income under section 954(c)(1)(D). § 1.987–7 [Redesignated as § 1.987–7B] 12. Section 1.987–7 is redesignated as § 1.987–7B. ■ 13. Section 1.987–7A is added to read as follows: ■ § 1.987–7A Partnerships and S corporations that own section 987 QBUs. (a) Scope and special rule—(1) In general. This section provides rules applicable to partnerships (other than section 987 aggregate partnerships) and S corporations that own section 987 QBUs and their partners and shareholders. Paragraph (b) of this section provides the general rule that partnerships are treated as owners of section 987 QBUs. Paragraph (c) of this section provides special rules that apply to section 987 QBUs owned by partnerships and their partners. Paragraph (d) of this section provides rules for adjusting the partner’s basis in its partnership interest for its section 987 gain or loss allocated from the partnership. Paragraph (e) of this section is reserved for rules regarding the treatment of section 987 gain or loss when a partner transfers or otherwise reduces its interest in a partnership. Paragraph (f) of this section is reserved for special rules regarding the source and character of section 987 gain and loss of a partner with respect to a section 987 QBU owned by a partnership that would apply in addition to § 1.987–6. Paragraph (g) of this section provides that S corporations are treated in the same manner as partnerships for purposes of the section 987 regulations. Paragraph (h) of this section provides examples. (2) References to partnerships are to non-section 987 aggregate partnerships. For purposes of the section 987 regulations, references to ‘‘partnerships’’ are treated as references to partnerships that are not section 987 aggregate partnerships, except where the context otherwise requires. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78186 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (b) Partnerships treated as owners of section 987 QBUs. Except as otherwise provided, the section 987 regulations apply to a partnership that is the owner of a section 987 QBU in the same manner as they apply to other owners of section 987 QBUs. See paragraph (c) of this section and § 1.987–1(b)(1)(ii) (de minimis rule), providing special rules for partnerships that are owners of a section 987 QBU. Thus, for example, if a partnership owns an eligible QBU with a functional currency that is different from the functional currency of the partnership, the eligible QBU is a section 987 QBU, the partnership is its owner, and the unrecognized section 987 gain or loss of the section 987 QBU for a taxable year is determined under § 1.987–4(d) by reference to the functional currency of the partnership and the section 987 QBU. (c) Section 987 QBUs owned by partnerships—(1) Annual allocation of a partnership’s unrecognized section 987 gain or loss to its partners—(i) In general. This paragraph (c)(1) applies to each taxable year of a partnership and with respect to each section 987 QBU of the partnership. A partnership determines its unrecognized section 987 gain or loss for a taxable year under § 1.987–4(d) with respect to each section 987 QBU. The partnership allocates to each partner the partner’s share of the unrecognized section 987 gain or loss for a taxable year with respect to each section 987 QBU. The partnership determines each partner’s share of unrecognized section 987 gain or loss for a taxable year under paragraph (c)(1)(ii) of this section. Each partner translates its share of unrecognized section 987 gain or loss for a taxable year into the partner’s functional currency, if necessary, at the yearly average exchange rate for the partnership’s taxable year. (ii) Determination of partner’s share of unrecognized section 987 gain or loss. A partnership determines a partner’s share of any unrecognized section 987 gain or loss for the taxable year with respect to a section 987 QBU based on the partner’s distributive share of profits or losses with respect to the section 987 QBU for the taxable year, as determined by the partnership agreement. The principles of section 706(d) apply to this determination. (iii) Partner-level attribute. Net unrecognized section 987 gain or loss, deferred section 987 gain or loss, and suspended section 987 loss of a partner that are attributable to a partnership are attributes of the partner (not the partnership). As a result, the section 987 gain or loss cannot be used by the partnership or any other partner, VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 including any person that acquires the partner’s partnership interest (other than in a transaction described in section 381(a)). (2) Net unrecognized section 987 gain or loss with respect to a section 987 QBU is determined at the partner level. A partner determines its net unrecognized section 987 gain or loss with respect to a section 987 QBU owned by a partnership under § 1.987– 4(b) and (c) at the partner level by taking into account the partner’s share of unrecognized section 987 gain or loss with respect to the section 987 QBU owned by a partnership. (3) Recognition (or suspension) of net unrecognized section 987 gain or loss upon remittance. With respect to a section 987 QBU owned by a partnership, a person that is a partner on the last day of the partnership’s taxable year determines the amount of its net unrecognized section 987 gain or loss that is recognized under § 1.987– 5(a) by reference to its net unrecognized section 987 gain or loss with respect to the section 987 QBU (after taking into account the adjustments under paragraphs (c)(1) and (4) of this section) and the partnership’s remittance proportion, as determined under § 1.987–5(a)(2). (4) Deferred section 987 gain or loss and suspended section 987 loss—(i) Loss to the extent of gain rule applied at the partner level. The amount of suspended section 987 loss recognized and taken into account by a partner under § 1.987–11(e) (loss to the extent of gain rule) is determined by reference to section 987 gain recognized by the partner, without regard to whether the section 987 gain is attributable to a section 987 QBU owned by a partnership. (ii) Partner- and partnership-level application of §§ 1.987–11 through 1.987–13—(A) Partner owns an interest in the partnership. During the time in which a partner or its controlled group owns an interest in a partnership from which it was allocated unrecognized section 987 gain or loss, §§ 1.987–11 through 1.987–13 are applied by treating the partnership as the owner, original deferral QBU owner, or original suspended loss QBU owner, as appropriate, and treating the partner’s net unrecognized section 987 gain or loss as deferred section 987 gain or loss or suspended section 987 loss, as appropriate. (B) Termination of partner’s interest in the partnership. If the partner ceases to own an interest in a partnership from which it was allocated unrecognized section 987 gain or loss, then each successor deferral QBU or successor PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 suspended loss QBU of the partnership is retested under § 1.987–12(b) or 1.987– 13(c) and treated as if the partner had transferred the eligible QBU to its actual owner immediately after the partner ceased to own an interest in the partnership. Accordingly, if the owner of the eligible QBU is not a member of the partner’s controlled group, the partner may recognize its deferred section 987 gain or loss or suspended section 987 loss to the extent provided in § 1.987–12(b) or 1.987–13(c). (5) Section 987 elections—(i) Elections made by the partnership. Except as provided in paragraph (c)(6)(ii) of this section, section 987 elections are made by the partnership and apply to the partnership and section 987 gain or loss attributable to the partnership. See section 703(b); see also § 1.987–1(g) (additional rules regarding section 987 elections). (ii) Elections made by partner—(A) Annual recognition election in certain cases. If a person ceases to be a partner in a partnership and becomes an original deferral QBU owner or original suspended loss QBU owner, that person (and not the partnership) may make the annual recognition election under § 1.987–5(b)(2) with respect to its deferred section 987 gain or loss or suspended section 987 loss that was originally attributable to a section 987 QBU of the partnership. (B) Election to recognize pretransition section 987 gain or loss ratably. The election to recognize pretransition section 987 gain or loss ratably over the transition period under § 1.987– 10(e)(5)(ii) is made by a partner, and not the partnership. (d) Basis adjustments—(1) In general. When, and to the extent that, a partner recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss attributable to the partnership, the partner’s adjusted basis in the partnership is adjusted under the principles of section 705 as if the item of income or loss was part of the partner’s distributive share of partnership items. (2) Tiered-partnership structures. If a partner (upper-tier partner) that adjusts its basis in a partnership under paragraph (d)(1) of this section owns the partnership indirectly through one or more other partnerships, the partner adjusts its basis in the partnership in which it owns a direct interest, and that partnership adjusts its basis in the partnership in which it owns a direct interest, with similar rules applying to each successive partnership through which the upper-tier partner owns its interest in the lower-tier partnership to which the section 987 gain or loss was E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules attributable. The adjustment with respect to an interest in a lower-tier partnership constitutes a basis adjustment solely with respect to the partner that adjusts its basis in the upper-tier partnership under paragraph (d)(1) of this section. (e) through (f) [Reserved] (g) S corporations treated as partnerships. For purposes of the section 987 regulations, S corporations are treated in the same manner as partnerships and shareholders of S corporations are treated in the same manner as partners of partnerships. Thus, for example, if an S corporation is the owner of a section 987 QBU, the unrecognized section 987 gain or loss of the section 987 QBU would be allocated annually to its shareholders. (h) Examples. The following examples illustrate the principles of this section. For purposes of these examples, DC1 and DC2 are domestic corporations, FC1 and FC2 are controlled foreign corporations that use the euro as their functional currency, DE1 and DE2 are disregarded entities, Business A is an eligible QBU that has the euro as its functional currency, and Business B is an eligible QBU that has the pound as its functional currency. Each person is a calendar year taxpayer. Except as otherwise indicated, no section 987 elections are in effect during any of the periods described in the examples. Exchange rates used in these examples are selected for the purpose of illustrating the principles of this section and no inference is intended by their use. (1) Example 1—(i) Facts. DC1 wholly owns FC1 and DC2 wholly owns FC2. FC1 and FC2 are not related within the meaning of section 267(b) or 707(b). FC1 and FC2 each own a 50 percent interest in P, a foreign partnership. P owns 100 percent of DE1, which owns Business A. P also owns 100 percent of DE2, which owns Business B. The partnership agreement provides that FC1 and FC2 will each be allocated 50 percent of the profits and losses from both Business A and Business B. P’s functional currency is the euro. (ii) Analysis. Because P’s two partners, FC1 and FC2, are not related within the meaning of section 267(b) or 707(b), P is not treated as a section 987 aggregate partnership under § 1.987– 1(h). As a result, pursuant to § 1.987– 1(b)(5), P is the owner of Business A and Business B because it has direct ownership of Business A and Business B, each of which is an eligible QBU. Because Business A is an eligible QBU with the same functional currency as its owner, P, Business A is not a section 987 QBU § 1.987–1(b)(3)(i). However, VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Business B is an eligible QBU with a functional currency that is different from the functional currency of its owner, P. As a result, Business B is a section 987 QBU under § 1.987– 1(b)(3)(i), and P is its owner under § 1.987–1(b)(5) and paragraph (b) of this section. (2) Example 2—(i) Facts. The facts are the same as in paragraph (h)(1) of this section (Example 1). In year 1, P has unrecognized section 987 gain (determined under § 1.987–4(d)) with respect to Business B of Ö100. In year 2, P has unrecognized section 987 loss with respect to Business B of Ö60. In year 3, P has unrecognized section 987 loss with respect to Business B of Ö120. In year 3, Business B transfers Ö50 to P on December 31. Following the transfer, its gross assets are Ö450. There are no other transfers between Business B and P in year 3. (ii) Analysis—(A) Partner’s net unrecognized section 987 gain or loss. Pursuant to paragraph (c)(1) of this section, in each of years 1, 2, and 3, P allocates to FC1 and FC2 their respective shares of the unrecognized section 987 gain or loss for the P taxable year with respect to its section 987 QBU, Business B. FC1 and FC2’s share of the unrecognized section 987 gain or loss in each taxable year is based on their distributive share of the profits or losses with respect to Business B. Accordingly, in year 1, P allocates unrecognized section 987 gain of Ö50 to each of FC1 and FC2; in year 2, P allocates unrecognized section 987 loss of Ö30 to each of FC1 and FC2; and in year 3, P allocates unrecognized section 987 loss of Ö60 to each of FC1 and FC2. As a result, in year 3, before taking into account any amount recognized under § 1.987–5, FC1 and FC2 each have net unrecognized section 987 loss with respect to Business B of Ö40 (Ö50¥Ö30¥Ö60) under § 1.987–4(b) and paragraphs (c)(1) and (2) of this section. (B) Recognition of section 987 loss. Because Business A distributed Ö50 to P in year 3, P’s remittance proportion is 10 percent (Ö50 over the sum of Ö450 and Ö50) under § 1.987–5(b). As a result, each partner, FC1 and FC2, recognizes 10 percent of its net unrecognized section 987 loss with respect to Business B under § 1.987–5(a) and paragraph (c)(3) of this section. Accordingly, FC1 and FC2 each recognize Ö4 (Ö40 × 10 percent) section 987 loss in year 3 and have net accumulated unrecognized section 987 loss of Ö36 (Ö40¥Ö4) in year 4. FC1’s adjusted basis in its partnership interest is reduced by Ö4 and FC2’s adjusted basis in its partnership interest is reduced by Ö4 under the principles of PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 78187 section 705, under paragraph (d)(1) of this section. (3) Example 3—(i) The facts are the same as in paragraph (h)(2) of this section (Example 2), except that in years 1 through 3, FC1 has a current rate election in effect and FC2 has an annual recognition election in effect. (ii) Analysis. The analysis is the same as in paragraph (h)(2) of this section (Example 2). Because P does not have a current rate election in effect, FC1 can recognize the section 987 loss of Ö4 in year 3 without limitation under § 1.987– 11(e) pursuant to paragraph (c)(5)(i) of this section. Similarly, because P does not have an annual recognition election in effect, while FC2 is a partner in P, FC2 does not recognize its section 987 gain or loss with respect to Business B on an annual basis pursuant to paragraphs (c)(5)(i) and (c)(5)(ii)(A) of this section. (4) Example 4—(i) Facts. The facts are the same as in paragraph (h)(2) of this section (Example 2), except that FC2 has the Japanese yen as its functional currency during all relevant time periods. The yearly average exchange rate is Ö1 = ¥150 in year 1; Ö1 = ¥175 in year 2; and Ö1 = ¥125 in year 3. (ii) Analysis. Each year, FC2 converts its share of P’s unrecognized section 987 gain or loss into yen at the yearly average exchange rate pursuant to paragraph (c)(1)(i) of this section. As a result, in year 1, FC2’s share of the unrecognized section 987 gain with respect to Business B is ¥7,500 (Ö50 section 987 gain converted to yen at the yearly average exchange rate of Ö1 = ¥150); in year 2, FC2’s share of the unrecognized section 987 loss with respect to Business B is ¥5,250 (Ö30 section 987 loss converted to yen at the yearly average exchange rate of Ö1 = ¥175); and in year 3, FC2’s share of the unrecognized section 987 loss with respect to Business B is ¥7,500 (Ö60 section 987 loss converted to yen at the yearly average exchange rate of Ö1 = ¥125). In year 3, FC2’s net unrecognized section 987 loss with respect to Business B is ¥5,250 (¥7,500¥¥5,250¥¥7,500). As explained in paragraph (h)(2)(i)(B) of this section (Example 2), P’s remittance proportion with respect to Business B is 10 percent. Therefore, FC2 recognizes section 987 loss of ¥525 under § 1.987–5(a) and paragraph (c)(3) of this section. FC2’s net accumulated unrecognized section 987 loss with respect to Business B in year 4 is ¥4,725 (¥5250¥¥525). FC2’s adjusted basis in its partnership interest is reduced by ¥525 under the principles of section 705, under paragraph (d)(1) of this section. E:\FR\FM\14NOP3.SGM 14NOP3 78188 § 1.987–7B Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules [Amended] 14. In newly redesignated § 1.987–7B amend paragraph (a) by removing the language ‘‘§ 1.987–1(b)(4)(ii)’’ and adding the language ‘‘§ 1.987– 1(b)(5)(ii)’’ in its place. ■ 15. Section 1.987–7C is added to read as follows: ■ khammond on DSKJM1Z7X2PROD with PROPOSALS3 § 1.987–7C Transitioning between partnership and section 987 aggregate partnership treatment. (a) In general. This section provides rules for when a partnership becomes or ceases to be a section 987 aggregate partnership. Paragraph (b) of this section provides transition rules regarding partnerships that cease to be section 987 aggregate partnerships but continue to be partnerships. Paragraph (c) of this section provides transition rules regarding partnerships that were not section 987 aggregate partnerships but become section 987 aggregate partnerships. See § 1.987–1(h) for the definition of a section 987 aggregate partnership. (b) Partnership ceases to be a section 987 aggregate partnership—(1) In general. Solely for purposes of section 987, when a partnership ceases to be a section 987 aggregate partnership but continues to be a partnership, each eligible QBU (pre-termination QBU) of a partner owned indirectly through the section 987 aggregate partnership is deemed to terminate and transfer all its assets and liabilities to the partnership (the deemed termination) and the partnership is then treated as forming each of its eligible QBUs (each, a posttermination QBU) and transferring to each post-termination QBU the assets and liabilities of the post-termination QBU (including those assets and liabilities that were assets and liabilities of a pre-termination QBU). (2) Section 987 gain or loss with respect to pre-termination QBU. Notwithstanding the deemed termination described in paragraph (b)(1) of this section, if, immediately before the deemed termination, a partner had any net unrecognized section 987 gain or loss or suspended section 987 loss with respect to a pretermination QBU that was a section 987 QBU, and after the deemed termination, the assets and liabilities of the pretermination QBU are assets and liabilities of a post-termination QBU, then either paragraph (b)(2)(i) or (ii) of this section applies. (i) Post-termination QBU is a section 987 QBU. If the post-termination QBU is a section 987 QBU, then— (A) Section 1.987–12 (deferral of section 987 gain and loss) does not apply to the deemed termination; and VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (B) The partner’s net unrecognized section 987 gain or loss or suspended section 987 loss with respect to the pretermination QBU is not recognized and instead becomes net unrecognized section 987 gain or loss or suspended section 987 loss with respect to the posttermination QBU that is treated as having been allocated to the partner by the partnership. (ii) Post-termination QBU is not a section 987 QBU. If paragraph (b)(2)(i) of this section does not apply, then § 1.987–13 (rules relating to suspended section 987 loss upon termination) is applied to the transactions described in paragraph (b)(1) of this section as if the partner had transferred the assets and liabilities of the pre-termination QBU to the partnership. Thus, if the partner had suspended section 987 loss with respect to the pre-termination QBU, § 1.987– 13(b) may apply to the deemed transfer and the post-termination QBU may be a successor suspended loss QBU. See §§ 1.987–5, 1.987–8, 1.987–11, and 1.987–13 for rules regarding when section 987 gain or loss is recognized on terminations. (3) Successor deferral QBUs and successor suspended loss QBUs. If a section 987 aggregate partnership ceases to be a section 987 aggregate partnership (the transition)— (i) If any pre-termination QBU was a successor deferral QBU before the transition, the successor deferral QBU is treated as transferring its assets and liabilities to the post-termination QBU that holds the assets and liabilities after the transition for purposes of §§ 1.987– 12 and 1.987–13. See § 1.987–12(c)(2). (ii) If any pre-termination QBU was a successor suspended loss QBU before the transition, the successor suspended loss QBU is treated as transferring its assets and liabilities to the posttermination QBU that hold the assets and liabilities after the transition for purposes of § 1.987–13. See § 1.987– 13(c). (4) Timing. If a partnership ceases to be a section 987 aggregate partnership within the meaning of § 1.987–1(h), the partnership continues to be treated as a section 987 aggregate partnership until this paragraph (b) is applied. This paragraph (b) is applied immediately after the transaction (or series of transactions) or event (or series of events) that causes the partnership to cease to be a section 987 aggregate partnership (the transition). Thus, for example, if person acquires an interest in a section 987 aggregate partnership from a partner, and the person is not related to the other partners within the meaning of section 267(b) or 707(b), first the section 987 regulations (such as PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 § 1.987–2(c)(5)) are applied to the transition as if the partnership continued to be a section 987 aggregate partnership; then this paragraph (b) applies to the partnership and its partners (including the acquiring partner) and the partnership ceases to be a section 987 aggregate partnership. (c) Partnership becomes a section 987 aggregate partnership—(1) In general. Solely for purposes of section 987, when a partnership that was not a section 987 aggregate partnership becomes a section 987 aggregate partnership, each eligible QBU (pre-termination QBU) of the partnership is deemed to terminate and transfer all of its assets and liabilities to the partnership (the deemed termination) and the partnership is treated as forming each eligible QBU (post-termination QBU) that is indirectly owned by a partner (the partner-owner) and transferring to each post-termination QBU the partnerowner’s share of the assets and liabilities of the partnership’s eligible QBU . (2) Section 987 gain or loss with respect to pre-termination QBU. Notwithstanding the deemed termination described in paragraph (c)(1) of this section, if a partner-owner had any net unrecognized section 987 gain or loss or suspended section 987 loss with respect to a pre-termination QBU that was a section 987 QBU, then either paragraph (c)(2)(i) or (ii) of this section applies. (i) Post-termination QBU is a section 987 QBU. If, after the deemed termination, the partner-owner’s indirectly owned post-termination QBU that relates to its share of the assets and liabilities of the pre-termination QBU is a section 987 QBU of the partner-owner, then— (A) Section 1.987–12 does not apply to the deemed termination of the pretermination QBU; and (B) The partner-owner’s net unrecognized section 987 gain or loss or suspended section 987 loss with respect to the pre-termination QBU is not recognized and instead becomes net unrecognized section 987 gain or loss or suspended section 987 loss with respect to the post-termination QBU. (ii) Post-termination QBU is not a section 987 QBU. If paragraph (c)(2)(i) of this section does not apply, then paragraphs (c)(2)(ii)(A) and (B) of this section are applied sequentially. (A) First, paragraph (c)(2)(i) of this section is applied as if the posttermination QBU was a section 987 QBU (the deemed section 987 QBU) after the deemed termination. (B) Second, the section 987 regulations are applied as if the deemed E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section 987 QBU had transferred its assets and liabilities to the posttermination QBU. Thus, if the partnerowner had suspended section 987 loss with respect to the pre-termination QBU, § 1.987–13(b) may apply to the deemed transfer and the posttermination QBU may be a successor suspended loss QBU. See §§ 1.987–5, 1.987–8, 1.987–11, and 1.987–13 for rules regarding when section 987 gain or loss is recognized on terminations. (3) Successor deferral QBUs and successor suspended loss QBUs. If a partnership that was not a section 987 aggregate partnership becomes a section 987 aggregate partnership (the transition)— (i) If the partnership owned any successor deferral QBUs before the transition, each successor deferral QBU is treated as transferring its assets and liabilities to the indirectly owned QBUs that hold the assets and liabilities after the transition for purposes of §§ 1.987– 12 and 1.987–13. See § 1.987–12(c)(2). (ii) If the partnership owned any successor suspended loss QBUs before the transition, each successor suspended loss QBU is treated as transferring its assets and liabilities to the indirectly owned QBUs that hold the assets and liabilities after the transition for purposes of § 1.987–13. See § 1.987–13(c). (iii) If the partnership was an original deferral QBU owner with respect to a successor deferral QBU before the transition, each partner that has deferred section 987 gain or loss with respect to the successor deferral QBU becomes an original deferral QBU owner with respect to the successor deferral QBU for purposes of § 1.987–12. (iv) If the partnership was an original suspended loss QBU owner with respect to a successor suspended loss QBU before the transition, each partner that has suspended section 987 loss with respect to the successor suspended loss QBU becomes an original suspended loss QBU owner with respect to the successor suspended loss QBU. (4) Timing. If a partnership that was not a section 987 aggregate partnership becomes a section 987 aggregate partnership within the meaning of § 1.987–1(h), the partnership is not treated as a section 987 aggregate partnership until this paragraph (c) is applied. This paragraph (c) is applied immediately after the transaction (or series of transactions) or event (or series of events) that causes the partnership to become a section 987 aggregate partnership (the transition). Thus, for example, if a person acquires an interest in a partnership that is not a section 987 aggregate partnership from a partner, VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 and as a result of the acquisition, all of the partners are related within the meaning of section 267(b) or 707(b), first the section 987 regulations (such as § 1.987–7A(e)) are applied to the transition as if the partnership was not a section 987 aggregate partnership; then this paragraph (c) applies to the partnership and its partners (including the acquiring partner) and the partnership becomes a section 987 aggregate partnership. ■ 16. Section 1.987–8 is amended by: ■ a. Adding a fourth sentence after the third sentence in paragraph (a); ■ b. Revising paragraph (b) introductory text; ■ c. In paragraph (b)(2) in the second sentence removing the language ‘‘shall be’’ and adding the language ‘‘is’’ in its place and revising the last sentence; ■ d. In paragraph (b)(3) in the first sentence removing the language ‘‘(as defined in section 957)’’; ■ e. Adding paragraphs (b)(5) and (6); ■ f. Revising paragraph (c); ■ g. In paragraph (d) removing the text ‘‘For further guidance, see § 1.987– 8T(d)’’; h. Revising the second and third sentences in paragraph (e); ■ i. Designating Examples 1 through 7 of paragraph (f) as paragraphs (f)(1) through (7). ■ j. In newly designated paragraph (f)(1): ■ i. Removing the language ‘‘2021’’ wherever it appears and adding the language ‘‘year 1’’ in its place; and ■ ii. Removing the language ‘‘2022’’ wherever it appears and adding the language ‘‘year 2’’ in its place; ■ k. Adding the language ‘‘the’’ before ‘‘Business A section 987 QBU’’ in the last sentence of newly designated paragraph (f)(1)(ii); ■ l. Revising newly designated paragraph (f)(3); ■ m. In newly designated paragraph (f)(4)(i), removing the language ‘‘transfers’’ and adding the language ‘‘distributes’’ in its place; ■ n. Removing and reserving newly designated paragraph (f)(5); ■ o. In newly designated paragraph (f)(6): ■ i. Removing the language ‘‘2021’’ wherever it appears and adding the language ‘‘year 1’’ in its place; and ■ ii. Removing the language ‘‘2026’’ wherever it appears and adding the language ‘‘year 6’’ in its place; ■ p. In newly designated paragraph (f)(6)(ii)(A), removing the language ‘‘§ 1.987–1(b)(4)(i)’’ and adding the language ‘‘§ 1.987–1(b)(5)’’ in its place. The revisions and additions read as follows: PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 § 1.987–8 QBU. 78189 Termination of a section 987 (a) * * * Paragraph (d) of this section is reserved. * * *. (b) In general. Except as provided in paragraph (c) of this section, a section 987 QBU terminates if the conditions described in any one of paragraphs (b)(1) through (6) of this section are satisfied. * * * * * (2) * * * See paragraphs (f)(2), (5), and (6) of this section (Examples 2, 5, and 6). * * * * * (5) Section 987 QBU ceases to be an eligible QBU with a functional currency different from its owner. The section 987 QBU ceases to be an eligible QBU that has a functional currency different from its owner. See also § 1.985–5(d)(2) (section 987 QBU changes its functional currency to that of its owner) and (e)(4)(iii) (owner changes its functional currency to that of its section 987 QBU). (6) Change in form of ownership. The owner of the section 987 QBU changes its form of ownership of the section 987 QBU from direct ownership to indirect ownership, or from indirect ownership to direct ownership. (c) Transactions described in section 381(a)—(1) Liquidations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner (distributor) of a section 987 QBU ceases to exist in a liquidation described in section 332 pursuant to which it transfers the section 987 QBU to another corporation (distributee), except in the following cases: (i) The distributor is a domestic corporation and the distributee is a foreign corporation. (ii) The distributor is a foreign corporation and the distributee is a domestic corporation. (iii) The distributor and the distributee are both foreign corporations and the functional currency of the distributee is the same as the functional currency of the distributor’s section 987 QBU. (2) Reorganizations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner (transferor) of the section 987 QBU ceases to exist in a reorganization described in section 381(a)(2) pursuant to which it transfers the section 987 QBU to another corporation (acquiring corporation), except in the following cases: (i) The transferor is a domestic corporation and the acquiring corporation is a foreign corporation. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78190 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (ii) The transferor is a foreign corporation and the acquiring corporation is a domestic corporation. (iii) The transferor is a controlled foreign corporation immediately before the transfer, the acquiring corporation is a foreign corporation that is not a controlled foreign corporation immediately after the transfer, and the acquiring corporation was related to the transferor within the meaning of section 267(b) immediately before the transfer. (iv) The transferor and the acquiring corporation are foreign corporations and the functional currency of the acquiring corporation is the same as the functional currency of the transferor’s section 987 QBU. * * * * * (e) * * * Thus, except as otherwise provided in the section 987 regulations, a termination generally results in the recognition of any net unrecognized section 987 gain or loss of the section 987 QBU (unless it is treated as deferred section 987 gain or loss or suspended section 987 loss). See §§ 1.987–5(c)(3) (generally recognizing section 987 gain or loss on a termination) and 1.987–11 through 1.987–13 (suspending section 987 gain or loss and deferring section 987 loss in certain instances). (f) * * * (3) Example 3. Cessation of controlled foreign corporation status—(i) Facts. Foreign parent (FP) is a foreign corporation that owns all the stock of U.S. Corp, a domestic corporation. U.S. Corp owns all of the stock of FC, a controlled foreign corporation as defined in section 957. FC is the owner of Business A. U.S. Corp liquidates into FP. FC no longer constitutes a controlled foreign corporation after the liquidation. (ii) Analysis. Because FC ceases to qualify as a controlled foreign corporation as a result of a transaction after which persons that were related to FC within the meaning of section 267(b) immediately before the transaction collectively own sufficient interests in FC such that FC would continue to be considered a controlled foreign corporation if such persons were United States shareholders within the meaning of section 951(b), the Business A section 987 QBU terminates pursuant to paragraph (b)(3) of this section. * * * * * ■ 17. Section 1.987–9 is revised to read as follows: § 1.987–9 Recordkeeping requirements. (a) In general. An owner (or the authorized person on behalf of an owner) must keep a copy of each section 987 election made by or on behalf of an VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 owner (if not required to be made on a form published by the Commissioner) and reasonable records sufficient to establish a section 987 QBU’s taxable income or loss and section 987 gain or loss. (b) Supplemental information. A person’s obligation to maintain records under section 6001 and paragraph (a) of this section is not satisfied unless the following information is maintained in those records with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU for each taxable year: (1) The amount of the items of income, gain, deduction, or loss attributed to the section 987 QBU in the functional currency of the section 987 QBU and its owner. (2) The adjusted balance sheet of the section 987 QBU in the functional currency of the section 987 QBU and its owner. (3) The exchange rates used to translate items of income, gain, deduction, or loss of the section 987 QBU into the owner’s functional currency and, if a spot rate convention is used, the manner in which the convention is determined. (4) The exchange rates used to translate the assets and liabilities of the section 987 QBU into the owner’s functional currency and, if a spot rate convention is used, the manner in which the convention is determined. (5) The amount of assets and liabilities transferred by the owner to the section 987 QBU determined in the functional currency of the owner. (6) The amount of assets and liabilities transferred by the section 987 QBU to the owner determined in the functional currency of the owner. (7) The amount of the unrecognized section 987 gain or loss for the taxable year. (8) The amount of the net accumulated unrecognized section 987 gain or loss at the close of the taxable year. (9) The amount of a remittance and the remittance proportion for the taxable year. (10) The computations required under §§ 1.861–9(g) and 1.861–9T(g) for purposes of sourcing and characterizing section 987 gain or loss, deferred section 987 gain or loss, or suspended section 987 loss under § 1.987–6. (11) The cumulative suspended section 987 loss in each recognition grouping. (12) The outstanding deferred section 987 gain or loss in each recognition grouping. PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 (13) The transition information required to be determined under § 1.987–10(k). (c) Retention of records. The records required by this section, or records that support the information required on a form published by the Commissioner regarding section 987, must be maintained and kept available for inspection by the Internal Revenue Service for so long as the contents thereof may become relevant in the administration of the Internal Revenue Code. (d) Information on a dedicated section 987 form. Information necessary to determine section 987 gain or loss and section 987 taxable income or loss must be reported on a form prescribed for that purpose in accordance with the instructions accompanying that form. A taxpayer satisfies its obligation described in paragraphs (a) and (b) of this section to the extent that the taxpayer provides the specific information required on Form 8858 (or its successor) or other form prescribed for this purpose (including the information required by the instructions accompanying those forms). ■ 18. Section 1.987–10 is revised to read as follows: § 1.987–10 Transition rules. (a) Overview—(1) In general. This section provides transition rules for the first taxable year in which the section 987 regulations apply. This paragraph (a) provides an overview of this section. Paragraph (b) of this section describes the scope of this section’s application. Paragraph (c) of this section provides rules for determining the transition date. Paragraph (d) of this section provides rules relating to the application of the section 987 regulations after the transition date. Paragraph (e) of this section provides rules relating to the determination and recognition of pretransition gain or loss. Paragraph (f) of this section provides special rules for section 987 QBUs to which the fresh start transition method was applied. Paragraph (g) of this section provides transition rules relating to partnerships. Paragraph (h) of this section provides rules relating to the source and character of pretransition gain or loss. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides adjustments to avoid double counting or omissions. Paragraph (k) of this section provides reporting requirements that apply in the taxable year beginning on the transition date. Paragraph (l) of this section provides examples illustrating the rules of this section. (2) Terms defined under prior § 1.987– 12. For purposes of this section, the E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules terms deferral QBU, deferral QBU owner, successor QBU, outbound loss QBU, outbound section 987 loss, and qualified successor have the meaning provided in prior § 1.987–12. (b) Scope—(1) Owner of a section 987 QBU. Except as provided in paragraph (f) of this section, any person that is an owner of a section 987 QBU on the applicable transition date must apply the rules of this section with respect to the section 987 QBU. (2) Deferral QBU owner and owner of outbound loss QBU. Except as provided in paragraph (f) of this section, a deferral QBU owner or the owner of an outbound loss QBU must apply the rules of this section with respect to the deferral QBU or outbound loss QBU if the deferral event or outbound loss event occurred before the applicable transition date. (c) Transition date—(1) In general. Except as provided in paragraph (c)(2) of this section, the transition date for a section 987 QBU, deferral QBU, or outbound loss QBU is the first day of the first taxable year described in § 1.987–14(a)(1), (b), or (c) to which this section applies. (2) Terminating QBU. With respect to a terminating QBU, the transition date is the termination date, and this section is applied immediately before the termination. Until the transition date described in paragraph (c)(1) of this section, the owner of the terminating QBU must apply the section 987 regulations with respect to the terminating QBU, and any section 987 gain or loss attributable thereto, without regard to any section 987 elections. (d) Application of the section 987 regulations after the transition date—(1) Owner functional currency net value on the last day of the preceding taxable year. Except as provided in paragraph (f) of this section, for purposes of applying § 1.987–4 in the taxable year beginning on the transition date, the owner functional currency net value of a section 987 QBU on the last day of the preceding taxable year under § 1.987– 4(d)(1)(B) is determined by translating the assets and liabilities that are attributable to the section 987 QBU on the day before the transition date into the owner’s functional currency at the spot rate applicable to the day before the transition date. (2) Determination of historic rate and adjustments required under the simplified inventory method. If a current rate election is not in effect for the taxable year beginning on the transition date, the historic rate for historic items that are attributable to a section 987 QBU on the day before the transition date (other than non-LIFO inventory VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 subject to the simplified inventory method under § 1.987–3(c)(2)(iv)(A)) is the spot rate applicable to the day before the transition date. The exchange rates used to apply § 1.987–3(c)(3) (adjustments required under the simplified inventory method) are determined as though a current rate election was in effect for the previous taxable year and was revoked for the taxable year beginning on the transition date. (e) Pretransition gain or loss--(1) In general. Except as provided in paragraph (f) of this section, pretransition gain or loss is determined and recognized under this paragraph (e). (2) Amount of pretransition gain or loss for an owner that applied an eligible pretransition method—(i) Owner of a section 987 QBU. If an owner of a section 987 QBU applied an eligible pretransition method with respect to the section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. See paragraphs (l)(1) through (3) of this section (Examples 1 through 3) for an illustration of this rule. (A) Deemed termination amount. The deemed termination amount is the amount of section 987 gain or loss that would have been recognized by the owner under the eligible pretransition method if the section 987 QBU terminated and transferred all of its assets and liabilities to the owner on the day before the transition date and prior § 1.987–12 did not apply. (B) Owner functional currency net value adjustment. The owner functional currency net value adjustment may be either positive or negative and is equal to the amount described in paragraph (e)(2)(i)(B)(1) of this section reduced by the amount described in paragraph (e)(2)(i)(B)(2) of this section. (1) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner’s functional currency at the spot rate applicable to the day before the transition date. (2) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner’s functional currency at the pretransition translation rate on the day before the transition date. (C) Pretransition translation rate. The pretransition translation rate is the rate PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 78191 that would be used under the eligible pretransition method to determine the basis of an asset or the amount of a liability in the hands of the owner of a section 987 QBU if the section 987 QBU transferred all of its assets and liabilities to the owner. (ii) Deferral QBU owner. If a deferral QBU owner applied an eligible pretransition method with respect to the deferral QBU, the amount of pretransition gain or loss with respect to the deferral QBU is equal to the deferred section 987 gain or loss (determined under prior § 1.987–12) that was not recognized before the transition date with respect to the deferral QBU. (iii) Owner of an outbound loss QBU. If the owner of an outbound loss QBU applied an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the outbound section 987 loss that was not added to the basis of stock or recognized under prior § 1.987–12 before the transition date with respect to the outbound loss QBU. (3) Amount of pretransition gain or loss for an owner that did not apply an eligible pretransition method—(i) In general. If the owner of a section 987 QBU did not apply an eligible pretransition method with respect to a section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is determined under paragraph (e)(3)(ii) of this section. See paragraph (l)(4) of this section (Example 4) for an illustration of this rule. (ii) Computation of pretransition gain or loss. With respect to a section 987 QBU described in paragraph (e)(3)(i) of this section, pretransition gain or loss is equal to the amount described in paragraph (e)(3)(ii)(A) of this section reduced by the amount described in paragraph (e)(3)(ii)(B) of this section. (A) The sum of the owner’s annual unrecognized section 987 gain or loss determined under paragraph (e)(3)(iii) of this section with respect to the section 987 QBU for all taxable years ending before the transition date in which it was the owner of the section 987 QBU. (B) The total net amount of section 987 gain or loss recognized by the owner with respect to the section 987 QBU in all taxable years ending before the transition date. (iii) Annual unrecognized section 987 gain or loss. An owner of a section 987 QBU described in paragraph (e)(3)(i) of this section determines annual unrecognized section 987 gain or loss with respect to a section 987 QBU under the rules of § 1.987–4(d), applied as though a current rate election was in E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78192 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules effect for all relevant taxable years, and subject to the following modifications— (A) Only § 1.987–4(d)(1) and (10) (steps 1 and 10) are applied; (B) Section 1.987–4(d)(10) is applied by replacing ‘‘paragraphs (d)(1) through (9)’’ with ‘‘paragraph (d)(1).’’ (iv) Deferral QBU owner. If a deferral QBU owner did not apply an eligible pretransition method with respect to the deferral QBU, the pretransition gain or loss with respect to the deferral QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the deferral QBU if the transition date was the day of the deferral event, reduced by the amount of deferred section 987 gain or loss (determined under prior § 1.987– 12) recognized before the actual transition date. (v) Owner of an outbound loss QBU. If the owner of an outbound loss QBU did not apply an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the outbound loss QBU if the transition date was the day of the outbound loss event, reduced by any outbound section 987 loss recognized or added to the basis of stock under prior § 1.987–12 before the actual transition date. (4) Eligible pretransition method. An eligible pretransition method means a method of applying section 987 before the transition date that is described in paragraphs (e)(4)(i) through (iii) of this section. An owner is treated as applying an eligible pretransition method with respect to a section 987 QBU only if it applied an eligible pretransition method with respect to each taxable year beginning before the transition date in which it was the owner of the section 987 QBU and any permissible change in pretransition method was applied in a reasonable manner that would not result in income, gain, deduction, or loss (including section 987 gain or loss) being taken into account more than once or not being taken into account. (i) Earnings and capital method. An earnings and capital method is an eligible pretransition method if it is applied in a reasonable manner. For purposes of this paragraph (e)(4)(i), an earnings and capital method means a method of applying section 987 that requires section 987 gain or loss to be determined and recognized with respect to both the earnings of the section 987 QBU and capital contributed to the section 987 QBU (for example, the method prescribed in the 1991 proposed regulations under section 987). See VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 paragraph (l)(1) of this section (Example 1) for an illustration of this rule. (ii) Other reasonable methods. Any reasonable method of applying section 987 is an eligible pretransition method if it produces the same total amount of income over the life of the owner of a section 987 QBU as the method described in paragraph (e)(4)(i) of this section (taking into account the aggregate of section 987 gain or loss, section 987 taxable income or loss, and income or loss recognized by the owner of the section 987 QBU with respect to property transferred between the section 987 QBU and the owner or any QBU of the owner). See paragraph (l)(2) of this section (Example 2) for an illustration of this rule. (iii) Other earnings only methods. An earnings only method (which determines section 987 gain or loss only with respect to the earnings of a section 987 QBU) that does not meet the requirements of paragraph (e)(4)(ii) of this section is an eligible pretransition method, provided that— (A) The earnings only method was first applied by the owner on a return filed before November 9, 2023; (B) The earnings only method was applied consistently to all section 987 QBUs of the owner; and (C) The owner of the section 987 QBU otherwise applies section 987 in a reasonable manner. See paragraph (l)(3) of this section (Example 3) for an illustration of this rule. (iv) Reasonable method must require recognition of section 987 gain or loss upon a transfer of property from the section 987 QBU. For purposes of this paragraph (e)(4), a method of applying section 987 is not reasonable unless the owner of the section 987 QBU recognizes section 987 gain or loss upon a transfer of property from the section 987 QBU to the owner (or recognizes section 987 gain or loss on an annual basis). Therefore, a method under which the owner of a section 987 QBU defers the recognition of section 987 gain or loss until the section 987 QBU is terminated, sold, or liquidated is not a reasonable method. (v) Anti-abuse rule. If an owner changes its pretransition method of applying section 987 with a principal purpose of reducing its pretransition gain or increasing its pretransition loss, the Commissioner may redetermine pretransition gain or loss based on the owner’s original method of applying section 987 or by treating the owner as not applying an eligible pretransition method. (5) Recognition of pretransition gain or loss—(i) In general. Except as PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 provided in paragraph (e)(5)(ii) of this section— (A) Pretransition gain with respect to a section 987 QBU is treated as net accumulated unrecognized section 987 gain (within the meaning of § 1.987– 4(c)). Pretransition gain with respect to a deferral QBU is treated as deferred section 987 gain and is attributed to one or more successor deferral QBUs under the principles of § 1.987–12(b)(2) and (c)(2). (B) Pretransition loss with respect to a section 987 QBU, a deferral QBU, or an outbound loss QBU is treated as suspended section 987 loss with respect to the section 987 QBU, the deferral QBU, or the outbound loss QBU. In the case of a deferral QBU or outbound loss QBU, suspended section 987 loss is attributed to one or more successor suspended loss QBUs under the principles of § 1.987–13(b)(1) and (c)(1). (ii) Election to recognize pretransition section 987 gain or loss ratably over the transition period—(A) In general. A taxpayer may elect to recognize pretransition gain or loss ratably over the transition period. If an election is made to recognize pretransition gain or loss ratably over the transition period, then paragraph (e)(5)(i) of this section does not apply, and each owner to which the election applies recognizes one tenth of its pretransition gain or loss with respect to each section 987 QBU, original deferral QBU, and outbound loss QBU in each taxable year for ten taxable years beginning with the taxable year that begins on the transition date. See § 1.987–1(g) for rules relating to section 987 elections (including consistency rules). (B) Special rules for inbound or outbound section 381(a) transactions— (1) Scope. This paragraph (e)(5)(ii)(B) applies if a corporation (acquiring corporation) acquires the assets of an owner that is subject to an election under paragraph (e)(5)(ii)(A) of this section in a transaction described in section 381(a), and either the owner is a foreign corporation and the acquiring corporation is a domestic corporation or the owner is a domestic corporation and the acquiring corporation is a foreign corporation. (2) Recognition of pretransition gain or loss. In the case of a transaction described in paragraph (e)(5)(ii)(B)(1) of this section, pretransition gain or loss that has not been recognized under paragraph (e)(5)(ii)(A) of this section ceases to be subject to the election to be recognized ratably over the transition period. Any unrecognized pretransition gain is recognized immediately before the transaction, and any unrecognized pretransition loss becomes suspended E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section 987 loss immediately before the transaction. As a result, the suspended section 987 loss may be recognized to the extent of section 987 gain recognized in the same recognition grouping pursuant to § 1.987–11(e). See also § 1.987–13(g) (providing that any remaining suspended section 987 loss does not carry over to the acquiring corporation upon an inbound transaction to which section 381(a) applies). (6) Predecessor of an owner—(i) In general. For purposes of this paragraph (e), references to an owner of a section 987 QBU, an original deferral QBU owner, and the owner of an outbound loss QBU include a predecessor described in paragraph (e)(6)(ii) of this section. (ii) Predecessor. If a corporation (acquiring corporation) becomes the owner of a section 987 QBU in a transaction described in section 381(a) in which the section 987 QBU does not terminate, the corporation that was the owner of the section 987 QBU immediately before the transaction is a predecessor of the acquiring corporation. If a corporation (acquiring corporation) becomes a qualified successor of a deferral QBU owner or the owner of an outbound loss QBU (each, a transferor corporation), the transferor corporation is a predecessor of the acquiring corporation. A predecessor of a corporation includes the predecessor of a predecessor of the corporation. (f) QBUs to which the fresh start transition method was applied—(1) In general. Paragraphs (d) and (e) of this section do not apply with respect to any section 987 QBU, deferral QBU, or outbound loss QBU with respect to which the taxpayer applied the rules of prior § 1.987–10 (or applied § 1.987–10 of the 2006 proposed regulations in a reasonable manner) on a return filed before November 9, 2023 or pursuant to paragraph (f)(3) of this section. (2) Application of the section 987 regulations after the transition date—(i) Owner functional currency net value on the last day of the preceding taxable year. For purposes of applying § 1.987– 4 with respect to a section 987 QBU described in paragraph (f)(1) of this section for the taxable year beginning on the transition date, the owner functional currency net value of the section 987 QBU on the last day of the preceding taxable year under § 1.987–4(d)(1)(B) is the amount that was determined for the preceding taxable year under § 1.987– 4(d)(1)(A) of the 2016 and 2019 section 987 regulations or the 2006 proposed section 987 regulations, as applicable. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (ii) Determination of historic rate. For purposes of applying the section 987 regulations with respect to historic items (other than inventory subject to the simplified inventory method under § 1.987–3(c)(2)(iv)(A)) that are attributable to the section 987 QBU on the day before the transition date, a taxpayer must use the same historic rates as were used under the taxpayer’s application of the 2016 and 2019 section 987 regulations or the 2006 proposed section 987 regulations, as applicable, in place of the historic rates that otherwise would be determined under § 1.987– 1(c)(3). (iii) Unrecognized section 987 gain or loss—(A) Net accumulated unrecognized section 987 gain or loss of a section 987 QBU. In taxable years beginning on or after the transition date, for purposes of calculating the net accumulated unrecognized section 987 gain or loss of a section 987 QBU described in paragraph (f)(1) of this section under § 1.987–4(c)— (1) Amounts determined under prior § 1.987–4(d) or under § 1.987–4(d) or 1.987–10 of the 2006 proposed section 987 regulations, as applicable, are included in amounts determined under § 1.987–4(d) for all prior taxable years; and (2) Amounts taken into account under prior § 1.987–5(a) or under § 1.987–5(a) of the 2006 proposed section 987 regulations, as applicable, are included in amounts recognized under § 1.987– 5(a) for all prior taxable years. For this purpose, amounts taken into account under prior § 1.987–5(a) or under § 1.987–5(a) of the 2006 proposed section 987 regulations, as applicable, are determined without regard to prior § 1.987–12 or prior § 1.987–12T. (B) Deferred section 987 gain or loss attributable to a successor deferral QBU. In the taxable year beginning on the transition date, the outstanding deferred section 987 gain or loss (as determined under prior § 1.987–12) of a deferral QBU described in paragraph (f)(1) of this section becomes deferred section 987 gain or loss (within the meaning of § 1.987–12). The deferred section 987 gain or loss is attributed to one or more successor deferral QBUs under the principles of § 1.987–12(b)(2) and (c)(2). (C) Suspended section 987 loss attributable to a successor suspended loss QBU. In the taxable year beginning on the transition date, outbound section 987 loss of an outbound loss QBU described in paragraph (f)(1) of this section that has not been recognized or added to the basis of stock under prior § 1.987–12 becomes suspended section 987 loss. The suspended section 987 loss is attributed to one or more PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 78193 successor suspended loss QBUs under the principles of § 1.987–13(b)(1) and (c)(1). (3) Taxpayers that are required to transition using the fresh start transition method. If a taxpayer is subject to a consent agreement under which it is required to apply the fresh start transition method with respect to a section 987 QBU, then the taxpayer must apply the transition rules of prior § 1.987–10 to that section 987 QBU for the taxable year beginning on the transition date and immediately before the taxpayer applies this section. In applying this section, the taxpayer is treated as having applied prior § 1.987– 10 to the section 987 QBU. (g) Partnerships—(1) Aggregate to entity. If, for section 987 purposes, an aggregate approach to partnerships was applied to a partnership that owns an eligible QBU before the transition date and the partnership is not a section 987 aggregate partnership on the transition date, then the partnership is treated as a section 987 aggregate partnership at the beginning of the transition date for purposes of applying paragraphs (d) through (f) of this section and then as ceasing to be a section 987 aggregate partnership in a transition to which § 1.987–7C(b) applies. (2) Entity to aggregate. If, for section 987 purposes, an entity approach to partnerships was applied to a partnership that owns an eligible QBU before the transition date and the partnership is a section 987 aggregate partnership on the transition date, then the partnership is treated as not being a section 987 aggregate partnership at the beginning of the transition date for purposes of applying paragraphs (d) through (f) of this section and then as becoming a section 987 aggregate partnership in a transition to which § 1.987–7C(c) applies. (h) Determination of source and character—(1) In general. Except as provided in paragraph (h)(2) of this section, the source and character of pretransition gain or loss is determined under the rules of § 1.987–6. See § 1.987–6(b)(1) (timing of source and character determination). (2) Deferral QBU or outbound loss QBU. Notwithstanding paragraph (h)(1) of this section and § 1.987–6, the source and character of pretransition gain or loss with respect to a deferral QBU or an outbound loss QBU is the same as the source and character of the outstanding deferred section 987 gain or loss (determined under prior § 1.987– 12) of the deferral QBU or the outbound section 987 loss of the outbound loss QBU (determined under § 1.987–12(e) of E:\FR\FM\14NOP3.SGM 14NOP3 78194 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules the 2016 and 2019 section 987 regulations). (i) [Reserved] (j) Adjustments to avoid double counting or omissions. If a difference between the treatment of any item under the section 987 regulations and the treatment of the item under the taxpayer’s prior section 987 method would result in income, gain, deduction, or loss being taken into account more than once or not being taken into account, then the pretransition gain or loss of the section 987 QBU, as determined under paragraphs (e)(2) and (3) of this section, is adjusted to account for the difference. (k) Reporting—(1) In general. Except as otherwise provided in this paragraph (k), a statement titled ‘‘Section 987 Transition Information’’ must be attached to an owner’s timely filed return for the taxable year beginning on the transition date providing the following information for each QBU described in paragraph (k)(2) of this section: (i) A description of each QBU, the QBU’s principal place of business, and a description of the prior method used by the taxpayer to determine its section 987 gain or loss, deferred section 987 gain or loss (under prior § 1.987–12), or outbound section 987 loss with respect to the QBU, including an explanation as to whether such method was an eligible pretransition method. (ii) The pretransition gain or loss with respect to each QBU and the computations used to determine pretransition gain or loss. (iii) Whether the authorized person has elected to recognize pretransition gain or loss ratably over the transition period pursuant to paragraph (e)(5)(ii) of this section. (iv) In the case of a statement filed by or on behalf of a partnership, a description of how section 987 was applied to the partnership, including whether an entity theory or aggregate theory of partnerships applied, and if an aggregate theory of partnerships applied, the owners of any QBUs consisting of assets and liabilities held by the partnership. (v) With respect to each QBU for which any adjustment is made under paragraph (j) of this section, a description of each adjustment and the basis for computing the adjustment. (vi) A list of the QBUs described in paragraph (f)(1) of this section, or a statement that no QBUs are described in paragraph (f)(1) of this section. (2) QBUs for which reporting is required—(i) In general. Except as provided in paragraph (k)(2)(ii) of this section, the information described in paragraph (k)(1) of this section must be provided with respect to— (A) Each section 987 QBU described in paragraph (b)(1) of this section; (B) Each deferral QBU described in paragraph (b)(2) of this section and each of its successor deferral QBUs; and (C) Each outbound loss QBU and each of the successor suspended loss QBUs to which suspended section 987 loss with respect to the outbound loss QBU is attributed. (ii) QBUs to which the fresh start transition method was applied. A taxpayer is not required to provide the information described in paragraphs (k)(1)(i) through (iv) of this section with respect to a QBU described in paragraph (f)(1) of this section. (3) Attachments not required where information is reported on a form. This paragraph (k) does not apply to the extent provided on a form or instructions published by the Commissioner. (4) Form 3115 not required. Taxpayers that properly comply with the reporting requirements in this paragraph (k) are not required to file a Form 3115 in connection with the transition onto the section 987 regulations. (l) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC is a domestic corporation with the U.S. dollar as its functional currency and Branch is a section 987 QBU with the euro as its functional currency. DC has a taxable year ending December 31, and the transition date is January 1, year 4. For purposes of the examples, except as otherwise indicated, assume that no section 987 elections are in effect. (1) Example 1—(i) Facts—(A) Formation of Branch and Branch’s operations. DC formed Branch on November 30, year 1, with a contribution of Ö150. In year 1, Branch purchased a parcel of unimproved land for Ö100. In year 2, Branch earned Ö25. In year 3, Branch again earned Ö25. On June 30, year 3, Branch distributed Ö100 cash to DC, and DC immediately exchanged the Ö100 for $135. (B) Exchange rates. The relevant exchange rates are shown below. TABLE 1 TO PARAGRAPH (l)(1)(i)(B)— EXCHANGE RATES Spot rate November 30, Year 1 December 31, Year 1 December 31, Year 2 June 30, Year 3 .......... December 31, Year 3 Year 1 ......................... Year 2 ......................... Year 3 ......................... Ö1 = $1. Ö1 = $1.10. Ö1 = $1.20. Ö1 = $1.35. Ö1 = $1.40. .................... .................... .................... Yearly average exchange rate Ö1 = $1.05. Ö1 = $1.15. Ö1 = $1.25. (C) Pretransition method. DC used the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch before the transition date. Under this method, DC maintains an equity pool in euros (Branch’s functional currency) and a basis pool in U.S. dollars (DC’s functional currency). When Branch makes a remittance (whether out of earnings or capital), DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the basis pool attributable to the remittance. DC’s basis in assets distributed from Branch is equal to Branch’s basis in the assets, translated into U.S. dollars at the spot rate on the date of the remittance. Branch’s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner. (D) Application of the pretransition method before the transition date. For purposes of determining section 987 gain or loss recognized as a result of the June 30, year 3, remittance, DC was required to determine the amount in Branch’s equity and basis pools. Branch’s equity pool was equal to Ö200, and its basis pool was equal to $210, as shown below: khammond on DSKJM1Z7X2PROD with PROPOSALS3 TABLE 2 TO PARAGRAPH (l)(1)(i)(D)—YEAR 3 EQUITY AND BASIS POOLS Equity pool Translation rate Basis pool Contribution (9/30/Year 1) ............................................................................................... Year 2 Earnings ............................................................................................................... Year 3 Earnings ............................................................................................................... Ö150 Ö25 Ö25 Ö1 = $1 ....................................................... Ö1 = $1.15 .................................................. Ö1 = $1.25 .................................................. $150 28.75 31.25 Total .......................................................................................................................... Ö200 ..................................................................... 210 VerDate Sep<11>2014 18:55 Nov 13, 2023 Jkt 262001 PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules Because the remittance was equal to 50% of the equity pool (Ö100), 50% of the basis pool, or $105, was attributable to the remittance. The amount of the remittance was $135 (Ö100 translated at the spot rate on June 30, year 3, of Ö1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $30, equal to the difference between the amount of the remittance ($135) and the portion of the basis pool attributable to the remittance ($105). As a result of the remittance, the equity pool was reduced by the amount distributed (Ö100), and the basis pool was reduced by the portion of the basis pool attributable to the remittance ($105). Therefore, after the remittance, the equity pool was equal to Ö100, and the basis pool was equal to $105. In the hands of DC, the euros distributed had a basis of $135 (equal to the Ö100 distribution translated at the spot rate on June 30, year 3, of Ö1 = $1.35). DC did not recognize section 988 gain or loss when it exchanged the euros for $135. (ii) Analysis—(A) DC’s method is an eligible pretransition method. Before the transition date, DC followed the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch. This method is an eligible pretransition method under paragraph (e)(4)(i) of this section. Therefore, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section. (B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC’s pretransition gain or loss with respect to Branch is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(1)(ii)(B)(1) and (2) of this section, DC’s deemed termination amount is $35 and its owner functional currency net value adjustment is zero. Therefore, DC has $35 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch’s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $3.50 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13. (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all its assets and liabilities to DC (the land with a basis of Ö100) on December 31, year 3, and prior § 1.987–12 did not apply. Under DC’s eligible pretransition method, DC would have recognized section 987 gain of $35, determined by subtracting the remaining basis pool of $105 from the amount of the remittance of $140 (Ö100 translated at the spot rate on December 31, year 3, of Ö1 = $1.40). Therefore, the deemed termination amount is $35. (2) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of Ö100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the spot rate on December 31, year 3, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate on December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC’s eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC’s eligible pretransition method, if Branch transferred the land to DC, DC’s basis in the land would be equal to Branch’s basis (Ö100) translated at the spot rate on the date of the remittance. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero. (C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987–4(d), the owner functional currency net value of Branch on the last 78195 day of year 3 is determined by translating the Ö100 basis of the land at the spot rate on December 31, year 3 (Ö1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140. (2) Example 2—(i) Facts—(A) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC uses an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(2)(i)(B) of this section. (B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch’s functional currency) and a basis pool in U.S. dollars (DC’s functional currency) with respect to Branch’s earnings. DC also maintains separate equity and basis pools with respect to Branch’s capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. DC’s basis in assets distributed out of Branch’s earnings is equal to Branch’s basis in the assets translated at the spot rate on the date of the remittance. DC’s basis in assets distributed out of Branch’s capital is equal to the portion of the capital basis pool attributable to the distribution. Branch’s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner. (C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed Ö100 cash to DC. Of this amount, Ö50 represented a remittance out of earnings, and Ö50 represented a distribution out of capital. (1) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch’s earnings equity pool was equal to Ö50, and its earnings basis pool was equal to $60, as shown below: TABLE 3 TO PARAGRAPH (l)(2)(i)(C)(1)—EARNINGS EQUITY AND BASIS POOLS Equity pool Ö25 Ö25 Year 2 Earnings ......................................................................................... Year 3 Earnings ......................................................................................... VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 PO 00000 Frm 00063 Fmt 4701 Sfmt 4702 Translation rate Ö1 = $1.15 ....................................... Ö1 = $1.25 ....................................... E:\FR\FM\14NOP3.SGM 14NOP3 Basis pool $28.75 31.25 78196 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules TABLE 3 TO PARAGRAPH (l)(2)(i)(C)(1)—EARNINGS EQUITY AND BASIS POOLS—Continued Equity pool Ö50 Total .................................................................................................... Because Branch remitted 100% of the earnings equity pool (Ö50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (Ö50 translated at the spot rate on June 30, year 3, of Ö1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and Translation rate .......................................................... the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero. In the hands of DC, the Ö50 distributed out of earnings had a basis of $67.50 (Ö50 translated at the spot rate on June 30, year 3, of Ö1 = $1.35). Basis pool 60 (2) Distribution out of capital. The basis of the Ö50 distributed out of capital was equal to the portion of the capital basis pool attributable to the distribution. For this purpose, the capital equity pool was equal to Ö150, and the capital basis pool was equal to $150, as shown below: TABLE 4 TO PARAGRAPH (l)(2)(i)(C)(2)—CAPITAL EQUITY AND BASIS POOLS khammond on DSKJM1Z7X2PROD with PROPOSALS3 Equity pool Translation rate Basis pool Contribution (6/30/Year 1) ......................................................................... Ö150 Ö1 = $1 ............................................ $150 Total .................................................................................................... Ö150 .......................................................... 150 Because Branch distributed 33% of the capital equity pool, or Ö50, 33% of the capital basis pool, or $50, was attributable to the distribution. In the hands of DC, the Ö50 distributed out of capital had a basis of $50. As a result of the capital distribution, the capital equity pool was reduced to Ö100 and the capital basis pool was reduced to $100. (3) Section 988 gain recognized. On June 30, year 3, DC exchanged Ö100 with an aggregate basis of $117.50 (equal to the sum of the $67.50 basis of the remittance out of earnings and the $50 basis of the distribution out of capital) for $135. Therefore, DC recognized $17.50 of gain under section 988. (ii) Analysis—(A) DC’s method is an eligible pretransition method. Before the transition date, DC followed a reasonable method of applying section 987 that would result in the same total amount of income over the life of DC ($125) as an earnings and capital method, as explained in paragraphs (l)(2)(ii)(A)(1) and (2) of this section. Therefore, this method is an eligible pretransition method under paragraph (e)(4)(ii) of this section. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section. (1) DC’s total amount of income under its pretransition method. Under DC’s pretransition method, DC recognized $7.50 of section 987 gain and $17.50 of section 988 gain in year 3. In addition, on December 31, year 3, DC had $40 of embedded gain in its capital equity and basis pools (equal to the difference VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 between its capital equity pool of Ö100, translated at the spot rate on December 31, year 3, of Ö1 = $1.40, and its capital basis pool of $100) which will be taken into account in the future (when Branch distributes property out of capital and the property is sold). DC also recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC’s total income (recognized and unrecognized) with respect to Branch is $125. (2) DC’s total amount of income under an earnings and capital method. If DC had instead applied an earnings and capital method, as described in paragraph (l)(1)(i)(C) of this section (Example 1), DC would have recognized section 987 gain of $30 in year 3 and would not have recognized section 988 gain in year 3, as explained in paragraph (l)(1)(i)(D) of this section. On December 31, year 3, DC would have unrecognized section 987 gain in its equity and basis pools of $35 (see paragraph (l)(1)(ii)(B)(1) of this section (Example 1)). DC would also have recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC’s total income (recognized and unrecognized) with respect to Branch is $125. (B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC’s pretransition gain or loss with respect to Branch is equal to sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(2)(ii)(B)(1) and (2) of PO 00000 Frm 00064 Fmt 4701 Sfmt 4702 this section, the deemed termination amount is zero and the owner functional currency net value adjustment is $40. Therefore, DC has $40 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch’s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13. (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3, and prior § 1.987– 12 did not apply. Under DC’s eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, this would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero. (2) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of Ö100. Under paragraph (e)(2)(i)(B) of this E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section, the owner functional currency net value adjustment is equal to the basis of Branch’s land, translated into U.S. dollars at the spot rate on December 31, year 3, reduced by the basis of Branch’s land, translated into U.S. dollars at the pretransition translation rate on December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under the eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC. Under DC’s eligible pretransition method, DC’s basis in assets distributed from Branch is equal to the portion of the capital basis pool attributable to the distribution. If Branch transferred the land with a basis of Ö100 to DC on December 31, year 3, its remaining capital basis pool of $100 would be attributable to the distribution, and the land would have a basis of $100 in the hands of DC. Because the land had a basis of Ö100 in the hands of Branch, and would have a basis of $100 in the hands of DC if it were distributed on December 31, year 3, the pretransition translation rate is Ö1 = $1. The Ö100 basis of Branch’s land, translated at the spot rate on December 31, year 3 of Ö1 = $1.40 is equal to $140. The Ö100 basis of Branch’s land, translated at the pretransition translation rate on December 31, year 3 of Ö1 = $1 is equal to $100. Therefore, the owner functional currency net value adjustment is equal to $40 ($140 ¥ $100). (C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987–4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the Ö100 basis of the land at the spot rate on December 31, year 3 (Ö1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140. (3) Example 3—(i) Facts—(A) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC used an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(3)(i)(B) of this section. (B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch’s functional currency) and a basis pool in U.S. dollars (DC’s functional currency) with respect to Branch’s earnings. However, DC does not maintain separate equity and basis pools with respect to Branch’s capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain 78197 or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. Under DC’s pretransition method, DC’s basis in assets distributed by Branch (whether out of earnings or capital) is equal to Branch’s basis in the assets translated at the spot rate on the date of the distribution. Branch’s earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC first applied its earnings only method on a return filed before November 9, 2023. In addition, DC applied its earnings only method consistently to all of its section 987 QBUs and otherwise applied section 987 in a reasonable manner. (C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed Ö100 cash to DC. Of this amount, Ö50 represented a remittance out of earnings, and Ö50 represented a distribution out of capital. (1) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch’s earnings equity pool was equal to Ö50, and its earnings basis pool was equal to $60, as shown below: TABLE 5 TO PARAGRAPH (l)(3)(i)(C)(1)—EARNINGS EQUITY AND BASIS POOLS khammond on DSKJM1Z7X2PROD with PROPOSALS3 Equity pool Translation rate Basis pool Year 2 Earnings ......................................................................................... Year 3 Earnings ......................................................................................... Ö25 Ö25 Ö1 = $1.15 ....................................... Ö1 = $1.25 ....................................... $28.75 31.25 Total .................................................................................................... Ö50 .......................................................... 60 Because Branch remitted 100% of the earnings equity pool (Ö50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (Ö50 translated at the spot rate on June 30, year 3, of Ö1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero. (2) Basis of euros distributed. In the hands of DC, the Ö100 distributed had a basis of $135 (Ö100 translated at the spot rate on June 30, year 3, of Ö1 = $1.35). DC did not recognize gain or loss VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 under section 988 when it exchanged the Ö100 for $135. (ii) Analysis—(A) DC’s method is an eligible pretransition method. Unlike in paragraph (l)(2) of this section (Example 2), DC’s earnings only method would not result in the same total amount of income over the life of DC as an earnings and capital method described in paragraph (e)(4)(i) of this section because DC does not maintain capital basis and equity pools and DC translates the basis of all property distributed from Branch at the spot rate on the distribution date. However, this method is an eligible pretransition method under paragraph (e)(4)(iii) of this section because DC first applied its earnings only method on a return filed before November 9, 2023, DC applied its earnings only method consistently to all PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 of its section 987 QBUs, and otherwise applied section 987 in a reasonable manner. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section. (B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC’s pretransition gain or loss with respect to Branch is equal to sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(2)(ii)(B)(1) and (2) of this section, the deemed termination amount is zero and the owner functional currency net value adjustment is zero. Therefore, DC has no pretransition gain or loss with respect to Branch. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78198 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3, and prior § 1.987– 12 did not apply. Under DC’s eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, it would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero. (2) Owner functional currency net value adjustment. On December 31, year 3, Branch has no liabilities and only one asset: land with a basis of Ö100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the spot rate on December 31, year 3, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate on December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC’s eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC’s eligible pretransition method, if Branch transferred the land to DC, DC’s basis in the land would be equal to Branch’s basis (Ö100) translated at the spot rate on the date of the distribution. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero. (C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987–4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the Ö100 basis of the land at the spot rate on December 31, year 3 (Ö1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140. (4) Example 4—(i) Facts. The facts and exchange rates are the same as in paragraph (l)(1) of this section (Example 1), except that DC did not apply section 987(3) with respect to Branch and did not recognize section 987 gain or loss with respect to Branch before the transition date. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (ii) Analysis—(A) DC’s method is not an eligible pretransition method. Because DC did not apply section 987(3) with respect to Branch before the transition date, DC did not apply an eligible pretransition method under paragraph (e)(4) of this section. Therefore, DC determines pretransition gain or loss under paragraph (e)(3) of this section. (B) Pretransition gain or loss. Under paragraph (e)(3) of this section, DC’s pretransition gain or loss with respect to Branch is equal to the annual unrecognized section 987 gain or loss with respect to Branch for all taxable years ending before the transition date in which DC was the owner of Branch (that is, years 1 through 3), reduced by section 987 gain or loss recognized by DC before the transition date. As explained in paragraphs (l)(4)(ii)(C) through (E) of this section, DC’s annual unrecognized section 987 gain for year 1 is $7.50, DC’s annual unrecognized section 987 gain for year 2 is $16.25, and DC’s annual unrecognized section 987 gain for year 3 is $23.75. DC did not recognize any section 987 gain or loss with respect to Branch before the transition date. Therefore, DC has $47.50 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch’s net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4.75 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13. (C) Annual unrecognized section 987 gain or loss for year 1. Under paragraph (e)(3)(iii) of this section, annual unrecognized section 987 gain or loss with respect to a section 987 QBU is determined under the rules of § 1.987– 4(d), applied as though a current rate election was in effect for all relevant taxable years (such that all items are treated as marked items), but modified so that only §§ 1.987–4(d)(1) (change in owner functional currency net value) and 1.987–4(d)(10) (adjustment for residual increase or decrease to the balance sheet) are applied. As explained in paragraphs (l)(4)(ii)(C)(1) and (2) of this section, in year 1, the change in owner functional currency net value under § 1.987–4(d)(1) is an increase of $165, and there is a negative adjustment of $157.50 under § 1.987–4(d)(10). Therefore, DC’s annual unrecognized section 987 gain for year 1 is $7.50. PO 00000 Frm 00066 Fmt 4701 Sfmt 4702 (1) Change in owner functional currency net value for year 1. On December 31, year 1, Branch held land with a basis of Ö100 and Ö50 cash. Therefore, on the last day of year 1, Branch’s owner functional currency net value is $165 (150 euros translated at the spot rate on December 31, year 1, of Ö1 = $1.10). Because Branch was formed in year 1, its owner functional currency net value on the last day of the preceding taxable year is zero. See § 1.987–4(d)(1)(iii). Therefore, the change in owner functional currency net value is an increase of $165. (2) Residual increase to the balance sheet for year 1. Under § 1.987–4(d)(10), unrecognized section 987 gain or loss for a taxable year is decreased by any residual increase to the balance sheet (and increased by any residual decrease to the balance sheet), translated into the owner’s functional currency at the yearly average exchange rate for the taxable year. For this purpose, the residual increase (or decrease) to the balance sheet is equal to the change in net value of the section 987 QBU, determined in the section 987 QBU’s functional currency. On December 31, year 1, Branch held land with a basis of Ö100 euros and Ö50 cash. Therefore, on the last day of year 1, Branch has a net value (in its own functional currency) of Ö150. Because Branch was formed in year 1, its functional currency net value on the last day of the preceding taxable year is zero. See § 1.987–4(d)(1)(iii). Therefore, the residual increase to the balance sheet is Ö150. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $157.50 for year 1 (equal to Ö150 translated at the yearly average exchange rate for year 1 of Ö1 = $1.05). (D) Annual unrecognized section 987 gain or loss for year 2. As explained in paragraphs (l)(4)(ii)(D)(1) and (2) of this section, in year 2, the change in owner functional currency net value under § 1.987–4(d)(1) is an increase of $45, and there is a negative adjustment of $28.75 under § 1.987–4(d)(10). Therefore, DC’s annual unrecognized section 987 gain for year 2 is $16.25. (1) Change in owner functional currency net value for year 2. On December 31, year 2, Branch held land with a basis of Ö100 euros and Ö75 cash. Therefore, on the last day of year 2, Branch’s owner functional currency net value is $210 (175 euros translated at the spot rate on December 31, year 2, of Ö1 = $1.20). As explained in paragraph (l)(4)(ii)(C)(1) of this section, Branch’s owner functional currency net value on the last day of year 1 was $165. Therefore, the change in owner E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules functional currency net value is an increase of $45. (2) Residual increase to the balance sheet for year 2. On December 31, year 2, Branch held land with a basis of Ö100 euros and Ö75 cash. Therefore, on the last day of year 2, Branch has a net value (in its own functional currency) of Ö175. As explained in paragraph (l)(4)(ii)(C)(2) of this section, Branch had a net value of Ö150 on December 31, year 1. Therefore, the residual increase to the balance sheet is Ö25. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $28.75 for year 2 (equal to a reduction of Ö25, translated at the yearly average exchange rate for year 2 of Ö1 = $1.15). (E) Annual unrecognized section 987 gain or loss for year 3. As explained in paragraphs (l)(4)(ii)(E)(1) and (2) of this section, in year 3, the change in owner functional currency net value under § 1.987–4(d)(1) is a decrease of $70, and there is a positive adjustment of $93.75 under § 1.987–4(d)(10). Therefore, DC’s annual unrecognized section 987 gain for year 3 is $23.75. (1) Change in owner functional currency net value for year 3. On December 31, year 3, Branch held land with a basis of Ö100. Therefore, on the last day of year 3, Branch’s owner functional currency net value is $140 (100 euros translated at the spot rate on December 31, year 3, of Ö1 = $1.40). As explained in paragraph (l)(4)(ii)(D)(1) of this section, Branch’s owner functional currency net value on the last day of year 2 was $210. Therefore, the change in owner functional currency net value is a decrease of $70. (2) Residual decrease to the balance sheet for year 3. On December 31, year 3, Branch held land with a basis of Ö100. Therefore, on the last day of year 3, Branch has a net value (in its own functional currency) of Ö100. As explained in paragraph (l)(4)(ii)(D)(2) of this section, Branch had a net value of Ö175 on December 31, year 2. Therefore, the residual decrease to the balance sheet is Ö75. This results in a positive adjustment to annual unrecognized section 987 gain or loss of $93.75 for year 3 (equal to Ö75, translated at the yearly average exchange rate for year 3 of Ö1 = $1.25). (F) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987–4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the Ö100 basis of the land at the spot rate on December 31, year 3 (Ö1 = $1.40). Therefore, the owner VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 functional currency net value of Branch on the last day of year 3 is $140. ■ 19. Section 1.987–11 is revised to read as follows: § 1.987–11 Suspended section 987 loss relating to certain elections; loss-to-theextent-of-gain rule. (a) In general. This section provides rules relating to suspended section 987 loss. This paragraph (a) provides an overview of this section. Paragraph (b) of this section provides rules for computing the cumulative suspended section 987 loss with respect to a section 987 QBU or successor suspended loss QBU. Paragraph (c) of this section provides rules that suspend section 987 loss that would otherwise be recognized when a current rate election is in effect. Paragraph (d) of this section provides rules that treat net unrecognized section 987 loss and deferred section 987 loss as suspended section 987 loss when an annual recognition election is made or a current rate election is revoked. Paragraph (e) of this section describes the extent to which suspended section 987 loss is recognized under a loss-to-the-extent-ofgain rule. Paragraph (f) of this section provides rules for determining recognition groupings based on the source and character of section 987 gain or loss. Paragraph (g) of this section provides examples illustrating the rules of this section. (b) Cumulative suspended section 987 loss in a recognition grouping—(1) In general. The cumulative suspended section 987 loss in a recognition grouping with respect to a section 987 QBU or a successor suspended loss QBU for the current taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping for the prior taxable year decreased by the amount of suspended section 987 loss in the recognition grouping that was recognized with respect to the QBU under paragraph (e) of this section or under § 1.987–13(b) through (d) in the prior taxable year, and increased by the amount that becomes suspended section 987 loss in the recognition grouping with respect to the QBU in the current taxable year. If the taxable year is the first taxable year of the section 987 QBU (or the first taxable year in which the section 987 regulations apply), the cumulative suspended section 987 loss for the prior taxable year is zero. An owner or original suspended loss QBU owner’s total cumulative suspended section 987 loss in a recognition grouping is equal to the sum of its cumulative suspended section 987 gain or loss with respect to each section 987 QBU and successor suspended loss PO 00000 Frm 00067 Fmt 4701 Sfmt 4702 78199 QBU. See § 1.987–13(g) for rules preventing the carryover of suspended section 987 loss in connection with certain inbound transactions. (2) Combined QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a combination, the cumulative suspended section 987 loss in a recognition grouping with respect to a combined QBU for the prior taxable year is equal to the sum of the cumulative suspended section 987 loss in the recognition grouping with respect to each combining QBU for the prior taxable year; the suspended section 987 loss in a recognition grouping with respect to a combined QBU that was recognized in the prior taxable year is equal to sum of the suspended section 987 loss in the recognition grouping with respect to each combining QBU that was recognized in the prior taxable year. (3) Separated QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a separation, the cumulative suspended section 987 loss in a recognition grouping with respect to a separated QBU for the prior taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping with respect to the separating QBU for the prior taxable year multiplied by the separation fraction; the suspended section 987 loss in a recognition grouping with respect to a separated QBU that was recognized in the prior taxable year is equal to the suspended section 987 loss in the recognition grouping with respect to the separating QBU that was recognized in the prior taxable year multiplied by the separation fraction. (c) Suspension of section 987 loss for taxable years in which a current rate election is in effect and an annual recognition election is not in effect. In a taxable year in which a current rate election is in effect and an annual recognition election is not in effect, to the extent that an owner’s net unrecognized section 987 loss with respect to a section 987 QBU would otherwise be recognized under § 1.987– 5 (including pursuant to § 1.987–12(b)), or its deferred section 987 loss would otherwise be recognized under § 1.987– 12(c), the net unrecognized section 987 loss or deferred section 987 loss is not recognized by the owner and instead becomes suspended section 987 loss. See paragraph (g)(1) of this section (Example 1) for an illustration of this rule. (d) Suspension of net unrecognized section 987 loss upon making or revoking certain elections—(1) Making an annual recognition election. At the beginning of the first taxable year for E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78200 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules which an annual recognition election is in effect, net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss if either— (i) A current rate election was in effect for the immediately preceding taxable year; or (ii) A current rate election was not in effect for the immediately preceding taxable year and, as of the beginning of the taxable year, the sum of the owner’s net accumulated unrecognized section 987 loss and deferred section 987 loss exceeds the sum of the owner’s net accumulated unrecognized section 987 gain and deferred section 987 gain by more than $5 million. (2) Revoking a current rate election. In the first taxable year in which a current rate election ceases to be in effect, net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss. See paragraph (g)(2) of this section (Example 2) for an illustration of this rule. (e) Recognition of suspended section 987 loss to the extent of recognition of section 987 gain—(1) In general. Subject to paragraph (e)(2) of this section, in a taxable year of an owner of a section 987 QBU or an original suspended loss QBU owner, the owner recognizes a portion of its total cumulative suspended section 987 loss in a single recognition grouping to the extent of the amount of section 987 gain in that recognition grouping that the owner recognizes in that taxable year (the loss-to-the-extentof-gain rule). Because the recognition groupings are determined on the basis of the initial assignment of section 987 gain or loss under § 1.987–6(b)(2)(i), the loss-to-the-extent-of-gain rule is applied on the basis of the initial assignment of section 987 gain or loss. The amount of cumulative suspended section 987 loss in a single recognition grouping that the owner or original suspended loss QBU owner recognizes in the taxable year is treated as attributable to each section 987 QBU or successor suspended loss QBU in proportion to its suspended section 987 loss in that recognition grouping. See paragraph (g)(1) of this section (Example 1) for an illustration of this rule. (2) Special rule for taxable years in which both an annual recognition election and a current rate election are in effect. This paragraph (e)(2) only applies to suspended section 987 loss in taxable years in which both a current rate election and an annual recognition election are in effect. (i) Loss to the extent of gain rule limited to net gain, not gross gain. For purposes of applying paragraph (e)(1) of VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 this section, references to section 987 gain in a recognition grouping are treated as references to net section 987 gain in that recognition grouping. (ii) Net section 987 gain in a recognition grouping. For purposes of this paragraph (e), net section 987 gain in a recognition grouping is equal to the total section 987 gain recognized and taken into account by the owner in that recognition grouping during the testing period, reduced by the total section 987 loss recognized and taken into account by the owner in that recognition grouping during the testing period (other than suspended section 987 loss recognized in the current taxable year). (iii) Testing period. For purposes of this paragraph (e), the testing period with respect to any suspended section 987 loss means the current taxable year and all prior taxable years during which both— (A) The section 987 loss was a suspended section 987 loss of the owner (including the taxable year in which it became a suspended section 987 loss of the owner); and (B) A current rate election and annual recognition election were in effect. (iv) Ordering rule. If an owner has any suspended section 987 loss that has a different testing period than other suspended section 987 loss (for example, because the owner succeeded to and took into account additional suspended section 987 loss in a section 381(a) transaction), all suspended section 987 loss that has the same testing period is aggregated in a single group and this paragraph (e) is applied separately to each suspended section 987 loss group, in chronological order based on the earliest date included in the testing period of the group. (3) Consolidated group members. All members of a consolidated group are treated as a single owner for purposes of applying this paragraph (e). (f) Recognition groupings. The term recognition grouping means the section 987 gain or loss (including section 987 gain or loss that is recognized, deferred section 987 gain or loss, or suspended section 987 loss) that is initially assigned to the statutory and residual groupings described in paragraph (f)(1) of this section and to the statutory and residual groupings described in paragraph (f)(2) of this section, if applicable, under § 1.987–6(b)(2)(i). (1) Sourcing and section 904 category. Section 987 gain or loss that is initially assigned to the following subcategories: (i) U.S. source income; and (ii) Foreign source income in a single section 904 category. (2) Statutory and residual groupings for CFC owners. Solely with respect to PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 owners that are controlled foreign corporations, section 987 gain or loss that is initially assigned to the following statutory and residual groupings: (i) Tentative tested income; (ii) Foreign currency gain or loss taken into account under section 954(c)(1)(D) pursuant to § 1.987– 6(b)(2)(i)(C); (iii) Income described in section 952(b) (ECI that is excluded from subpart F income); and (iv) Income not described in paragraphs (f)(2)(i) through (iii) of this section. (g) Examples. The following examples illustrate the application of this section. (1) Example 1: Suspension of section 987 loss and recognition of suspended section 987 loss—(i) Facts. CFC is a controlled foreign corporation that has the U.S. dollar as its functional currency. CFC owns three section 987 QBUs, QBU1, QBU2, and QBU3. QBU1 has the euro as its functional currency, QBU2 has the pound as its functional currency, and QBU3 has the yen as its functional currency. CFC is subject to a current rate election but not an annual recognition election. An election has not been made under § 1.951A–2(c)(7) with respect to CFC. In year 1, CFC did not have cumulative suspended section 987 loss with respect to any of its QBUs and did not have outstanding deferred section 987 gain or loss. In year 2, CFC has net unrecognized section 987 loss of $200 with respect to QBU1, net unrecognized section 987 loss of $1,000 with respect to QBU2, and net unrecognized section 987 gain of $1,000 with respect to QBU3. In year 2, each QBU makes a remittance, and CFC’s remittance proportion (determined under § 1.987–5(b)(1)) is 25% with respect to QBU1, 15% with respect to QBU2, and 10% with respect to QBU3. For purposes of § 1.987–6(b)(2)(i), all of QBU1’s assets generate foreign source passive category income that corresponds to one or more subpart F income groups described in § 1.960– 1(d)(2)(ii)(B)(2)(i) through (v) and all of QBU2’s and QBU3’s assets generate foreign source general category tested income. (ii) Analysis—(A) Application of §§ 1.987–5 and 1.987–6 and paragraph (c) of this section. In year 2, CFC recognizes $100 of section 987 gain with respect to QBU3 (10% of $1,000) under § 1.987–5(a). Under § 1.987– 6(b)(2)(i)(A), (B), and (D), the section 987 gain is initially characterized as foreign source general category tentative tested income. If a current rate election was not in effect, CFC would recognize $50 of section 987 loss with respect to QBU1 (25% of $200) and $150 of E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section 987 loss with respect to QBU2 (15% of $1,000). However, under paragraph (c) of this section, these amounts instead become suspended section 987 loss. Under § 1.987– 6(b)(2)(i)(A) and (B), the $50 of suspended section 987 loss with respect to QBU1 is initially characterized as foreign source passive category income assigned to a subpart F income group described in § 1.960–1(d)(2)(ii)(B)(2)(i) through (v), and under § 1.987– 6(b)(2)(i)(C) is treated as foreign currency loss taken into account under section 954(c)(1)(D). Under § 1.987– 6(b)(2)(i)(A), (B), and (D), the $150 of suspended section 987 loss with respect to QBU2 is initially characterized as foreign source general category tentative tested income. (B) Cumulative suspended section 987 loss. Under paragraph (b) of this section, in year 2, CFC’s cumulative suspended section 987 loss in the recognition grouping of foreign source passive category foreign currency gain or loss taken into account under section 954(c)(1)(D) with respect to QBU1 is $50, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC’s total cumulative suspended section 987 loss in that recognition grouping is $50. Similarly, CFC’s cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income with respect to QBU2 is $150, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC’s total cumulative suspended section 987 loss in that recognition grouping is $150. (C) Recognition of suspended section 987 loss. Under paragraph (e)(1) of this section, in year 2, CFC recognizes a portion of its total cumulative suspended section 987 loss in a single recognition grouping to the extent that it recognizes section 987 gain in the same recognition grouping with respect to any section 987 QBU. In year 2, CFC has $50 of total cumulative suspended section 987 loss in the recognition grouping of foreign source passive category foreign currency gain or loss taken into account under section 954(c)(1)(D) and $150 of total cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. CFC recognized $100 of section 987 gain in year 2 with respect to QBU3 in the recognition grouping of foreign source general category tentative tested income. Therefore, CFC also recognizes $100 of its total cumulative suspended section 987 loss in the same recognition grouping. The cumulative suspended VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 section 987 loss that is recognized by CFC is attributable to QBU2, because QBU2 is CFC’s only QBU with cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. Because no election under § 1.951A–2(c)(7) applies in year 2, both the $100 of recognized section 987 gain and the $100 of recognized section 987 loss are allocated to foreign source general category tested income. See § 1.987–6(b)(2)(ii). The amounts of suspended section 987 loss not recognized (that is, $50 of suspended section 987 loss characterized as foreign source passive category foreign currency gain or loss taken into account under section 954(c)(1)(D) with respect to QBU1 and $50 of suspended section 987 loss characterized as foreign source general category tentative tested income with respect to QBU2) remain suspended. Paragraph (e)(2) of this section does not apply because an annual recognition election is not in effect. The result would be the same if CFC had recognized section 987 gain in year 1, because section 987 gain from prior years is not taken into account under paragraph (e)(1) of this section. (2) Example 2: Suspension of section 987 loss when a current rate election is revoked—(i) Facts. U.S. Corp is a domestic corporation that owns all of the interests in DE1. DE1 owns Business A, which is a section 987 QBU of U.S. Corp. In year 1, U.S. Corp made a current rate election but not an annual recognition election. In year 9, U.S. Corp has net unrecognized section 987 loss of $2 million with respect to Business A, which is not recognized or suspended in year 9. U.S. Corp revokes its current rate election effective for year 10. In year 10, before the application of this section, U.S. Corp has net accumulated unrecognized section 987 loss of $2 million. (ii) Analysis. Under paragraph (d)(2) of this section, U.S. Corp’s net accumulated unrecognized section 987 loss of $2 million with respect to Business A is converted into suspended section 987 loss at the beginning of year 10, the first taxable year in which the current rate election ceases to be in effect. ■ 20. Section 1.987–12 is revised to read as follows: § 1.987–12 loss. Deferral of section 987 gain or (a) Overview—(1) Scope. This section provides rules that defer the recognition of section 987 gain or loss and rules for recognizing (or suspending) deferred section 987 gain or loss. This paragraph (a) provides an overview of this section PO 00000 Frm 00069 Fmt 4701 Sfmt 4702 78201 and certain instances when this section does not apply. Paragraph (b) of this section describes the extent to which net unrecognized section 987 gain or loss is recognized under § 1.987–5 (or in certain cases, suspended) or becomes deferred section 987 gain or loss in connection with a deferral event. Paragraph (c) of this section describes the extent to which deferred section 987 gain or loss is recognized (or in certain cases, suspended) upon the occurrence of subsequent events. Paragraph (d) of this section provides a rule relating to the treatment of a successor deferral QBU when deferred section 987 loss becomes suspended section 987 loss. Paragraph (e) of this section provides an anti-abuse rule. Paragraph (f) of this section provides rules for determining the deferred section 987 gain or loss of combined and separated QBUs. Paragraph (g) of this section provides definitions. Paragraph (h) of this section provides examples illustrating the rules described in this section. (2) Exceptions—(i) Annual recognition election. This section does not apply to a termination of a section 987 QBU in a taxable year in which an annual recognition election is in effect. (ii) De minimis rule. This section does not apply in a taxable year if the aggregate amount of net unrecognized section 987 gain or loss of the owner with respect to all of its section 987 QBUs that would become deferred section 987 gain or loss under this section does not exceed $5 million. (b) Treatment of section 987 gain and loss in connection with a deferral event. Notwithstanding § 1.987–5 (general rule requiring recognition of section 987 gain or loss in the taxable year of a remittance), the owner of a section 987 QBU with respect to which a deferral event occurs (an original deferral QBU) includes in taxable income section 987 gain or loss in connection with the deferral event only to the extent provided in this paragraph (b). (1) Gain or loss recognized (or suspended) in the taxable year of a deferral event. In the taxable year of a deferral event with respect to an original deferral QBU, the owner of the original deferral QBU recognizes section 987 gain or loss under § 1.987–5, except that, solely for purposes of applying § 1.987–5, all assets and liabilities of the original deferral QBU that, immediately after the deferral event, are reflected on the books and records of a successor deferral QBU are treated as not having been transferred and therefore as remaining on the books and records of the original deferral QBU notwithstanding the deferral event. Notwithstanding the prior sentence, any E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78202 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules section 987 loss that would otherwise be recognized under this paragraph (b)(1) and § 1.987–5 may instead become suspended loss under § 1.987–11(c) if a current rate election is in effect, or under § 1.987–13(h) if the deferral event also constitutes an outbound loss event. (2) Deferred section 987 gain or loss attributable to a successor deferral QBU. In the taxable year of a deferral event with respect to an original deferral QBU, any net unrecognized section 987 gain or loss that is not recognized (under § 1.987–5 including pursuant to paragraph (b)(1) of this section) or suspended (under § 1.987–11(c) or (d) or 1.987–13(h)) in the taxable year of the deferral event becomes deferred section 987 gain or loss of the original deferral QBU owner. A portion of the deferred section 987 gain or loss becomes deferred section 987 gain or loss with respect to each successor deferral QBU. Such portion is equal to the deferred section 987 gain or loss multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor deferral QBU in connection with the deferral event and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor deferral QBUs in connection with the deferral event. (c) Recognition (or suspension) of deferred section 987 gain or loss following a deferral event. An original deferral QBU owner recognizes deferred section 987 gain or loss with respect to a successor deferral QBU in the taxable year of the deferral event and in subsequent taxable years as provided in this paragraph (c). (1) Recognition upon a subsequent remittance—(i) In general. Except as provided in paragraph (c)(2) of this section, an original deferral QBU owner recognizes deferred section 987 gain or loss in the taxable year of the deferral event, and in subsequent taxable years, upon a remittance from a successor deferral QBU to the owner of the successor deferral QBU (successor deferral QBU owner) in the amount described in paragraph (c)(1)(ii) of this section. Notwithstanding the prior sentence, any deferred section 987 loss that would otherwise be recognized under this paragraph (c)(1) may instead become suspended section 987 loss under § 1.987–11(c) if a current rate election is in effect with respect to the original deferral QBU owner. (ii) Amount. The amount of deferred section 987 gain or loss that is recognized (or suspended) pursuant to this paragraph (c)(1) in a taxable year of the original deferral QBU owner is the original deferral QBU owner’s VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 outstanding deferred section 987 gain or loss (that is, the amount of deferred section 987 gain or loss not previously recognized or suspended) with respect to the successor deferral QBU multiplied by the remittance proportion of the successor deferral QBU owner with respect to the successor deferral QBU for the taxable year ending with or within the taxable year of the original deferral QBU owner, as determined under § 1.987–5(b) without regard to any annual recognition election of the successor deferral QBU owner. See paragraph (h)(4) of this section (Example 4) for an illustration of this rule. (iii) Deemed remittance by a successor deferral QBU. For purposes of this paragraph (c)(1), in a taxable year of the original deferral QBU owner in which a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the successor deferral QBU is treated as having a remittance proportion of one. Accordingly, if a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the original deferral QBU owner’s outstanding deferred section 987 gain or loss with respect to that successor deferral QBU will be recognized (or suspended). For purposes of this paragraph (c)(1), if the original deferral QBU owner goes out of existence and there is no qualified successor, in the last taxable year of the original deferral QBU owner, each successor deferral QBU is treated as having a remittance proportion of one. This paragraph (c)(1)(iii) does not affect the application of the section 987 regulations to the successor deferral QBU owner with respect to its ownership of the successor deferral QBU. (2) Deferral events and outbound loss events with respect to a successor deferral QBU. Notwithstanding paragraph (c)(1) of this section, if assets of the successor deferral QBU (transferred assets) are transferred (or deemed transferred) in a transaction (the deemed transaction) that would constitute a deferral event or an outbound loss event if the original deferral QBU owner owned the successor deferral QBU directly and the original deferral QBU owner had net unrecognized section 987 gain or loss with respect to the successor deferral QBU equal to its outstanding deferred section 987 gain or loss with respect to the successor deferral QBU, then, in accordance with § 1.987–13(h)— (i) The original deferral QBU owner recognizes outstanding deferred section PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 987 gain or loss, or suspends outstanding deferred section 987 loss, to the extent it would have recognized or suspended net unrecognized section 987 gain or loss under the deemed transaction; (ii) Each section 987 QBU is a successor deferral QBU to the extent it would have been under the deemed transaction and the original deferral QBU owner has deferred section 987 gain or loss with respect to the successor deferral QBU to the extent it would have under the deemed transaction; (iii) Each eligible QBU is a successor suspended loss QBU to the extent it would have been under the deemed transaction and the original deferral QBU owner has suspended section 987 loss with respect to the suspended loss QBU to the extent it would have under the deemed transaction. (d) Successor deferral QBU becomes a successor suspended loss QBU. A successor deferral QBU becomes a successor suspended loss QBU, and an original deferral QBU owner becomes an original suspended loss QBU owner, if any of the original deferral QBU owner’s deferred section 987 loss with respect to the successor deferral QBU becomes suspended section 987 loss. An eligible QBU may be both a successor deferral QBU and a successor suspended loss QBU and the original deferral QBU owner may also be an original suspended loss QBU owner. (e) Anti-abuse. No section 987 loss is recognized under this section, § 1.987– 5, or § 1.987–13 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section. (f) Combinations and separations of successor deferral QBUs. A combined QBU is a successor deferral QBU if either combining QBU was a successor deferral QBU. A separated QBU is a successor deferral QBU if the separating QBU was a successor deferral QBU. (1) Combined QBU. The deferred section 987 gain or loss of a combined QBU in each recognition grouping for a taxable year is equal to the sum of the combining QBUs’ deferred section 987 gain or loss in that recognition grouping. (2) Separated QBU. The deferred section 987 gain or loss of a separated QBU in each recognition grouping for a taxable year is equal to the sum of the separating QBU’s deferred section 987 gain or loss in each recognition grouping multiplied by the separation fraction. (g) Definitions. The following definitions apply for purposes of this section. E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules (1) Deferral event. A deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy the conditions described in both paragraphs (g)(1)(i) and (ii) of this section. (i) Events. The transaction or series of transactions constitutes either: (A) A termination of the section 987 QBU under § 1.987–8(b)(2) (substantially all the assets transferred to the owner), § 1.987–8(b)(5) (section 987 QBU ceases to be a section 987 QBU), or § 1.987–8(b)(6) (ownership of section 987 QBU changes between direct and indirect ownership); or (B) A disposition of part of an interest in a section 987 aggregate partnership or DE through which the section 987 QBU is owned, a disposition of part of a directly held section 987 QBU, or any contribution by another person to a section 987 aggregate partnership, DE, or section 987 QBU of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the contribution gives rise to a deemed transfer from the section 987 QBU to the owner. (ii) Assets on books of successor deferral QBU. Immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor deferral QBU. (2) Successor deferral QBU. A section 987 QBU (potential successor deferral QBU) is a successor deferral QBU with respect to a section 987 QBU referred to in paragraph (g)(1)(i) of this section if, immediately after the transaction or series of transactions described in that paragraph, the potential successor deferral QBU satisfies all of the conditions described in paragraphs (g)(2)(i) through (iii) of this section. (i) The books and records of the potential successor deferral QBU reflect assets that, immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section, were reflected on the books and records of the section 987 QBU referred to in that paragraph. (ii) The owner of the potential successor deferral QBU and the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in that paragraph are members of the same controlled group. (iii) If the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in that paragraph was a U.S. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 person, the potential successor deferral QBU is owned by a U.S. person. (3) Original deferral QBU owner. An original deferral QBU owner means, with respect to an original deferral QBU, the owner of the original deferral QBU immediately before the deferral event, or the owner’s qualified successor. (4) Qualified successor. A qualified successor with respect to a corporation (transferor corporation) means another corporation that acquires the assets of the transferor corporation in a transaction described in section 381(a) (acquiring corporation), provided that the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or the acquiring corporation is a controlled foreign corporation and the transferor corporation was a controlled foreign corporation. A qualified successor with respect to a partnership (transferor partnership) means another partnership (acquiring partnership) that acquires the assets of the transferor partnership in a merger or consolidation described in section 708(b)(2)(A). A qualified successor with respect to an individual decedent means the estate of the decedent. A qualified successor of a person includes the qualified successor of a qualified successor. (h) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the stock of DC2, which is also a domestic corporation, and CFC1, a controlled foreign corporation. In addition, DC1, DC2, and CFC1 are members of a controlled group, and the de minimis rule of paragraph (a)(2)(ii) of this section is not applicable. Finally, except as otherwise provided, Business A is a section 987 QBU with the euro as its functional currency, there are no transfers between Business A and its owner, and Business A’s assets are not depreciable or amortizable. (1) Example 1: Contribution of a section 987 QBU with net unrecognized section 987 gain to a member of the controlled group—(i) Facts. DC1 owns Business A. The adjusted balance sheet of Business A reflects assets with an aggregate adjusted basis of Ö1,000x and no liabilities. DC1 contributes Ö900x of Business A’s assets to DC2 in exchange for DC2 stock in a transaction to which section 351 applies. Immediately after the contribution, the remaining Ö100x of Business A’s assets are no longer reflected on the books and records of a section 987 QBU (but are instead reflected on the books and records of DC1’s home office). DC2, which has the U.S. dollar as its functional currency, uses the Business A assets in a business PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 78203 (Business B) that constitutes a section 987 QBU. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x. (ii) Analysis—(A) Under § 1.987– 2(c)(2)(ii), DC1’s contribution of Ö900x of Business A’s assets to DC2 is treated as a transfer of all of the assets of Business A to DC1, immediately followed by DC1’s contribution of Ö900x of Business A’s assets to DC2. The contribution of Business A’s assets is a deferral event within the meaning of paragraph (g)(1) of this section because: (1) The transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, resulting in a termination of the Business A QBU under § 1.987–8(b)(2); and (2) Immediately after the transaction, assets of Business A are reflected on the books and records of Business B, a section 987 QBU owned by a member of DC1’s controlled group and a successor deferral QBU within the meaning of paragraph (g)(2) of this section. Accordingly, Business A is an original deferral QBU within the meaning of paragraph (b) of this section, and DC1 is an original deferral QBU owner of Business A within the meaning of paragraph (g)(3) of this section. (B) Under paragraph (b)(1) of this section, DC1’s taxable income in the taxable year of the deferral event includes DC1’s section 987 gain or loss determined with respect to Business A under § 1.987–5, except that, for purposes of applying § 1.987–5, all assets of Business A that are reflected on the books and records of Business B immediately after Business A’s termination are treated as not having been transferred and therefore as though they remained on Business A’s books and records (notwithstanding the deemed transfer of those assets under § 1.987–8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of Ö100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the Ö100x remittance by the sum of the remittance and the Ö900x aggregate adjusted basis of the gross assets deemed to remain on Business A’s books and records at the end of the taxable year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year of the deferral event. DC1’s deferred section 987 gain equals $90x, which is the amount of section 987 gain that, but for the application of paragraph (b) of this section, DC1 would have recognized under § 1.987–5 (which E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78204 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules is $100x), less the amount of section 987 gain recognized by DC1 under § 1.987– 5 and this section (which is $10x). (2) Example 2: Contribution of a section 987 QBU to a member of the controlled group when a current rate election is in effect—(i) Facts. DC1 owns Business A, which is engaged in the business of manufacturing Product X. In a taxable year in which a current rate election is in effect (and an annual recognition election is not in effect), the adjusted balance sheet of Business A reflects assets with an aggregate adjusted basis of Ö1,000x and no liabilities. DC1 contributes Ö900x of Business A’s assets to DC2 in exchange for DC2 stock in a transaction to which section 351 applies. Immediately after the contribution, the remaining Ö100x of Business A’s assets are no longer reflected on the books and records of an eligible QBU that is engaged in the business of manufacturing Product X (but are instead reflected on the books and records of DC1’s home office). DC2, which has the U.S. dollar as its functional currency, uses the Business A assets in a Product X manufacturing business (Business B) that constitutes a section 987 QBU. At the time of the contribution, Business A has net unrecognized section 987 loss of $100x. (ii) Analysis—(A) For the reasons described in paragraph (h)(1) of this section (Example 1), the contribution results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; and DC2 is a successor deferral QBU owner. (B) Under paragraph (b)(1) of this section, for purposes of applying § 1.987–5, all the assets of Business A that are reflected on the books and records of Business B immediately after Business A’s termination are treated as not having been transferred and therefore as though they remained on Business A’s books and records (notwithstanding the deemed transfer of those assets under § 1.987–8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of Ö100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and DC1 is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the Ö100x remittance by the sum of the remittance and the Ö900x aggregate adjusted basis of the gross assets deemed to remain on Business VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 A’s books and records at the end of the taxable year. Thus, but for the application of § 1.987–11(c), DC1 would recognize $10x of section 987 loss in the taxable year of the deferral event. Under § 1.987–11(c), because a current rate election is in effect (and an annual recognition election is not in effect), the loss is instead treated as suspended section 987 loss. DC1’s deferred section 987 loss equals $90x, which is the amount of section 987 loss that, but for the application of paragraph (b) of this section, would have been suspended under § 1.987–11(c) (which is $100x), less the amount of section 987 loss suspended under § 1.987–11(c) (which is $10x). (C) Under § 1.987–13(b)(1)(i), Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, a significant portion of the assets of Business A was reflected on the books and records of Business B (an eligible QBU), Business B continued to carry on the trade or business of Business A, and Business B was owned by DC2, a member of the same controlled group as DC1 (which is the original suspended loss QBU owner under § 1.987–13(l)(1)). Therefore, under § 1.987–13(b)(1)(ii), all of Business A’s suspended section 987 loss (including the suspended section 987 loss resulting from the termination of Business A) becomes suspended section 987 loss with respect to Business B. (3) Example 3: Election to be classified as a corporation—(i) Facts. DC1 owns all of the interests in Entity A, a DE. Entity A conducts Business A, which has net unrecognized section 987 gain of $500x. Entity A elects to be classified as a corporation under § 301.7701–3(c). As a result of the election and pursuant to § 301.7701– 3(g)(1)(iv), DC1 is treated as contributing all of the assets and liabilities of Business A to newly-formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1’s books and records. (ii) Analysis. Under § 1.987–2(c)(2)(ii), DC1’s deemed contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1’s contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, the Business A QBU terminates under § 1.987–8(b)(2). The contribution of Business A’s assets is not a deferral event within the meaning PO 00000 Frm 00072 Fmt 4701 Sfmt 4702 of paragraph (b) of this section because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of paragraph (g)(2) of this section due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination. In addition, the requirement of paragraph (g)(2)(iii) of this section is not met because Business A was owned by a U.S. person and the potential successor deferral QBU, which is owned by CFC1, is not owned by a U.S. person. Accordingly, DC1 recognizes section 987 gain of $500x with respect to Business A under § 1.987–5 without regard to this section. Because the requirement of paragraph (g)(2)(iii) of this section is not met, the result would be the same even if the assets of Business A were transferred in a section 351 exchange to an existing foreign corporation that had a different functional currency than Business A. (4) Example 4: Partial recognition of deferred gain or loss—(i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A in Country X. During year 1, DC1 contributes all of its interests in Entity A to DC2 in an exchange to which section 351 applies. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x. After the contribution, Entity A continues to conduct business in Country X (Business B). In year 3, as a result of a net transfer of property from Business B to DC2, DC2’s remittance proportion with respect to Business B, as determined under § 1.987–5, is 0.25. (ii) Analysis—(A) For the reasons described in paragraph (h)(1) of this section (Example 1), the contribution of all the interests in Entity A by DC1 to DC2 results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; DC2 is a successor deferral QBU owner; and the $100x of net unrecognized section 987 gain with respect to Business A becomes deferred section 987 gain as a result of the deferral event. (B) Under paragraph (c)(1)(i) of this section, DC1 recognizes deferred section 987 gain in year 3 as a result of the remittance from Business B to DC2. Under paragraph (c)(1)(ii) of this section, the amount of deferred section 987 gain that DC1 recognizes is $25x, which is DC1’s outstanding deferred section 987 gain of $100x with respect to Business A multiplied by the E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules remittance proportion of 0.25 of DC2 with respect to Business B for the taxable year as determined under § 1.987–5(b). ■ 21. Section 1.987–13 is added to read as follows: khammond on DSKJM1Z7X2PROD with PROPOSALS3 § 1.987–13 Suspended section 987 loss upon terminations. (a) Overview—(1) In general. This section provides rules relating to suspended section 987 loss of an owner with respect to a section 987 QBU or successor suspended loss QBU that terminates. Paragraph (b) of this section provides rules treating suspended section 987 loss as recognized or attributable to a successor when a section 987 QBU terminates. Paragraph (c) of this section provides rules treating suspended section 987 loss as recognized or attributable to a subsequent successor when a successor suspended loss QBU terminates. Paragraph (d) of this section provides rules regarding the recognition of suspended section 987 loss when interests in a successor suspended loss QBU owner are transferred. Paragraph (e) of this section provides rules that apply when interests in an original suspended loss QBU owner are transferred. Paragraph (f) of this section provides rules that apply when an original suspended loss QBU owner ceases to exist. Paragraph (g) of this section provides rules preventing the carryover of suspended section 987 loss in connection with certain inbound transactions. Paragraph (h) of this section provides rules that suspend section 987 loss in connection with certain outbound transactions. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides rules relating to the termination of a successor suspended loss QBU. Paragraph (k) of this section provides an anti-abuse rule. Paragraph (l) of this section provides definitions that apply for purposes of this section. Paragraph (m) of this section provides examples illustrating the rules of this section. (2) Ordering rule. Paragraphs (b) through (d) of this section are applied after the application of § 1.987–11(e) (loss-to-the-extent-of-gain rule). (b) Termination of a section 987 QBU with suspended loss. If a section 987 QBU terminates, and at the time of termination, the owner has suspended section 987 loss with respect to the section 987 QBU (including because the termination was an outbound loss event or because net unrecognized section 987 loss became suspended section 987 loss upon termination as a result of a current rate election), then either paragraph (b)(1) or (2) of this section applies. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 (1) Suspended section 987 loss becomes suspended section 987 loss with respect to a successor suspended loss QBU—(i) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating section 987 QBU are reflected on the books and records of an eligible QBU that carries on a trade or business of the section 987 QBU and is owned by the owner of the section 987 QBU or a member of its controlled group, then the eligible QBU is a successor suspended loss QBU and the rules described in paragraph (b)(1)(ii) of this section apply. (ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the terminating section 987 QBU that is not recognized in the taxable year of the termination under § 1.987–11(e) becomes suspended section 987 loss with respect to each successor suspended loss QBU. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor suspended loss QBU in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor suspended loss QBUs in connection with the termination. (2) Recognition of suspended loss. If, immediately after the termination of the section 987 QBU, there is no successor suspended loss QBU under paragraph (b)(1) of this section, then the owner recognizes the cumulative suspended section 987 loss with respect to the section 987 QBU that is not recognized in the taxable year of the termination under § 1.987–11(e). (c) Termination of a successor suspended loss QBU. If a successor suspended loss QBU terminates (as described in paragraph (j) of this section), then either paragraph (c)(1) or (2) of this section applies. (1) Successor to the successor suspended loss QBU—(i) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating successor suspended loss QBU (initial successor) are reflected on the books and records of an eligible QBU (subsequent successor) that carries on a trade or business of the initial successor and is owned by the original suspended loss QBU owner or a member of its controlled group, then the subsequent successor is a successor suspended loss PO 00000 Frm 00073 Fmt 4701 Sfmt 4702 78205 QBU and the rules described in paragraph (c)(1)(ii) of this section apply. (ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under § 1.987–11(e) becomes suspended section 987 loss with respect to each subsequent successor. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the subsequent successor in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all subsequent successors in connection with the termination. (2) Recognition of suspended loss. If, immediately after the termination of the initial successor, there is no subsequent successor that is a successor suspended loss QBU under paragraph (c)(1) of this section, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under § 1.987–11(e). (d) Transfer of successor suspended loss QBU owner. If a successor suspended loss QBU ceases to be owned by a member of the original suspended loss QBU owner’s controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the successor suspended loss QBU owner, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the successor suspended loss QBU that is not recognized in the taxable year under § 1.987–11(e). (e) Transfer of original suspended loss QBU owner. If an original suspended loss QBU owner ceases to be a member of the successor suspended loss QBU owner’s controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the original suspended loss QBU owner, the original suspended loss QBU owner’s suspended section 987 loss ceases to be suspended section 987 loss with respect to any section 987 QBU or successor suspended loss QBU. As a result, the suspended section 987 loss can be recognized under § 1.987–11(e) but cannot be recognized under paragraph (b)(2), (c)(2), or (d) of this section. (f) Original suspended loss QBU owner ceases to exist. If an original E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78206 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules suspended loss QBU owner ceases to exist and there is no successor under paragraph (l)(1)(ii) of this section (for example, as a result of a section 331 liquidation), then any suspended section 987 loss that is not recognized after application of the loss-to-theextent-of-gain rule in § 1.987–11(e) cannot be recognized and is eliminated. (g) Inbound nonrecognition transactions—no carryover of suspended section 987 loss. If an owner of a section 987 QBU with suspended section 987 loss, or an original suspended loss QBU owner, ceases to exist in a transaction described in § 1.987–8(c)(1)(ii) (inbound section 332 liquidation) or (c)(2)(ii) (inbound reorganization), then any suspended section 987 loss of the owner or original suspended loss QBU owner that is not recognized after application of the lossto-the-extent-of-gain rule in § 1.987– 11(e) is eliminated. As a result, the distributee or acquiring corporation does not succeed to or take into account any suspended section 987 loss of the owner or original suspended loss QBU owner under section 381. (h) Outbound transactions— recognition or suspension of net unrecognized section 987 loss. This paragraph (h) applies to taxable years in which neither a current rate election nor an annual recognition election is in effect. (1) In general. Notwithstanding § 1.987–5, if an outbound loss event occurs with respect to a section 987 QBU (an outbound loss QBU), the original owner of the section 987 QBU includes in taxable income in the taxable year of the outbound loss event section 987 loss with respect to the outbound loss QBU only to the extent provided in paragraph (h)(3) of this section. (2) Outbound loss event. An outbound loss event means, with respect to a section 987 QBU: (i) Any termination of the section 987 QBU as a result of a transfer by a U.S. person of assets of the section 987 QBU to a foreign person that is a member of the same controlled group as the U.S. person immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person), provided that the termination would result in the recognition of section 987 loss with respect to the section 987 QBU under § 1.987–5 but for this paragraph (h); or (ii) Any transfer by a U.S. person of part of an interest in a section 987 aggregate partnership, or part of an interest in a DE, through which the U.S. VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 person owns the section 987 QBU to a related foreign person that has the same functional currency as the section 987 QBU, or any contribution by such a related foreign person to such a partnership or DE of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the transfer would result in the recognition of section 987 loss with respect to the section 987 QBU under § 1.987–5 but for this paragraph (h). (3) Loss recognition upon an outbound loss event. In the taxable year of an outbound loss event with respect to an outbound loss QBU, the owner of the outbound loss QBU recognizes section 987 loss as determined under §§ 1.987–5 and 1.987–12(b), except that, solely for purposes of applying § 1.987– 5, assets and liabilities of the outbound loss QBU that, immediately after the outbound loss event, are reflected on the books and records of an eligible QBU owned by the related foreign person described in paragraph (h)(2) of this section are treated as not having been transferred and therefore as remaining on the books and records of the outbound loss QBU notwithstanding the outbound loss event. (4) Loss suspension upon outbound loss event. Net unrecognized section 987 loss or deferred section 987 loss that, as a result of this paragraph (h), is not recognized in the taxable year of the outbound loss event (outbound section 987 loss) under § 1.987–5 becomes suspended section 987 loss. (i) [Reserved] (j) Termination of a successor suspended loss QBU. For purposes of applying paragraph (c) of this section, a successor suspended loss QBU terminates if it ceases to be an eligible QBU of its owner. (k) Anti-abuse. No section 987 loss is recognized under this section, § 1.987– 5, or § 1.987–12 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section. (l) Definitions. The following definitions apply for purposes of this section. (1) Original suspended loss QBU owner—(i) In general. An original suspended loss QBU owner is the person that was the owner of a section 987 QBU before its termination in a transaction to which paragraph (b)(1) of this section applies. (ii) Successors. If an original suspended loss QBU owner is a corporation (transferor corporation) and another corporation acquires the assets of the transferor corporation in a PO 00000 Frm 00074 Fmt 4701 Sfmt 4702 transaction described in section 381(a), then the acquiring corporation becomes the original suspended loss QBU owner. (2) Successor suspended loss QBU. A successor suspended loss QBU is an eligible QBU (which may or may not be a section 987 QBU) with respect to which the original suspended loss QBU owner has suspended section 987 loss after the termination of its section 987 QBU. See paragraphs (b)(1) and (c)(1) of this section and § 1.987–12(d) for rules regarding when an eligible QBU is a successor suspended loss QBU. (3) Successor suspended loss QBU owner. A successor suspended loss QBU owner is the owner of the assets and liabilities of a successor suspended loss QBU. (4) Ownership interests. The term ownership interests means stock in a corporation, partnership interests in a partnership, and beneficiary interests in a non-grantor trust or an estate. (5) Significant portion. With respect to the assets of an eligible QBU, the term significant portion means a significant portion of the operating assets, determined based on all the facts and circumstances, provided that more than 30 percent of the operating assets will constitute a significant portion in all cases and less than 10 percent of the operating assets will not constitute a significant portion in all cases. (m) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the interests in Entity A, a DE. Entity A conducts Business A, a section 987 QBU that is engaged in the business of selling Product X. Business A has the euro as its functional currency and has cumulative suspended section 987 loss under § 1.987–11(b) of $500x. (1) Example 1: Trade or business of a section 987 QBU ceases—(i) Facts. Entity A’s trade or business of selling Product X ceases, resulting in a termination of the Business A section 987 QBU under § 1.987–8(b)(1). After the trade or business is wound up, the remaining assets are transferred to DC1 and are not used in the trade or business of selling Product X immediately following the termination. (ii) Analysis. Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A’s assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section. (2) Example 2: Trade or business of a section 987 QBU is sold to a third party—(i) Facts. DC1 sells all the interests in Entity A to a third party for cash. (ii) Analysis. Under § 1.987–2(c)(2)(ii), the sale of the Business A assets and liabilities for cash that is reflected on the books of DC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1’s sale of those assets and liabilities. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, the Business A section 987 QBU terminates under § 1.987–8(b)(2). Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A’s assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section. (3) Example 3: Outbound loss event— (i) Facts. Entity A elects to be classified as a corporation under § 301.7701–3(c) of this chapter. As a result of the election and pursuant to § 301.7701– 3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the assets and liabilities of Business A to newlyformed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1’s books and records. After being classified as a corporation, CFC1 owns Business A, and Business A conducts the same trade or business it conducted when it was owned by DC1. Neither a current rate election nor an annual recognition election is in effect. (ii) Analysis—(A) Under § 1.987– 2(c)(2)(ii), DC1’s contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1’s contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A’s assets to DC1, the Business A section 987 QBU terminates under § 1.987–8(b)(2). The contribution of Business A’s assets to CFC1 is not a VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 deferral event within the meaning of § 1.987–12(g)(1) because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of § 1.987–12(g)(2) due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination, as well as the fact that the requirement of § 1.987–12(g)(2)(iii) is not met because Business A was owned by a U.S. person and the potential successor deferral QBU, which is owned by CFC1, is not owned by a U.S. person. The termination of the Business A section 987 QBU as a result of the transfer of the assets of Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a member of DC1’s controlled group is an outbound loss event described in paragraph (h)(2) of this section. (B) Under paragraphs (h)(1) and (3) of this section, in the taxable year of the outbound loss event, DC1 includes in taxable income section 987 loss recognized with respect to Business A as determined under § 1.987–5, except that, for purposes of applying § 1.987– 5, all assets and liabilities of Business A that are reflected on the books and records of CFC1, a related foreign person described in paragraph (h)(2) of this section, are treated as not having been transferred. Accordingly, DC1’s remittance proportion with respect to Business A is 0, and DC1 recognizes no section 987 loss with respect to Business A. DC1’s outbound section 987 loss is $500x, which is the amount of section 987 loss that DC1 would have recognized under § 1.987–5 without regard to paragraph (h) of this section ($500x), less the amount of section 987 loss recognized by DC1 under paragraph (h)(3) of this section ($0). Under paragraph (h)(4) of this section, the $500x of outbound section 987 loss becomes suspended section 987 loss. (C) Under paragraph (b)(1)(i) of this section, Business A (in the hands of CFC1) is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, the Business A assets are reflected on the books and records of Business A (in the hands of CFC1), Business A was an eligible QBU that continued to carry on the same trade or business, and Business A was owned by CFC1, a member of the same controlled group as DC (which is the original suspended loss QBU owner under paragraph (l)(1) of this section). Therefore, under paragraph (b)(1)(ii) of this section, all of Business A’s suspended section 987 loss (including the suspended section 987 loss resulting PO 00000 Frm 00075 Fmt 4701 Sfmt 4702 78207 from the termination of Business A) is treated as suspended section 987 loss with respect to Business A (in the hands of CFC1). ■ 22. Section 1.987–14 is added to read as follows: § 1.987–14 Applicability date. (a) Section 987 regulations applicability date—(1) In general. Except as provided in this section, the section 987 regulations apply to taxable years beginning after December 31, 2024. (2) Applicability date for a terminating QBU. The section 987 regulations apply to the owner of a terminating QBU beginning on the day the section 987 QBU terminates, but only with respect to the section 987 QBU, any successor deferral QBUs or successor suspended loss QBUs (in their capacity as such), and any net unrecognized section 987 gain or loss, deferred section 987 gain or loss, or suspended section 987 loss with respect thereto. See § 1.987–1(h) for the definition of a terminating QBU. (3) Partnerships. If the section 987 regulations apply to a taxable year of a partnership and would not otherwise apply to the taxable year of a partner in which or with which the partnership’s taxable year ends, then the section 987 regulations apply to that taxable year of the partner solely with respect to the partner’s interest in the partnership and its section 987 gain or loss attributable to an eligible QBU held by the partnership. (b) Application of the section 987 regulations to taxable years beginning on or before December 31, 2024, and ending after November 9, 2023. A taxpayer (including a taxpayer that has applied the 2016 and 2019 section 987 regulations to a prior taxable year under paragraph (c) of this section) may choose to apply the section 987 regulations to a taxable year beginning on or before December 31, 2024, and ending after November 9, 2023, provided the taxpayer and each member of its consolidated group and section 987 electing group: (1) Consistently apply the section 987 regulations in their entirety to the taxable year and all subsequent taxable years beginning on or before December 31, 2024; and (2) Apply the section 987 regulations on their original timely filed (including extensions) returns in the first taxable year in which the section 987 regulations apply. (c) Application of the 2016 and 2019 section 987 regulations—(1) In general. A taxpayer may choose to apply the 2016 and 2019 section 987 regulations E:\FR\FM\14NOP3.SGM 14NOP3 khammond on DSKJM1Z7X2PROD with PROPOSALS3 78208 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules to a taxable year beginning after December 7, 2016, and beginning on or before December 31, 2024, provided the taxpayer and each member of its consolidated group and section 987 electing group: (i) First apply the 2016 and 2019 section 987 regulations to a taxable year ending before November 9, 2023; (ii) Consistently apply the 2016 and 2019 section 987 regulations in their entirety to all section 987 QBUs (within the meaning of prior § 1.987–1(b)(2)) directly or indirectly owned (within the meaning of prior § 1.987–1(b)(4)) by the taxpayer and each member of its consolidated group and section 987 electing group on the transition date for that taxable year and all subsequent taxable years before the taxable year in which the taxpayer and each member of its consolidated group and section 987 electing group apply the section 987 regulations pursuant to paragraph (a) or (b) of this section; and (iii) Either— (A) First applied the 2016 and 2019 section 987 regulations on their returns filed before November 9, 2023; or (B) First apply the 2016 and 2019 section 987 regulations on their returns filed on or after November 9, 2023 and apply § 1.987–10 in lieu of prior § 1.987–10. (2) Application to section 987 QBUs not owned on the transition date. For any taxable year in which a taxpayer applies the 2016 and 2019 section 987 regulations pursuant to paragraph (c)(1) of this section, the taxpayer may choose to apply the 2016 and 2019 section 987 regulations to any section 987 QBU (within the meaning of prior § 1.987– 1(b)(2)) that the taxpayer did not directly or indirectly own (within the meaning of prior § 1.987–1(b)(4)) on the transition date, provided the taxpayer applies the 2016 and 2019 section 987 regulations consistently to that QBU for that taxable year and all subsequent taxable years before the taxable year in which the taxpayer applies the section 987 regulations pursuant to paragraph (a) or (b)(1) of this section, provided that the taxpayer either— (i) First applied the 2016 and 2019 section 987 regulations to the section 987 QBU on its return filed before November 9, 2023; or (ii) First applies the 2016 and 2019 section 987 regulations to the section 987 QBU on its return filed on or after November 9, 2023 and applies § 1.987– 10 in lieu of prior § 1.987–10. (3) Modifications of defined terms for purposes of this paragraph (c). Solely for purposes of this paragraph (c)— (i) Application of § 1.987–10 in lieu of prior § 1.987–10. For any taxpayer to VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 which paragraph (c)(1)(iii)(B) or (c)(2)(ii) of this section applies, the term 2016 and 2019 section 987 regulations includes § 1.987–10 and not prior § 1.987–10. (ii) Partnerships not included in section 987 electing group. The term section 987 electing group does not include foreign partnerships, foreign non-grantor trusts, or foreign estates. (iii) Transition date. The term transition date has the meaning provided in prior § 1.987–10. (d) Prior § 1.987–12. For the applicability dates of prior § 1.987–12, see prior § 1.987–12(j). Prior § 1.987–12 applies through the end of the taxable year immediately preceding the first taxable year in which a taxpayer applies § 1.987–12 pursuant to paragraph (a) or (b) of this section. ■ 23. Section 1.988–1, as proposed to be amended by 81 FR 88882 (December 8, 2016), is further amended by: ■ a. Removing the language ‘‘§ 1.987– 1(b)(5)’’ in paragraph (a)(4)(i) and adding the language ‘‘§ 1.987–1(h)’’ in its place. ■ b. Removing the language ‘‘§ 1.987– 1(b)(3)’’ wherever it appears in paragraphs (a)(4)(i) and (iv) and adding the language ‘‘§ 1.987–1(b)(4)’’ in its place. c. Removing the language ‘‘§ 1.987– 1(b)(4)’’ wherever it appears in paragraphs (a)(4)(ii) and (iii) and adding the language ‘‘§ 1.987–1(b)(5)’’ in its place. ■ d. Removing the language ‘‘§ 1.987– 7(b)’’ in the second sentence of paragraph (a)(4)(ii) and adding the language ‘‘§ 1.987–7B(b)’’ in its place. ■ 2. Revising paragraph (i). The revisions read as follows: § 1.988–1 rules. Certain definitions and special * * * * * (i) Applicability date—(1) In general. Except as otherwise provided in this section, this section applies to taxable years beginning after December 31, 1986. Thus, except as otherwise provided in this section, any payments made or received with respect to a section 988 transaction in taxable years beginning after December 31, 1986, are subject to this section. (2) Paragraphs (a)(4) and (a)(10)(ii). Generally, paragraphs (a)(4) and (a)(10)(ii) of this section apply to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987– 14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987–14(a)(1), then paragraphs (a)(4) and (a)(10)(ii) of this section apply to that taxable year. See PO 00000 Frm 00076 Fmt 4701 Sfmt 4702 § 1.988–1(i), as contained in 26 CFR in part 1 in effect on April 1, 2017, for a prior applicability date for paragraphs (a)(4) and (a)(10)(ii) of this section. ■ 24. Section 1.988–4 is amended by revising paragraph (b)(2) to read as follows: § 1.988–4 Source of gain or loss realized on a section 988 transfer * * * * * (b) * * * (2) Proper reflection on the books of the taxpayer or qualified business unit—(i) In general. For purposes of paragraph (b)(1) of this section, the principles of § 1.987–2(b) apply in determining whether an asset, liability, or item of income, gain, deduction, or loss is reflected on the books and records of a qualified business unit. (ii) Applicability date. Generally, paragraph (b)(2)(i) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987–14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987– 14(a)(1), then paragraph (b)(2)(i) of this section applies to that taxable year. * * * * * ■ 25. Section 1.989(a–1 is amended by: ■ a. In paragraph (b) removing the language ‘‘§ 1.987–1(b)(5)’’ in paragraph (b)(2)(i)(C) and adding the language ‘‘§ 1.987–1(h)’’ in its place; and ■ b. Revising paragraphs (b)(2)(i)(D), (b)(4), and (d)(3) and (4). The revisions read as follows: § 1.989(a)–1 Definition of a qualified business unit. * * * * * (b) * * * (2) * * * (i) * * * (D) Trusts and estates. A non-grantor trust (within the meaning of § 1.987– 1(h)) and an estate is a QBU. * * * * * (4) Applicability date. Generally, paragraph (b)(2)(i) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987–14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987– 14(a)(1), then paragraph (b)(2)(i) of this section applies to that taxable year. See § 1.989(a)–1(b)(4), as contained in 26 CFR in part 1 in effect on April 1, 2017, for a prior applicability date for paragraph (b)(2)(i) of this section. * * * * * (d) * * * (3) Proper reflection on the books of the taxpayer or qualified business unit. E:\FR\FM\14NOP3.SGM 14NOP3 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules The principles of § 1.987–2(b) apply in determining whether an asset, liability, or item of income, gain, deduction, or loss is reflected on the books of a qualified business unit (and therefore is attributable to such unit). (4) Applicability date. Generally, paragraph (d)(3) of this section applies to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987–14(b), a taxpayer applies §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987–14(a)(1), then paragraph (b)(2)(i) of this section applies to that taxable year. See § 1.989(a)– 1(d)(4), as contained in 26 CFR in part 1 in effect on April 1, 2017, for a prior applicability date for paragraph (d)(3) of this section. * * * * * ■ 26. Section 1.1502–13, as proposed to be amended at 88 FR 52057 (August 7, 2023), is further amended by: ■ a. In paragraph (a)(6)(ii) in the table revising the entry ‘‘(G) Miscellaneous operating rules’’ General location Rule khammond on DSKJM1Z7X2PROD with PROPOSALS3 * * * * * (j) * * * (9) Section 987 QBUs. No intercompany transaction is attributable to a section 987 QBU (within the meaning of § 1.987–2(b)). That is, in order to produce single entity treatment, an intercompany transaction that otherwise would involve the section 987 QBU(s) of one or more members is treated instead as occurring directly between the members (without the involvement of any section 987 QBUs), and transfers are deemed to take place between each section 987 QBU and its owner (see § 1.987–2(c)(2)(ii)). For example, if a member (M1) lends money to the section 987 QBU of another member (M2), this intercompany transaction is treated as a loan from M1 to M2 and a contribution from M2 to its section 987 QBU. (10) * * * (viii) Example 8. Loan by section 987 QBU. (A) Facts. S owns all the interests in DE1, a disregarded entity operating a business that is a section 987 QBU (S QBU) whose functional currency is the euro. S has net unrecognized section 987 gain with respect to S QBU. In year 1, S QBU lends Ö100 to B with interest due annually. B makes interest payments on the loan to S QBU in years 1 through 3. In year 3, B repays the loan and recognizes section 988 loss of $12 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 Frm 00077 Fmt 4701 § 1.1502–13 Intercompany transactions. (a) * * * (6) * * * (ii) * * * Example * * * (i) .................. Example 1. Intercompany sale followed by section 351 transfer to member. (ii) ................. Example 2. Intercompany sale of member stock followed by recapitalization. (iii) ................ Example 3. Back-to-back intercompany transactions—matching. (iv) ................ Example 4. Back-to-back intercompany transactions—acceleration. (v) ................. Example 5. Successor group. (vi) ................ Example 6. Liquidation—80% distributee. (vii) ............... Example 7. Liquidation—no 80% distributee. (viii) .............. Example 8. Loan by section 987 QBU. (ix) ................ Example 9. Sale of property by section 987 QBU. on the loan repayment. B recognizes no section 988 gain or loss on the euros it uses to pay the interest and principal. Other than with respect to the loan, there are no transfers between S and S QBU during years 1 through 3. (B) Analysis—(1) Loan. Under paragraph (j)(9) of this section, the loan is treated as a transfer from S QBU to S and a loan directly between S and B. Specifically, S is treated as receiving a transfer of Ö100 from S QBU in year 1; S is then treated as lending Ö100 directly to B. For purposes of § 1.987– 2, the loan is attributable to S, not to S QBU. As an intercompany loan, S’s loan to B is subject to the rules of this section. Because there is a remittance from S QBU to S in year 1, S recognizes section 987 gain under § 1.987–5. (2) Interest payments. While the loan is outstanding, each of B’s interest payments to S QBU is treated as an interest payment from B to S, followed by a transfer from S to S QBU. S’s intercompany interest income offsets B’s corresponding interest expense. See paragraph (g)(7)(ii)(A)(2) of this section (Example 1). Since the functional currency of both S and B is the dollar, if B recognizes any section 988 gain or loss on the interest payments, S will recognize an offsetting amount of section 988 loss or gain. Because the only transfer between S and S QBU in PO 00000 b. Redesignating paragraph (j)(9) as paragraph (j)(10). ■ c. Adding a new paragraph (j)(9). ■ d. Adding paragraphs (j)(10)(viii) and (ix). ■ e. Adding paragraph (l)(10). The additions and revision read as follows: ■ Paragraph * * * * (G) Miscellaneous operating rules ......................... § 1.1502–13(j)(10) ......... 78209 Sfmt 4702 year 2 is from S to S QBU, there is no remittance from S QBU to S and S does not recognize section 987 gain under § 1.987–5. (3) Repayment. Upon the year 3 repayment of the loan, B is treated as repaying Ö100 to S, and S is treated as transferring Ö100 to S QBU. Since the functional currency of both S and B is the dollar, and B recognizes section 988 loss of $12 on the loan repayment, S will recognize an offsetting section 988 gain of $12. Because the only transfers between S and S QBU in year 3 are from S to S QBU, there is no remittance from S QBU to S and S does not recognize section 987 gain under § 1.987–5. (4) Summary. Overall, the group’s taxable income includes S’s section 987 gain in year 1 (the section 988 inclusions offset). This result is consistent with the treatment of a single corporation that borrows from its section 987 QBU. (ix) Example 9. Sale of property by section 987 QBU—(A) Facts. M1 owns all the interests in DE1, a disregarded entity operating a business that is a section 987 QBU (M1 QBU) whose functional currency is the euro. M1 has net unrecognized section 987 gain with respect to M1 QBU. M1 QBU sells property to M2 for Ö100 in year 1. (B) Analysis—(1) In general. Under paragraph (j)(9) of this section, the sale E:\FR\FM\14NOP3.SGM 14NOP3 78210 Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS3 of property is treated as a transfer of the property from M1 QBU to M1, followed by an exchange of the property for Ö100 directly between M1 and M2, and a transfer of the Ö100 from M1 to M1 QBU. (2) Distribution. M1 QBU is treated as transferring the property to M1. (3) Exchange. M1 is then treated as selling the property to M2 for Ö100. M1 will take into account its intercompany gain or loss on the property under the rules of this section. M2 recognizes intercompany section 988 gain or loss on its exchange of Ö100 for the property. See paragraph (b)(1)(iii) of this section for property exchanges between members. (4) Contribution. Finally, M1 is treated as transferring the Ö100 to M1 QBU. Because M1’s basis in the Ö100 VerDate Sep<11>2014 17:12 Nov 13, 2023 Jkt 262001 equals its fair market value, M1 has a corresponding section 988 gain or loss of zero upon the contribution. See § 1.988–1(a)(10). Both the transfer of the property from M1 QBU to M1 and the transfer of the Ö100 from M1 to M1 QBU are taken into account in determining whether there is a remittance from M1 QBU to M1 in year 1 and whether M1 recognizes section 987 gain under § 1.987–5. (5) Summary. Overall, in year 1, M1 may take into account section 987 gain if the transfers between M1 and M1 QBU result in a remittance, and M2 takes into account section 988 gain or loss on the Ö100. This result is consistent with the treatment of a single corporation that purchases property from its section 987 QBU. (l) * * * PO 00000 Frm 00078 Fmt 4701 Sfmt 9990 (10) Applicability date. Generally, paragraph (j)(9) of this section applies to taxable years beginning after December 31, 2024, for which the original Federal income tax return is due (without extensions) after [DATE OF PUBLICATION OF THE FINAL REGULATIONS IN THE FEDERAL REGISTER]. However, if pursuant to § 1.987–14(b), a taxpayer chooses to apply §§ 1.987–1 through 1.987–14 to a taxable year before the first taxable year described in § 1.987–14(a)(1), then paragraph (j)(9) of this section applies to that taxable year and subsequent years. Douglas W. O’Donnell, Deputy Commissioner for Services and Enforcement. [FR Doc. 2023–24649 Filed 11–9–23; 4:15 pm] BILLING CODE 4830–01–P E:\FR\FM\14NOP3.SGM 14NOP3

Agencies

[Federal Register Volume 88, Number 218 (Tuesday, November 14, 2023)]
[Proposed Rules]
[Pages 78134-78210]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2023-24649]



[[Page 78133]]

Vol. 88

Tuesday,

No. 218

November 14, 2023

Part III





Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





Income and Currency Gain or Loss With Respect to a Qualified Business 
Unit; Proposed Rule

Federal Register / Vol. 88, No. 218 / Tuesday, November 14, 2023 / 
Proposed Rules

[[Page 78134]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-132422-17]
RIN 1545-BO07


Income and Currency Gain or Loss With Respect to a Qualified 
Business Unit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and partial withdrawal of notice 
of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
determination of taxable income or loss and foreign currency gain or 
loss with respect to a qualified business unit. These proposed 
regulations include an election to treat all items of a qualified 
business unit as marked items (subject to a loss suspension rule), an 
election to recognize all foreign currency gain or loss with respect to 
a qualified business unit on an annual basis, and a new transition 
rule.

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 12, 2024.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically via the Federal eRulemaking Portal at https://www.regulations.gov (indicate IRS and REG-132422-17) by following the 
online instructions for submitting comments. Requests for a public 
hearing must be submitted as prescribed in the ``Comments and Requests 
for a Public Hearing'' section. Once submitted to the Federal 
eRulemaking Portal, comments cannot be edited or withdrawn. The 
Department of the Treasury (Treasury Department) and the IRS will 
publish for public availability any comments submitted to the IRS's 
public docket. Send paper submissions to: CC:PA:01:PR (REG-132422-17), 
Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin 
Station, Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations 
generally, Raphael J. Cohen at (202) 317-6938; concerning consolidated 
groups, Jeremy Aron-Dine at (202) 317-6847; concerning submissions of 
comments, requests for a public hearing, and access to a public 
hearing, Vivian Hayes at (202) 317-5306 (not toll-free numbers) or by 
email to [email protected] (preferred).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

    This document contains proposed regulations (the ``proposed 
regulations'') under section 987 and related provisions under sections 
861, 985 through 989, and 1502 of the Internal Revenue Code (``Code''). 
Section 987 applies to any taxpayer that has a qualified business unit 
(``QBU'') with a functional currency other than the dollar. Section 
987(1) and (2) provide rules for determining and translating taxable 
income or loss (``section 987 taxable income or loss'') with respect to 
the QBU. In addition, foreign currency gain or loss must be determined 
under section 987(3) (``section 987 gain or loss''), which requires 
proper adjustments (as prescribed by the Secretary) for transfers of 
property between QBUs of the taxpayer having different functional 
currencies. Section 989(c) authorizes the Secretary to prescribe 
necessary and appropriate regulations, including regulations limiting 
the recognition of foreign currency loss on certain remittances from 
QBUs.

II. Regulations Addressing the Application of Section 987

A. 1991 Proposed Regulations and Notice 2000-20
    On September 25, 1991, the Treasury Department and the IRS 
published in the Federal Register proposed regulations under section 
987 (56 FR 48457, September 25, 1991) (``1991 proposed regulations''). 
The 1991 proposed regulations provided that section 987 taxable income 
or loss is computed in the QBU's functional currency and is translated 
into the taxpayer's functional currency at the weighted average 
exchange rate for the taxable year. For purposes of determining section 
987 gain or loss, taxpayers were required to maintain an equity pool in 
the QBU's functional currency and a basis pool in the taxpayer's 
functional currency. The equity and basis pools were increased by the 
QBU's earnings and by capital contributed to the QBU, and they were 
reduced by remittances, losses, and other transfers from the QBU. 
Taxpayers recognized section 987 gain or loss at the time of a 
remittance or upon a termination of the QBU. The amount of section 987 
gain or loss recognized was equal to the difference between the value 
of the remittance in the taxpayer's functional currency (translated at 
the applicable spot rate) and the portion of the basis pool 
attributable to the remittance. Thus, under the 1991 proposed 
regulations, section 987 gain or loss was determined by reference to a 
taxpayer's entire equity interest in a QBU. The 1991 proposed 
regulations reserved on the treatment of partnerships.
    On April 3, 2000, the Treasury Department and the IRS issued Notice 
2000-20, 2000-1 C.B. 851. The Notice expressed concern that the 1991 
proposed regulations may not have achieved their goal of providing 
administrable rules that result in foreign currency gain and loss 
recognition under the appropriate circumstances. The Notice also 
identified certain abusive transactions that could inappropriately 
accelerate recognition of section 987 loss under the 1991 proposed 
regulations.
B. 2006 Proposed Regulations
1. Concerns Relating to the 1991 Proposed Regulations
    On September 7, 2006, the Treasury Department and the IRS withdrew 
the 1991 proposed regulations and published in the Federal Register new 
proposed regulations under section 987 (71 FR 52876, September 7, 2006) 
(``2006 proposed regulations''). The preamble to the 2006 proposed 
regulations explained that the IRS had identified many cases in which 
taxpayers inappropriately claimed substantial section 987 losses 
resulting from the application of the 1991 proposed regulations when a 
QBU's functional currency depreciated relative to the functional 
currency of its owner. The 1991 proposed regulations also could create 
a ``trap for the unwary'' by requiring recognition of large section 987 
gains when a QBU's functional currency appreciated.
    These results arose because the 1991 proposed regulations imputed 
section 987 gain or loss to all assets and liabilities of a QBU, 
regardless of whether those assets and liabilities were economically 
exposed to currency fluctuations or had been subject to a realization 
event, and because the 1991 proposed regulations did not limit the 
selective recognition of section 987 losses. Consequently, under the 
1991 proposed regulations, exchange rate fluctuations that, at most, 
had only an uncertain and remote effect on the economic results 
experienced by the owner of a QBU could give rise to substantial 
section 987 gains and losses that taxpayers could selectively recognize 
by strategically timing remittances or causing a termination of the 
QBU. For example, the 1991 proposed regulations provided taxpayers with 
substantial flexibility to

[[Page 78135]]

recognize section 987 losses selectively by causing QBUs with a weak 
functional currency to make remittances while avoiding remittances from 
QBUs with a strong functional currency that would give rise to gains.
2. Foreign Exchange Exposure Pool Method
    To address the concerns relating to the 1991 proposed regulations, 
the 2006 proposed regulations provided a new method of applying section 
987, referred to as the foreign exchange exposure pool (``FEEP'') 
method. Under the FEEP method, the owner of a QBU that is subject to 
section 987 (``section 987 QBU'') determines all items of income, gain, 
deduction, and loss attributable to the QBU in the QBU's functional 
currency, and then translates those items into the owner's functional 
currency. For this purpose, the basis of certain assets (referred to as 
``historic assets'') is translated at the exchange rate for the date on 
which the asset was acquired (the ``historic rate''). For example, cost 
recovery deductions, such as depreciation, in respect of historic 
assets are translated at the historic rate. Other items (including the 
amount realized on a sale or exchange of a historic asset) are 
translated into the owner's functional currency at the average exchange 
rate for the taxable year.
    In addition, the owner of a section 987 QBU must determine the pool 
of unrecognized section 987 gain or loss (``net unrecognized section 
987 gain or loss'') based on the annual increase or decrease to the 
section 987 QBU's balance sheet that is attributable to foreign 
exchange rate fluctuations. The amount of section 987 gain or loss that 
is added to the pool each year is equal to the increase or decrease in 
the basis of assets (net of the amount of liabilities) of the section 
987 QBU, measured in the owner's functional currency and adjusted for 
transfers between the section 987 QBU and its owner and section 987 
taxable income or loss. See Sec.  1.987-4(d) of the 2006 proposed 
regulations. For this purpose, certain assets and liabilities (referred 
to as ``historic items'') are translated into the owner's functional 
currency at the historic rate, while others (referred to as ``marked 
items'') are translated into the owner's functional currency at the 
applicable spot rate. As a result, when translated into the owner's 
functional currency, the balance sheet value of marked items fluctuates 
when the QBU's functional currency strengthens or weakens, but the 
balance sheet value of historic items does not.
    Marked items and historic items are defined by reference to section 
988. A marked item is an asset or liability that would generate gain or 
loss under section 988 if it were held or entered into directly by the 
owner of the section 987 QBU but is not a section 988 transaction with 
respect to the QBU itself. A historic item is an asset or liability 
that is not a marked item. Thus, under the FEEP method, section 987 
gain or loss reflects currency fluctuations with respect to marked 
items, which would be subject to section 988 in the hands of the QBU's 
owner. By contrast, section 987 gain or loss is not imputed to historic 
items that are not subject to section 988.
    As a result of the use of a balance sheet approach, together with 
the use of historic rates for historic items, the FEEP method 
distinguishes between those items whose value is highly correlated with 
exchange rates and those items for which exchange rate fluctuations 
have no effect on value, or only an uncertain or remote effect that is 
more appropriately recognized upon a realization event with respect to 
that item. Unlike the 1991 proposed regulations, which imputed section 
987 gain or loss to all assets and liabilities of a QBU, section 987 
gain or loss under the FEEP method relates to those assets and 
liabilities that are economically exposed to currency fluctuations. The 
FEEP method also minimizes a taxpayer's ability to recognize large 
section 987 losses unrelated to its economic exposure and, thus, the 
need for a limitation on the selective recognition of such losses.
3. Partnerships
    The 2006 proposed regulations applied section 987 to partnerships 
using an aggregate approach. Under this approach, an individual or 
corporation that is a partner in a partnership is treated as an 
indirect owner of a portion of the assets and liabilities of the 
partnership for purposes of section 987. If the partner indirectly owns 
a QBU with a functional currency different from that of the partner, 
the QBU is a section 987 QBU, and the partner determines and recognizes 
section 987 gain or loss with respect to the section 987 QBU under the 
FEEP method. An elective de minimis exception was provided for partners 
with a less than five percent interest in a partnership.
4. Transition Rules
    The 2006 proposed regulations provided two alternative methods for 
taxpayers to transition from their prior method of applying section 
987: the ``deferral transition method'' and the ``fresh start 
transition method.'' Under both transition methods, all the taxpayer's 
section 987 QBUs were deemed to terminate on the day before the 
transition date, and the owner was treated as having transferred each 
section 987 QBU's assets and liabilities to a new section 987 QBU on 
the transition date. The transition date was defined as the first day 
of the first taxable year to which the 2006 proposed regulations apply 
to a taxpayer.
    Under the deferral transition method, section 987 gain or loss 
determined on the date of the deemed termination (under the taxpayer's 
prior method) was treated as net unrecognized section 987 gain or loss 
of the new section 987 QBU, which could be recognized on a remittance 
(or termination) in subsequent taxable years. The assets and 
liabilities that were deemed transferred to the section 987 QBU on the 
transition date (including marked assets and liabilities) were 
translated using historic rates, increased or decreased to take into 
account any amount treated as net unrecognized section 987 gain or loss 
determined with respect to the deemed termination. The deferral 
transition method thus preserved the taxpayer's section 987 gain or 
loss computed under its prior method and adjusted the applicable 
exchange rates to avoid double counting.
    Under the fresh start transition method, section 987 gain or loss 
that would have been recognized under the taxpayer's prior method as a 
result of the deemed termination was neither recognized nor carried 
forward as net unrecognized section 987 gain or loss. The assets and 
liabilities that were deemed transferred to the section 987 QBU on the 
transition date (including marked assets and liabilities) were 
translated using historic rates without adjustment.
    The fresh start transition method was designed to prevent 
recognition of non-economic section 987 gain or loss that was not 
recognized before the transition date. Because marked assets and 
liabilities were translated at historic rates under the fresh start 
transition method, any section 987 gain or loss inherent in those 
assets and liabilities would be added to the pool of net unrecognized 
section 987 gain or loss in the taxable year beginning on the 
transition date. However, exchange rate fluctuations with respect to 
historic items would not give rise to section 987 gain or loss. In 
addition, section 987 gain or loss attributable to items that were no 
longer reflected on the section 987 QBU's balance sheet on the 
transition date (for example, assets that

[[Page 78136]]

had been sold before the transition date) would never be taken into 
account.
    Only taxpayers that were applying section 987(3) using a reasonable 
method before the transition date were permitted to use the deferral 
transition method. A taxpayer whose prior method was unreasonable, or 
that failed to make required determinations under section 987 in prior 
years, was required to use the fresh start transition method.
    For this purpose, the preamble to the 2006 proposed regulations 
explained that the method of applying section 987 provided in the 1991 
proposed regulations would be treated as a reasonable method. The 
preamble to the 2006 proposed regulations further stated that the use 
of an ``earnings only'' method would be treated as a reasonable method. 
Under an ``earnings only'' method, section 987 gain or loss is 
recognized on a distribution out of a QBU's earnings, but not on a 
distribution in excess of earnings (which represents a return of 
capital).
C. 2016 Final Regulations
    On December 8, 2016, the Treasury Department and the IRS published 
final regulations (TD 9794) in the Federal Register (81 FR 88806, 
December 8, 2016) (the ``2016 final regulations''). The 2016 final 
regulations largely adopt the FEEP method contained in the 2006 
proposed regulations but modify those regulations to make the FEEP 
method easier for the IRS to administer and for taxpayers to apply. For 
example, the 2016 final regulations permit taxpayers to use the yearly 
average exchange rate as the historic rate applicable to historic 
items. See Sec.  1.987-3(c)(3). The 2016 final regulations also modify 
the computation of net unrecognized section 987 gain or loss for a 
taxable year by requiring adjustments for nondeductible expenses and 
tax-exempt income. See Sec.  1.987-4(d)(7) and (8).
    The 2016 final regulations maintain the aggregate approach of the 
2006 proposed regulations for partnerships. However, in response to 
comments relating to the complexity of the aggregate approach, the 2016 
final regulations apply only to partnerships that are wholly owned by 
related persons (``section 987 aggregate partnerships''). The preamble 
to the 2016 final regulations indicated that the treatment of other 
partnerships under section 987 would be addressed separately and such 
partnerships might be subject to a different approach.
    The 2016 final regulations require taxpayers to transition using 
the fresh start transition method. See Sec.  1.987-10. The Treasury 
Department and the IRS were concerned that an election between two 
transition methods (as permitted under the 2006 proposed regulations) 
would result in a whipsaw to the fisc, because each taxpayer could 
choose the method that produces more section 987 loss and less section 
987 gain (as was noted by comments on the 2006 proposed regulations). 
The Treasury Department and the IRS were also concerned about 
administrative difficulties and planning opportunities associated with 
adjustments to the translation rate under the deferral transition 
method.
    Section 1.987-11(a) provides that the 2016 final regulations 
generally apply to taxable years beginning on or after one year after 
the first day of the first taxable year following December 7, 2016. 
However, taxpayers could choose to apply them to an earlier taxable 
year under Sec.  1.987-11(b).
D. 2016 Temporary and Proposed Regulations
    On December 8, 2016, the Treasury Department and the IRS published 
Treasury Decision 9795 (the ``temporary regulations'') in the Federal 
Register (81 FR 88854, December 8, 2016) and published a notice of 
proposed rulemaking (81 FR 88882, December 8, 2016) (the ``2016 
proposed regulations'') in the Federal Register by cross-reference to 
the temporary regulations. The temporary regulations (other than Sec.  
1.987-12T) had the same applicability date as the 2016 final 
regulations.
    The temporary regulations and the 2016 proposed regulations 
include: (1) rules relating to the recognition and deferral of section 
987 gain or loss in connection with certain QBU terminations and 
certain other transactions involving partnerships; (2) an annual deemed 
termination election; (3) an elective method, available to taxpayers 
that make the annual deemed termination election, for translating all 
items of income or loss with respect to a section 987 QBU at the yearly 
average exchange rate; (4) rules regarding the treatment of section 988 
transactions of a section 987 QBU; (5) rules regarding QBUs with the 
U.S. dollar as their functional currency; (6) rules regarding 
combinations and separations of section 987 QBUs; (7) rules regarding 
the translation of income used to pay creditable foreign income taxes; 
(8) rules regarding the allocation of assets and liabilities of certain 
partnerships for purposes of section 987; and (9) rules requiring the 
deferral of certain section 988 loss that arises with respect to 
related-party loans.
    Under the annual deemed termination election provided in the 
temporary regulations, a taxpayer could elect to deem all of its 
section 987 QBUs to terminate on the last day of each taxable year, 
resulting in the recognition of all net unrecognized section 987 gain 
or loss on an annual basis. See Sec.  1.987-8T(d). The assets and 
liabilities of a section 987 QBU subject to the election were deemed to 
be distributed to the owner pursuant to the deemed termination on the 
last day of each taxable year and recontributed on the first day of the 
following taxable year. The temporary regulations further provided that 
a taxpayer who made an annual deemed termination election could elect 
to translate all items of section 987 taxable income or loss at the 
yearly average exchange rate. See Sec.  1.987-3T(d).
    The temporary regulations (other than those finalized or withdrawn 
in 2019, as described in part II.E of this Background section) expired 
on December 6, 2019. The Treasury Department and the IRS intend to 
remove the temporary regulations from the Federal Register when the 
proposed regulations are finalized.
    The following parts of the 2016 proposed regulations remain 
outstanding: (1) rules regarding the treatment of section 988 
transactions of a section 987 QBU (see Sec. Sec.  1.987-1, 1.987-3, and 
1.988-1 of the 2016 proposed regulations); (2) rules regarding QBUs 
with the U.S. dollar as their functional currency (see Sec. Sec.  
1.987-1 and 1.987-6 of the 2016 proposed regulations); (3) rules 
regarding the translation of income used to pay creditable foreign 
income taxes (see Sec.  1.987-3 of the 2016 proposed regulations); and 
(4) rules requiring the deferral of certain section 988 loss that 
arises with respect to related-party loans (see Sec.  1.988-2 of the 
2016 proposed regulations). A notice reopening the comment period for 
the parts of the 2016 proposed regulations that remain outstanding is 
published in this issue of the Federal Register.
E. 2019 Final Regulations
    On May 13, 2019, the Treasury Department and the IRS published 
Treasury Decision 9857 (84 FR 20790, May 13, 2019) (the ``2019 final 
regulations'' and, collectively with the 2016 final regulations, the 
``final regulations'') in the Federal Register. The 2019 final 
regulations finalized parts of the 2016 proposed regulations relating 
to combinations and separations of section 987 QBUs and the recognition 
and deferral of section 987 gain or loss in connection with certain QBU 
terminations and certain other transactions involving partnerships. The 
2019 final regulations also withdrew

[[Page 78137]]

Sec.  1.987-7T of the temporary regulations, relating to the allocation 
of assets and liabilities of a section 987 aggregate partnership to its 
partners for purposes of section 987, in response to comments noting 
that these rules could cause distortions in the computation of section 
987 gain or loss. The 2019 final regulations (other than Sec.  1.987-
12) have the same applicability date as the 2016 final regulations.

III. Executive Order 13789 and Interim Report to the President

    Executive Order 13789, issued on April 21, 2017, instructs the 
Secretary of the Treasury (the ``Secretary'') to review all significant 
tax regulations issued on or after January 1, 2016, and to take action 
to mitigate the burden of regulations that, in relevant part, impose an 
undue financial burden on U.S. taxpayers or add undue complexity to the 
Federal tax laws. The Executive order further instructs the Secretary 
to submit two reports to the President: an interim report that 
identifies regulations that meet the criteria described in the 
Executive order; and a report that recommends specific actions to 
mitigate the burden imposed by regulations identified in the interim 
report.
    In an interim report to the President dated June 22, 2017, the 
Treasury Department identified eight regulations, including the 2016 
final regulations, as meeting at least one of the criteria described in 
the Executive order. In Notice 2017-38, 2017-30 I.R.B. 147, which was 
published on July 24, 2017, the Treasury Department and the IRS 
requested comments on whether the regulations identified in the interim 
report (including the 2016 final regulations) should be rescinded or 
modified and, if not rescinded, how the regulations should be modified 
to reduce the burden and complexity.
    The Treasury Department and the IRS received several comments in 
response to Notice 2017-38. In addition, one comment was submitted in 
response to Notice 2017-57, 2017-42 I.R.B. 325 (which was the first of 
the deferral notices described in part V of this Background section). 
The comments that are relevant to the proposed regulations are 
discussed in the Explanation of Provisions.

IV. Second Report to the President on Identifying and Reducing Tax 
Regulatory Burdens

    On October 16, 2017, the Secretary published a report (the 
``Report'') in the Federal Register (82 FR 48013, October 16, 2017) 
recommending specific actions to mitigate the burden imposed by the 
regulations identified in the interim report. The Report stated that 
the Treasury Department and the IRS intend to propose modifications to 
the 2016 final regulations and to issue guidance permitting taxpayers 
to elect to defer the application of Sec. Sec.  1.987-1 through 1.987-
10.
    In particular, the Report stated that, in response to comments, the 
Treasury Department and the IRS intend to propose rules that would 
permit taxpayers to elect to adopt a simplified method of calculating 
section 987 gain or loss and translating section 987 taxable income or 
loss, subject to certain limitations on the recognition of section 987 
loss. One simplified method discussed in the Report would allow a 
taxpayer to treat all assets and liabilities of a section 987 QBU as 
marked items and to translate all items of income and expense at the 
average exchange rate for the taxable year. Under this method, the 
amount of section 987 gain or loss would generally be consistent with 
the amount determined under the 1991 proposed regulations and would 
more closely conform to the applicable financial accounting rules.
    The Report also noted that the Treasury Department and the IRS were 
considering limitations on the recognition of section 987 loss that 
would apply to taxpayers using the simplified method. Two potential 
limitations were mentioned in the Report: (1) a rule that would allow 
the electing taxpayer to recognize net section 987 loss only to the 
extent of net section 987 gain recognized in prior or subsequent years; 
and (2) a rule that would defer the recognition of all section 987 gain 
or loss until the earlier of (i) the year that the trade or business 
conducted by the section 987 QBU ceases to be performed by any member 
of its controlled group or (ii) the year that substantially all of the 
assets and activities of the QBU are transferred outside of the 
controlled group.
    Finally, the Report stated that the Treasury Department and the IRS 
were considering alternative transition rules. One alternative would 
allow taxpayers to carry forward unrealized section 987 gains and 
losses (measured on the transition date with appropriate adjustments), 
and a second alternative would allow taxpayers to translate all items 
of the section 987 QBU at the spot rate on the transition date without 
carrying forward any unrecognized section 987 gain or loss.

V. Deferral Notices

    The Treasury Department and the IRS have issued several notices 
stating that future guidance would defer the applicability dates of the 
2016 final regulations, Sec. Sec.  1.987-2(c)(9) and 1.987-4(c)(2) and 
(f) of the 2019 final regulations (the ``related 2019 final 
regulations''), and Sec. Sec.  1.987-1T (other than Sec. Sec.  1.987-
1T(g)(2)(i)(B) and (g)(3)(i)(H)) through 1.987-4T, 1.987-6T, 1.987-7T, 
1.988-1T, and 1.988-2T(i) of the temporary regulations. Most recently, 
on August 22, 2022, Notice 2022-34, 2022-34 I.R.B. 150, announced that 
future guidance would defer the applicability date of the 2016 final 
regulations and the related 2019 final regulations by one additional 
year to taxable years beginning after December 7, 2023. Thus, following 
the amendments described in that Notice, the 2016 final regulations and 
the related 2019 final regulations would first apply to the taxable 
year beginning on January 1, 2024, for calendar year taxpayers. The 
applicability date of Sec.  1.987-12 would not be affected by these 
amendments.

VI. Financial Accounting Rules

    The rules of the final regulations under section 987 differ from 
the U.S. generally accepted accounting principles (``U.S. GAAP'') 
relating to foreign currency translation gain or loss.\1\ For financial 
accounting purposes, the consolidated financial statements of a 
reporting entity may include operations denominated or measured in 
currencies other than the reporting currency (each such operation, a 
foreign entity),\2\ resulting in the need to translate those operations 
into the reporting currency of the reporting entity. FASB, 2023, ASC 
par. 830-10-10-1. The assets and liabilities and other elements, such 
as revenues and expenses, of the financial statements of a foreign 
entity are translated to the reporting currency using a current 
exchange rate. FASB, 2023, ASC pars. 830-30-45-3 through 830-30-45-5. 
For example, assets and liabilities of the foreign entity are 
translated into the reporting currency using the spot rate on the 
balance sheet date. Translation adjustments resulting from the process 
of translating a foreign entity's financial statements to the reporting 
currency are not included in determining net income

[[Page 78138]]

but are reported in the cumulative translation adjustment (CTA), which 
is part of other comprehensive income, included in the in the equity 
section of the reporting entity's consolidated balance sheet. FASB, 
2023, ASC par. 830-30-45-12. Upon the sale or liquidation of the 
investment in the foreign entity, the CTA attributable to that foreign 
entity is removed from equity and is reported as part of the gain or 
loss on the sale or liquidation of the investment. FASB, 2023, ASC par. 
830-30-40-1.
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    \1\ The relevant U.S. GAAP financial accounting rules are 
contained in Financial Accounting Standards Board (``FASB''), 
Accounting Standards Codification (``ASC''), Foreign Currency 
Matters, Topic 830 (formerly known as FASB Statement No. 52, Foreign 
Currency Translation).
    \2\ A foreign entity is an operation, including a subsidiary, 
division, and branch, whose financial statements are both (a) 
prepared in a currency other than the reporting currency of the 
reporting entity, and (b) combined or consolidated with or accounted 
for on the equity basis in the financial statements of the reporting 
entity. FASB, 2023, ASC sec. 830-10-20.
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    The treatment of translation gain or loss under FASB, ASC Topic 
830, under which translation gain or loss is deferred until a sale or 
liquidation, differs from the requirements of section 987(3), under 
which a taxpayer is required to make proper adjustments for the 
transfer of property between QBUs of a taxpayer by including section 
987 gain or loss in income upon a remittance. Further, in contrast to 
the translation adjustments in the financial accounting rules, which 
apply to all assets and liabilities of a foreign entity, the FEEP 
method imputes section 987 gain or loss only to marked items of a 
section 987 QBU and requires the basis of historic assets to be 
translated at historic rates for purposes of computing section 987 
taxable income or loss.

Explanation of Provisions

    The proposed regulations retain the basic approach and structure of 
the final regulations, while adopting a number of the simplifications 
discussed in the Report and providing additional guidance regarding the 
determination of section 987 taxable income or loss and section 987 
gain or loss.

I. FEEP Method

    As explained in parts II.B and II.C of the Background section, the 
final regulations provide that section 987 gain or loss and section 987 
taxable income or loss are determined under the FEEP method. This 
method uses a balance sheet approach to determine section 987 gain or 
loss. In addition, historic items are translated at historic rates 
(both for purposes of determining section 987 gain or loss and for 
purposes of translating recovery of basis with respect to historic 
assets in computing section 987 taxable income or loss). As a result, 
the FEEP method does not impute section 987 gain or loss to historic 
items, for which exchange rate changes have only an uncertain or remote 
effect on value that is more appropriately recognized upon a 
realization event.
    Several comments asserted that the FEEP method is overly complex 
and presents significant compliance burdens, primarily related to the 
treatment of historic items. Comments stated that, because the 
requirement to use historic rates to translate historic items diverges 
from financial accounting rules, taxpayers would need to keep a 
separate set of books with respect to each section 987 QBU and to 
develop costly reporting systems to maintain information that is not 
used for any other purpose.
    Comments recommended that, to reduce the complexity and 
administrative burden of the final regulations, taxpayers should be 
permitted to apply a method similar to that provided in the 1991 
proposed regulations. Comments noted that this method could be coupled 
with rules to prevent the selective recognition of section 987 losses, 
as discussed in part III of this Explanation of Provisions.
    The proposed regulations retain the FEEP method of the 2016 final 
regulations, with modifications discussed in this Explanation of 
Provisions, as the default rule for determining section 987 taxable 
income or loss and net unrecognized section 987 gain and loss. See 
proposed Sec. Sec.  1.987-3 and 1.987-4. The FEEP method is an 
appropriate default rule because it generally provides a more precise 
measure of section 987 gain or loss. Moreover, the enactment of the Tax 
Cuts and Jobs Act, Public Law 115-97, 131 Stat. 2054 (2017), on 
December 22, 2017, has made it even more important to accurately 
calculate taxable income with respect to a section 987 QBU. For 
example, section 951A, relating to global intangible low-taxed income 
(``GILTI''), has significantly expanded the scope of taxable income of 
a controlled foreign corporation (``CFC'') that is subject to current 
U.S. taxation.\3\
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    \3\ Previously, section 987 gain or loss recognized by a CFC 
generally would be taken into account in determining a U.S. 
shareholder's taxable income only if a portion of the section 987 
gain or loss affected the calculation of subpart F income or when 
the earnings of the CFC were relevant, such as on a distribution or 
sale.
---------------------------------------------------------------------------

    In addition, because the 2016 final regulations permit the yearly 
average exchange rate to be used as the historic rate, a taxpayer that 
knows the year in which an asset was acquired or placed in service can 
determine the applicable historic rate based on publicly available 
information. Information relating to the year in which an asset was 
acquired or placed in service is often tracked for other reasons, 
including for purposes of computing depreciation and amortization. For 
example, in computing a CFC's qualified business asset investment, 
section 951A(d)(3)(A) now requires the adjusted basis of assets to be 
determined using the alternative depreciation system under section 
168(g).
    However, the Treasury Department and the IRS acknowledge that in 
some cases it may be burdensome to translate the basis of each historic 
asset using a different historic rate (including for purposes of 
depreciation) in determining section 987 taxable income or loss. 
Accordingly, as described in parts II and IV of this Explanation of 
Provisions, the proposed regulations provide several simplifying 
elections that permit section 987 to be applied in a way that more 
closely conforms to the financial accounting rules and reduces the 
compliance burden. Taxpayers who make these elections would still 
compute section 987 gain or loss by reference to the year-end balance 
sheet of the section 987 QBU (though the computation would be modified, 
as described in part V of this Explanation of Provisions). The proposed 
regulations do not include an election to use the method prescribed in 
the 1991 proposed regulations, because the use of fundamentally 
different computational methods by different taxpayers (or by the same 
taxpayer in different years) would increase the complexity of the 
section 987 regulations and make them more difficult to administer.

II. Current Rate Election

    As discussed in part I of this Explanation of Provisions section, 
comments noted that the compliance burden associated with the FEEP 
method relates primarily to the treatment of historic items. Under the 
2016 final regulations, taxpayers are required to track the historic 
rate for historic items and to use the historic rate for purposes of 
computing section 987 taxable income or loss and section 987 gain or 
loss.
    To alleviate this compliance burden, proposed Sec.  1.987-1(d)(2) 
would provide an election to treat all items that are properly 
reflected on the books and records of a section 987 QBU as marked items 
(the ``current rate election''). If a current rate election applies, 
all items of income, gain, deduction, and loss with respect to a 
section 987 QBU would be translated at the yearly average exchange rate 
for the current taxable year for purposes of computing section 987 
taxable income or loss. See proposed Sec.  1.987-3(c)(2). In addition, 
all items of a section 987 QBU would be translated at the year-end spot 
rate for purposes of computing section 987 gain or loss.
    The current rate election is expected to produce an amount of 
section 987

[[Page 78139]]

gain or loss and section 987 taxable income or loss that is similar to 
the amounts determined under the 1991 proposed regulations. If a 
current rate election is made, all assets and liabilities of a section 
987 QBU would generate section 987 gain or loss, in conformity with the 
approach used for financial reporting purposes and the 1991 proposed 
regulations.
    In general, a current rate election would increase the pool of net 
unrecognized section 987 gain or loss with respect to a section 987 QBU 
(relative to the pool that would be determined without the current rate 
election). In addition, under a current rate election amounts in the 
pool may substantially exceed any economic gain or loss attributable to 
currency fluctuations. The Treasury Department and the IRS are 
concerned that without appropriate limitation, the current rate 
election would facilitate the abuses and inappropriate outcomes that 
occurred under the 1991 proposed regulations, including the potential 
for taxpayers to choose to recognize significant, and potentially 
uneconomic, section 987 losses while avoiding or deferring section 987 
gains. Accordingly, the proposed regulations include a rule that would 
suspend the recognition of section 987 loss when a current rate 
election is in effect. See part III of this Explanation of Provisions.

III. Suspension of Section 987 Loss Under a Current Rate Election

    Comments discussed several options for addressing the potential for 
selective recognition of section 987 losses. First, comments asserted 
that certain rules provided in the 2016 final regulations (for example, 
the annual netting of contributions and distributions to determine the 
amount of a remittance under Sec.  1.987-5(c)) would be sufficient to 
prevent abuse. Alternatively, comments recommended that the recognition 
of section 987 gain or loss be deferred until a QBU is terminated or 
its assets are sold to an unrelated party, consistent with the 
financial accounting rules. Comments also suggested that section 987 
loss could be deferred until the owner recognizes an equal or greater 
amount of section 987 gain from the same QBU. Finally, some comments 
proposed a ``lookback'' approach, under which section 987 loss would be 
deferred only to the extent that the loss exceeded section 987 gain 
previously recognized with respect to the same section 987 QBU.
    The Treasury Department and the IRS are concerned that, 
notwithstanding the annual netting rule of Sec.  1.987-5(c) and the 
other rules provided in the 2016 final regulations, taxpayers generally 
have a significant degree of control over whether and when their 
section 987 QBUs make remittances and, therefore, could still 
selectively recognize section 987 losses. In addition, because 
taxpayers that make a current rate election are expected to have 
substantial pools of net unrecognized section 987 gain or loss, special 
rules are needed to prevent the selective recognition of losses.
    Accordingly, if a current rate election is in effect, the proposed 
regulations generally would suspend the recognition of section 987 loss 
until a taxable year in which an equal or greater amount of section 987 
gain is recognized (as described in part III.A of this Explanation of 
Provisions) or until the occurrence of certain recognition events (as 
described in part III.B of this Explanation of Provisions).
A. General Rules Relating to Suspended Section 987 Loss
1. In General
    In a taxable year in which a current rate election applies, any 
section 987 loss that would otherwise be recognized as a result of a 
remittance (including a deemed remittance resulting from the 
termination of a section 987 QBU) is treated as suspended section 987 
loss. Proposed Sec.  1.987-11(c). In general, an owner of a section 987 
QBU would recognize suspended section 987 loss in a taxable year in 
which the owner recognizes section 987 gain that has the same source 
and character as the suspended section 987 loss (the ``loss-to-the-
extent-of-gain rule''). Proposed Sec.  1.987-11(e). Whether section 987 
gain has the same source and character as suspended section 987 loss 
would be determined on the basis of the initial assignment in proposed 
Sec.  1.987-6(b)(2)(i). See proposed Sec.  1.987-11(e)(1) and (f).
    The Treasury Department and the IRS considered applying the loss-
to-the-extent-of-gain rule at the QBU level, such that suspended 
section 987 loss with respect to a section 987 QBU would be recognized 
only to the extent of section 987 gain recognized with respect to the 
same section 987 QBU (as was recommended by some comments). However, 
the Treasury Department and the IRS were concerned that a QBU-level 
limitation would be overly restrictive. Moreover, if an owner has 
suspended section 987 loss with respect to one QBU, the concern of 
selective loss recognition may be mitigated to the extent that the same 
owner recognizes section 987 gain with respect to another QBU.
    Therefore, under the proposed regulations, the loss-to-the-extent-
of-gain rule applies at the owner level. An owner of a section 987 QBU 
recognizes suspended section 987 loss to the extent that it recognizes 
section 987 gain, regardless of which QBU generates the gain. However, 
because this rule applies at the owner level, the Treasury Department 
and the IRS were concerned that an owner might trigger the recognition 
of section 987 gain that is not subject to residual U.S. tax (or is 
taxed at a low rate) to release suspended section 987 loss of a 
different source or character. Accordingly, proposed Sec.  1.987-
11(e)(1) provides that an owner does not recognize suspended section 
987 loss until it recognizes section 987 gain in the same recognition 
grouping as the suspended section 987 loss.
    In general, section 987 gain and suspended section 987 loss are in 
the same recognition grouping if they are both initially assigned to 
U.S. source income or to foreign source income in the same section 904 
category. Proposed Sec.  1.987-11(f)(1). In addition, if the owner of a 
section 987 QBU is a CFC, in order to be in the same recognition 
grouping, section 987 gain and suspended section 987 loss must both be 
initially assigned to the same statutory and residual grouping of 
subpart F income, tentative tested income, income described in section 
952(b) (certain income that is effectively connected with the conduct 
of a trade or business within the United States (``ECI'') and excluded 
from subpart F income), or other income.\4\ Proposed Sec.  1.987-
11(f)(2).
---------------------------------------------------------------------------

    \4\ See part VI of this Explanation of Provisions (requesting 
comments concerning the treatment of section 987 gain or loss as 
ECI).
---------------------------------------------------------------------------

    Suspended section 987 loss that is not recognized in a taxable year 
is recognized in the next taxable year in which (and to the extent 
that) the owner recognizes section 987 gain in the same recognition 
grouping. The Treasury Department and the IRS also considered a 
lookback rule, under which suspended section 987 loss could be 
recognized to the extent that section 987 gain was recognized in a 
prior taxable year. However, a lookback rule would permit taxpayers to 
selectively trigger section 987 gain in taxable years in which such 
gain would not give rise to additional U.S. tax (for example, because 
the gain is offset by losses or because the additional U.S. tax is 
offset with foreign tax credits). In light of these concerns, the 
Treasury Department and the IRS request comments regarding, if a 
lookback rule were to be adopted, how to prevent section 987 gain that 
has no

[[Page 78140]]

net effect on U.S. tax from releasing suspended section 987 loss that 
reduces U.S. tax.
2. Suspension of Section 987 Loss When an Annual Recognition Election 
Is Made
    In general, a taxpayer who makes an annual recognition election 
will recognize the full amount of net unrecognized section 987 gain or 
loss that is added to the pool each year. If an annual recognition 
election and a current rate election are both in effect for a taxable 
year, section 987 loss generally would not be suspended under proposed 
Sec.  1.987-11(c). See part IV of this Explanation of Provisions.
    The Treasury Department and the IRS are concerned that taxpayers 
who are subject to a current rate election might seek to avoid the 
application of the loss-to-the-extent-of-gain rule by making an annual 
recognition election after net unrecognized section 987 loss has 
accrued. Similarly, the Treasury Department and the IRS are concerned 
that taxpayers that have not made a current rate election, but which 
have substantial pools of net unrecognized section 987 loss, might make 
an annual recognition election to recognize the loss without the need 
for a remittance. Accordingly, the proposed regulations would treat any 
net accumulated unrecognized section 987 loss and deferred section 987 
loss as suspended section 987 loss in the first year in which an annual 
recognition election takes effect if either (1) a current rate election 
was in effect in the previous year or (2) the owner had more than $5 
million of net section 987 losses. Proposed Sec.  1.987-11(d).
3. Recognition of Suspended Section 987 Loss When an Annual Recognition 
Election Is in Effect
    The proposed regulations also contain a special rule relating to 
the recognition of suspended section 987 loss when a current rate 
election and an annual recognition election are both in effect. The 
Treasury Department and the IRS are concerned that, absent a 
modification to the general loss-to-the-extent-of-gain rule in proposed 
Sec.  1.987-11(e)(1), taxpayers that have suspended section 987 loss 
would get an unwarranted benefit from making an annual recognition 
election. Specifically, absent a modification, these taxpayers would be 
able to recognize suspended section 987 loss even if they had net 
losses on a cumulative basis for the taxable years to which the annual 
recognition election applied.
    For example, assume that an owner of a section 987 QBU has 
suspended section 987 loss of $400 that arose in prior years (for 
example, under a current rate election). The owner's functional 
currency is the U.S. dollar, and the section 987 QBU's functional 
currency is the euro. In year 1, the owner makes an annual recognition 
election. The euro weakens in year 1 and partially recovers in year 2. 
As a result of the annual recognition election, the owner recognizes 
section 987 loss of $200 in year 1 and recognizes section 987 gain of 
$150 in year 2. Under the general loss-to-the-extent-of-gain rule in 
Sec.  1.987-11(e)(1), even though the owner recognized net section 987 
loss of $50 on a cumulative basis (over years 1 and 2), the owner would 
recognize suspended section 987 loss equal to the section 987 gain in 
the same recognition grouping that it recognizes in year 2. Assuming 
all of the section 987 gain or loss is in the same recognition 
grouping, the owner would recognize $350 of total section 987 loss 
(equal to $200 of section 987 loss recognized under the annual 
recognition election in year 1 and $150 of suspended section 987 loss 
recognized under the loss-to-the-extent-of-gain rule in year 2), even 
though it recognizes only $150 of section 987 gain.
    Accordingly, if a taxpayer makes both an annual recognition 
election and a current rate election, the loss-to-the-extent-of-gain 
rule would apply by reference to the net cumulative amount of section 
987 gain in each recognition grouping that is recognized by the 
taxpayer during the relevant testing period (rather than the gross 
amount recognized each taxable year). Proposed Sec.  1.987-11(e)(2). 
The testing period generally is the period in which section 987 loss is 
suspended and both a current rate election and an annual recognition 
election are in effect. Proposed Sec.  1.987-11(e)(2)(iii). The 
Treasury Department and the IRS request comments on whether any 
modifications to the limitation in proposed Sec.  1.987-11(e)(2) would 
allow for simplification while preventing inappropriate outcomes.
B. Suspended Section 987 Loss Recognized or Attributed to a Successor 
on Termination
    The proposed regulations provide a successor rule that applies when 
a section 987 QBU with suspended section 987 loss terminates. Under the 
successor rule, suspended section 987 loss is not recognized in the 
taxable year of termination, but instead becomes attributable to a 
successor suspended loss QBU.
    For this purpose, an eligible QBU is treated as a successor of a 
section 987 QBU if it holds a significant portion of the assets of the 
section 987 QBU following its termination, is engaged in the same trade 
or business, and is owned by the owner of the section 987 QBU or a 
member of the owner's controlled group. Proposed Sec.  1.987-13(b)(1). 
For this purpose, any eligible QBU may qualify as a successor, whether 
or not it is a section 987 QBU (that is, whether or not it has a 
different functional currency than its owner). Thus, for example, if an 
owner of a section 987 QBU with suspended section 987 loss contributes 
the assets of the section 987 QBU to a subsidiary where they are held 
by an eligible QBU of the subsidiary that uses them in the same trade 
or business (the ``subsidiary QBU''), the subsidiary QBU is a successor 
suspended loss QBU even if it is not a section 987 QBU. Similar 
principles apply when a successor terminates. Proposed Sec.  1.987-
13(c)(1).
    If a section 987 QBU (or its successor) terminates without a 
successor, the original owner of the section 987 QBU recognizes all of 
its suspended section 987 loss with respect to the section 987 QBU (or 
its successor). Proposed Sec.  1.987-13(b)(2) and (c)(2). Therefore, an 
owner generally would recognize suspended section 987 loss when it 
transfers the section 987 QBU's assets to an unrelated party or the 
section 987 QBU ceases its trade or business (such that there is no 
successor suspended loss QBU). These events are similar to the events 
that result in a release of the CTA for financial reporting purposes. 
Moreover, the Treasury Department and the IRS expect that taxpayers 
would be less likely to sell or wind up the trade or business of a 
section 987 QBU for the purpose of selectively recognizing section 987 
losses and, accordingly, there is less of a need for continued 
suspension of section 987 loss after these events occur.
    In addition, suspended section 987 loss is recognized if the owner 
of the successor ceases to be related to the original owner of the 
suspended loss QBU due to a direct or indirect transfer of interests in 
the owner of the successor. Proposed Sec.  1.987-13(d). If the owner of 
a successor suspended loss QBU ceases to be related to the original 
owner of the section 987 QBU for a different reason (for example, due 
to a transfer of interests in the original owner of the suspended loss 
QBU), the successor suspended loss QBU is no longer treated as a 
successor, and suspended section 987 loss can no longer be recognized 
in connection with a termination (though it can still be recognized 
under the loss-to-the-extent-of-gain rule). Proposed Sec.  1.987-13(e).

[[Page 78141]]

This rule is intended to prevent taxpayers from transferring the stock 
of the original owner out of its controlled group for the purpose of 
selectively recognizing suspended section 987 loss, while leaving 
behind the assets and activities of the section 987 QBU in the hands of 
a different controlled group member.
    Similarly, suspended section 987 loss is not recognized when the 
owner of a section 987 QBU liquidates in a transaction described in 
section 331. Proposed Sec.  1.987-13(f). Instead, suspended section 987 
loss that is not recognized in the taxable year of the liquidation is 
eliminated and will never be recognized. This rule is intended to 
prevent taxpayers from entering into section 331 transactions in order 
to trigger the recognition of suspended section 987 loss. For example, 
a U.S. shareholder could cause an upper-tier CFC that owns a section 
987 QBU with suspended section 987 loss to transfer all of its assets 
and liabilities to a lower-tier CFC in a section 351 contribution, and 
then cause the upper-tier CFC to liquidate in a transaction described 
in section 331 in order to recognize the suspended loss. The Treasury 
Department and the IRS are aware that similar transactions have been 
used to claim large section 987 losses under current law.
    In the case of a combination or separation, the suspended section 
987 loss of a combined or separated QBU is determined under rules 
similar to those applicable to net accumulated unrecognized section 987 
gain or loss under proposed Sec.  1.987-4(f). Proposed Sec.  1.987-
11(b)(2) and (3). Therefore, the suspended section 987 loss of a 
separating QBU is allocated to the separated QBUs in proportion to the 
assets properly reflected on the books and records of each separated 
QBU after the separation. Proposed Sec.  1.987-11(b)(3)
C. Special Rule for Inbound Liquidations and Reorganizations
    Under the proposed regulations, if a foreign corporation liquidates 
or merges into a domestic corporation in a section 381(a) transaction, 
the domestic corporation does not succeed to or take into account any 
unused suspended section 987 loss of the foreign corporation. Proposed 
Sec.  1.987-13(g). This rule is intended to prevent the importation of 
suspended section 987 loss that was generated offshore. Due to 
differences in how income of a CFC is taxed to its U.S. shareholders, 
these losses may relate to income subject to tax at a significantly 
reduced effective rate. For example, a suspended section 987 loss that 
is allocated and apportioned to the other income grouping under 
proposed Sec.  1.987-6 may effectively reduce only earnings that would 
typically not be subject to current U.S. tax, and which may be eligible 
for a dividends received deduction under section 245A upon 
distribution. As a result, depending on the particular facts, such 
losses may have little or no impact on the U.S. tax liability of a 
CFC's U.S. shareholder when they are recognized and are generally not 
equivalent to the section 987 gains or losses typical of a domestic 
corporation.
    Furthermore, even if the domestic corporation could, in theory, 
succeed to the suspended section 987 loss, the loss may have been 
assigned to an income group, such as the tested income group, that is 
not relevant to a domestic corporation, in which case, it would be 
highly unlikely that the suspended section 987 loss could ever be used 
(absent a subsequent outbound asset transfer by the domestic 
corporation to a foreign successor) under the loss-to-the-extent-of-
gain rule because the domestic corporation would not recognize section 
987 gain in the same recognition grouping.
D. Rejection of Financial Accounting Deferral Rule
    The Treasury Department and the IRS also considered a rule that 
would defer the recognition of all section 987 gain and loss of a 
section 987 QBU until a taxable year in which the section 987 QBU's 
trade or business ceases to be performed by any member of the 
controlled group or substantially all of the assets and activities of 
the QBU are transferred outside of the controlled group. This approach 
would more closely parallel the rules for determining when the CTA is 
released for financial accounting purposes.
    However, the loss limitation rule provided in the proposed 
regulations is more consistent with the statutory provisions of section 
987(3), which contemplates the recognition of section 987 gain or loss 
at the time of a remittance, and section 989(c)(2), which authorizes 
regulations limiting the recognition of foreign currency loss on 
certain remittances. Moreover, the Treasury Department and the IRS are 
concerned that a rule that defers the recognition of all section 987 
gain or loss may be difficult to administer. For example, as a 
practical matter, taxpayers might not properly track section 987 gain 
or loss on an annual basis if it is not expected to be recognized in 
the foreseeable future and the sale or liquidation of a section 987 QBU 
might occur many years after the accrual of section 987 gain or loss 
(at which time the necessary records may no longer be available).

IV. Annual Recognition Election

A. Annual Deemed Termination Election Provided in the 2016 Temporary 
and Proposed Regulations
    As explained in part II.D of the Background section, the 2016 
temporary and proposed regulations contained an annual deemed 
termination election. Under this election, a section 987 QBU would be 
deemed to terminate on the last day of each taxable year, resulting in 
the remittance of all the gross assets of the section 987 QBU to its 
owner and the recognition of all net unrecognized section 987 gain or 
loss on an annual basis. See Sec. Sec.  1.987-8T(d) and 1.987-8(e). The 
assets and liabilities of a section 987 QBU subject to the election 
would then be deemed to be contributed to the section 987 QBU on the 
first day of the following taxable year. See Sec.  1.987-8T(d).
    A comment asserted that it was difficult to apply the rules under 
the annual deemed termination election. If the election was made, a 
section 987 QBU's historic assets and the amount of its historic 
liabilities would be translated at the end of each year into the 
owner's functional currency using historic rates (due to the deemed 
termination and remittance); the historic rate would generally be the 
yearly average exchange rate for the year of the deemed termination. 
The assets and liabilities would then be retranslated into the section 
987 QBU's functional currency at the beginning of the following taxable 
year at the yearly average exchange rate for the following taxable year 
(due to the deemed contribution). See Sec. Sec.  1.987-2(d)(2) and 
1.987-5(f)(3). As a result, the basis of a section 987 QBU's assets and 
the amount of its liabilities (determined in the section 987 QBU's 
functional currency) generally would change from one year to the next, 
which would increase the compliance burden of applying the section 987 
regulations.
B. Annual Recognition Election Provided in the Proposed Regulations
    The proposed regulations would replace the annual deemed 
termination election with an annual recognition election. Like the 
annual deemed termination election, an owner that makes the annual 
recognition election would recognize the full amount of net 
unrecognized section 987 gain or loss each year. However, the proposed 
annual recognition election does not result in a deemed termination of 
a

[[Page 78142]]

section 987 QBU and a deemed remittance of its assets or a deemed 
contribution to the section 987 QBU. Instead, the owner of a section 
987 QBU simply recognizes the full amount of its net unrecognized 
section 987 gain or loss on an annual basis. Therefore, the annual 
recognition election would not alter the functional currency basis of a 
section 987 QBU's assets, the amount of its liabilities, or their 
historic exchange rates.
C. Special Rules That Apply When a Current Rate Election and an Annual 
Recognition Election Are Both in Effect
    The annual recognition election is available to owners whether or 
not they make a current rate election. If an owner makes both an annual 
recognition election and a current rate election for a taxable year, 
the loss suspension rule described in part III of this Explanation of 
Provisions does not apply to net unrecognized section 987 loss accrued 
while the election is in effect. Because the annual recognition 
election requires both gains and losses to be recognized without regard 
to whether a remittance occurs, selective recognition of losses is not 
possible and, accordingly, a loss limitation should not be needed. 
However, see part III.A.3 of this Explanation of Provisions regarding 
the application of the loss-to-the-extent-of-gain rule when an annual 
recognition election is in effect.
D. Translation of Taxable Income Under an Annual Recognition Election 
When a Current Rate Election Is Not in Effect
    If an owner of a section 987 QBU makes an annual recognition 
election, but does not make a current rate election, section 987 
taxable income or loss is determined by translating all items at the 
yearly average exchange rate. Unlike under the 2016 temporary and 
proposed regulations, this rule is mandatory (rather than elective). 
Use of the yearly average exchange rate simplifies the determination of 
section 987 taxable income or loss without sacrificing accuracy and is 
consistent with financial accounting principles. Therefore, an election 
to use historic rates for this purpose should not be needed.
E. Consequences of Making an Annual Recognition Election if a Current 
Rate Election Is Not in Effect
    As described in part IV.D of this Explanation of Provisions, if an 
owner of a section 987 QBU makes an annual recognition election, and 
does not make a current rate election, the owner would use the yearly 
average exchange rate for purposes of determining section 987 taxable 
income or loss. However, the owner would use historic rates to 
translate historic items for purposes of determining section 987 gain 
or loss. Thus, the same historic item would be translated at different 
exchange rates for different purposes. Under the mechanics of the FEEP 
method, if a historic asset is sold or depreciated during the taxable 
year, the difference between the historic rate basis and the current 
year average rate basis would be added to the pool of unrecognized 
section 987 gain or loss (and recognized pursuant to the annual 
recognition election).
    The effect of these rules is that--with respect to historic assets 
of a section 987 QBU--an owner that does not make a current rate 
election would recognize the same total amount of taxable income each 
year regardless of whether it makes an annual recognition election. For 
example, assume a section 987 QBU has the euro as its functional 
currency, and its owner is a calendar year taxpayer with the U.S. 
dollar as its functional currency. At the end of year 1, the section 
987 QBU owns a non-depreciable historic asset (Asset A) with a basis of 
100 euros, and the historic rate for Asset A is [euro]1=$1. The yearly 
average exchange rate in year 2 and the spot rate on December 31, year 
2 is [euro]1=$2. In year 2, the section 987 QBU sells Asset A for 150 
euros and holds the 150 euros on its balance sheet until the end of 
year 2.
    If the owner does not make an annual recognition election, the 
owner will have section 987 taxable income of $200 for year 2. This 
reflects the excess of the amount realized (150 euros, translated at 
the yearly average exchange rate of [euro]1=$2 into $300) over the 
basis of Asset A (100 euros, translated at the historic rate of 
[euro]1=$1 into $100). The owner will have no unrecognized section 987 
gain or loss for the taxable year under Sec.  1.987-4(d). A comparison 
of the year 2 and year 1 year-end balance sheets under Sec.  1.987-
4(d)(1) will reflect an increase of $200 (the excess of 150 euros held 
at the end of year 2, translated at the year 2 year-end spot rate of 
[euro]1=$2 into $300, over the [euro]100 basis of Asset A, which was 
held at the end of year 1, translated at the historic rate of 
[euro]1=$1 into $100). However, this increase is fully offset by the 
negative adjustment for taxable income of $200 under Sec.  1.987-
4(d)(6).
    By contrast, if the owner makes an annual recognition election, the 
owner will have section 987 taxable income in year 2 of only $100 (50 
euros of taxable income, translated at the yearly average exchange rate 
of [euro]1=$2). The owner will also have unrecognized section 987 gain 
for the taxable year of $100 under Sec.  1.987-4(d), which reflects the 
balance sheet increase of $200 (computed under Sec.  1.987-4(d)(1) as 
described in the preceding paragraph) reduced by the negative 
adjustment for taxable income of $100. Thus, the difference between 
Asset A's basis translated at the yearly average exchange rate (which 
is $200) and its basis translated at the historic rate (which is $100) 
is added to the pool of unrecognized section 987 gain or loss and this 
amount is recognized in year 2 due to the annual recognition election.
    The example illustrates that, whether or not the annual recognition 
election is made, the owner recognizes the same amount of total income 
with respect to Asset A (that is, $200). However, the annual 
recognition election has the effect of converting a portion of the 
owner's income into section 987 gain or loss. Because section 987 gain 
or loss is subject to special source and character rules under proposed 
Sec.  1.987-6, the annual recognition election can change the source 
and character of an owner's taxable income.
F. Impact of an Annual Recognition Election on the Timing of 
Recognition With Respect to Marked and Historic Items
    Under an annual recognition election, section 987 gain or loss with 
respect to marked items would be recognized annually (whereas, in the 
absence of an annual recognition election, section 987 gain or loss 
would be deferred until the section 987 QBU makes a remittance). 
Therefore, with respect to marked items, an annual recognition election 
would accelerate the recognition of section 987 gain or loss. If a 
current rate election is in effect, all items of the section 987 QBU 
will be treated as marked items generating section 987 gain or loss; 
this gain or loss would be accelerated if an annual recognition 
election is made.
    However, if a current rate election is not in effect, the annual 
recognition election would not accelerate the recognition of income 
with respect to historic assets. As explained in part IV.E of this 
Explanation of Provisions, in the absence of a current rate election, 
the owner of a section 987 QBU recognizes the same amount of total 
income with respect to historic assets whether or not an annual 
recognition election is in effect (though the annual recognition 
election has the effect of changing the portion of the income that is 
section 987 gain or loss and the portion that is section 987 taxable 
income or loss). In addition, as explained in part IV.D of this 
Explanation of Provisions, an annual recognition election is expected 
to simplify the computation of section

[[Page 78143]]

987 taxable income or loss (because all items would be translated at 
the yearly average exchange rate). Therefore, for section 987 QBUs that 
do not have a significant amount of marked assets or liabilities, the 
election is expected to reduce the compliance burden on taxpayers 
without materially accelerating the recognition of income.

V. Changes to the Computation of Unrecognized Section 987 Gain or Loss 
for a Taxable Year

    The proposed regulations contain several changes to the computation 
of unrecognized section 987 gain or loss for a taxable year under Sec.  
1.987-4(d) (that is, the amount added to the pool of net unrecognized 
section 987 gain or loss each year).\5\ These modifications are 
intended to ensure that section 987 gain or loss is attributable only 
to exchange rate fluctuations. For example, the proposed regulations 
would modify the adjustments for tax-exempt income and non-deductible 
expenses to cover all items of income, gain, deduction, or loss that 
affect the section 987 QBU's balance sheet but are not taken into 
account in determining section 987 taxable income or loss for the 
taxable year. Proposed Sec.  1.987-4(d)(7) and (8). The proposed 
regulations would also require an adjustment for items of income, gain, 
deduction, or loss that are taken into account in determining section 
987 taxable income or loss but do not affect the section 987 QBU's 
balance sheet for the taxable year. Proposed Sec.  1.987-4(d)(9).
---------------------------------------------------------------------------

    \5\ Proposed Sec.  1.987-4(g) contains new examples illustrating 
the proposed modifications to the computation of unrecognized 
section 987 gain or loss under proposed Sec.  1.987-4(d). The 
Treasury Department and the IRS intend to make conforming changes to 
the existing examples in Sec.  1.987-4 of the final regulations when 
the proposed regulations are finalized.
---------------------------------------------------------------------------

    Thus, the proposed regulations would account for deferred items 
that are expected to be taken into account in computing taxable income 
in a subsequent year by taking them into account in the year in which 
they impact the section 987 QBU's balance sheet and effectively backing 
them out in the future year when they impact taxable income but do not 
change the balance sheet. For example, if a section 987 QBU incurs an 
expense in year 1, but the deduction associated with the expense is 
deferred until year 5, proposed Sec.  1.987-4(d)(7) would treat the 
expense as a non-deductible expense in year 1, increasing the year 1 
unrecognized section 987 gain or loss. In year 5, the deduction would 
have no net effect on unrecognized section 987 gain or loss, since the 
deduction would result in a positive adjustment under proposed Sec.  
1.987-4(d)(6) (because the deduction reduces taxable income, and 
taxable income is a negative adjustment to unrecognized section 987 
gain or loss), and an offsetting negative adjustment under proposed 
Sec.  1.987-4(d)(9) (since the deduction represents a taxable deduction 
that does not affect the balance sheet). As a result, the expense would 
impact the calculation of section 987 gain or loss in the same manner 
as if it had been deductible in year 1.
    In addition, the proposed regulations require an adjustment to 
unrecognized section 987 gain or loss for any residual increase or 
decrease to the adjusted balance sheet of the section 987 QBU 
(determined in the functional currency of the section 987 QBU) that is 
not accounted for under the other computational steps. Proposed Sec.  
1.987-4(d)(10). This residual amount is translated into the owner's 
functional currency at the yearly average exchange rate. The residual 
increase or decrease is computed by applying the other computational 
steps described in proposed Sec.  1.987-4(d) (steps 1 through 9) in the 
functional currency of the section 987 QBU. Because these steps must 
already be performed in the owner's functional currency, determining 
the residual increase or decrease to the adjusted balance sheet under 
proposed Sec.  1.987-4(d)(10) is not expected to significantly increase 
the burden of determining net unrecognized section 987 gain or loss.
    The application of proposed Sec.  1.987-4(d)(10) would ensure that 
non-currency-related changes to the balance sheet do not artificially 
increase or decrease the pool of net unrecognized section 987 gain or 
loss. However, if the computational steps are applied correctly in the 
functional currency of a section 987 QBU, there should not be any 
residual increase or decrease to the balance sheet under proposed Sec.  
1.987-4(d)(10) (unless a current rate election or an annual recognition 
election is made). Rather, the year-over-year increase (or decrease) to 
the functional currency balance sheet (step 1) should equal the 
functional currency amount of net transfers to the section 987 QBU 
(steps 2 through 5) and income of the section 987 QBU (steps 6 through 
8), after backing out items of income that do not impact the balance 
sheet (step 9). By contrast, when these steps are applied in owner 
functional currency, they serve to identify the balance sheet change 
attributable to currency movements.
    For taxpayers that make a current rate election or an annual 
recognition election, the proposed regulations provide that steps 6 
through 9 of the computation (relating to income, gain, deduction, or 
loss) do not need to be applied. For these taxpayers, all items of 
income, gain, deduction, or loss would be taken into account as a 
residual increase or decrease to the section 987 QBU's balance sheet 
and translated at the yearly average exchange rate. The Treasury 
Department and the IRS request comments on whether any additional 
adjustments are needed for section 988 gain or loss of a section 987 
QBU that is subject to a current rate election or an annual recognition 
election. See part XV of this Explanation of Provisions (requesting 
comments as to whether section 988 gain or loss of a section 987 QBU 
should be determined in the owner's functional currency or the section 
987 QBU's functional currency).

VI. Source and Character of Section 987 Gain or Loss

    The final regulations provide that the source and character of 
section 987 gain or loss is determined in the year of a remittance 
using the asset method of Sec. Sec.  1.861-9(g) and 1.861-9T(g). See 
Sec.  1.987-6(b)(2). For this purpose, only the assets of the section 
987 QBU are taken into account. The proposed regulations would 
generally retain this character and source rule, subject to certain 
modifications, and would further provide that taxpayers must apply only 
the tax book value method in characterizing the assets under proposed 
Sec. Sec.  1.861-9(g) and 1.861-9T(g).\6\ See proposed Sec.  1.987-
6(b)(2)(i)(A).
---------------------------------------------------------------------------

    \6\ The proposed regulations would also make a clarifying change 
to Sec.  1.861-9T(g)(2)(ii)(A)(1) to clarify that the references to 
beginning-of-year and end-of-year functional currency amounts are to 
the owner functional currency amounts and to move certain provisions 
from Sec.  1.861-9T to proposed Sec.  1.861-9.
---------------------------------------------------------------------------

    Proposed Sec.  1.987-6(b)(2)(i) would provide special rules for the 
application of the tax book value method for initially characterizing 
section 987 gain or loss. Under these proposed regulations, the assets 
of the section 987 QBU would be initially assigned to statutory and 
residual groupings under the tax book value method. However, to prevent 
circularity, the proportions in which the tax book value of the assets 
would be initially assigned to the statutory and residual groups are 
determined without regard to section 987 gain or loss. Proposed Sec.  
1.987-6(b)(2)(i)(B). The initial assignment would occur after the 
application of the income attribution rules of Sec.  1.904-4(f)(2)(vi) 
or 1.951A-2(c)(7) (or the

[[Page 78144]]

principles of these rules), but before expenses are allocated and 
apportioned to gross income and before the application of provisions 
that require a net income computation, such as the high-tax exception 
to passive category income in Sec.  1.904-4(c), the high-tax exception 
to foreign base company income in Sec.  1.954-1(d), and the high-tax 
exclusion from tested income in Sec.  1.951A-2(c)(7).
    In addition, because, at the time of the initial assignment, a 
taxpayer may not yet know whether a GILTI high-tax election will be in 
effect in the taxable year in which the section 987 gain or loss is 
recognized (since deferred section 987 gain or loss and suspended 
section 987 loss may be recognized in future year), the proposed 
regulations would initially assign all of the section 987 gain or loss 
that would have been assigned to a tested income group if no GILTI 
high-tax election was in effect to a tentative tested income group. See 
proposed Sec.  1.987-6(b)(2)(i)(D).
    The initial assignment would generally be made in the taxable year 
in which section 987 gain or loss is treated as recognized, deferred, 
or suspended under proposed Sec.  1.987-6(b)(1). Then, in the taxable 
year in which the section 987 gain or loss is recognized (which may be 
the same taxable year as the year in which the initial assignment was 
made or a future taxable year), any section 987 gain or loss that was 
initially assigned to a tentative tested income group would be 
reassigned to a tested income group or residual group based on whether 
the GILTI high-tax election is in effect in that taxable year and, if 
so, whether the income is high-tax. The initial characterization under 
proposed Sec.  1.987-6(b)(2)(i) would be used for purposes of applying 
the loss-to-the-extent-of-gain rule in proposed Sec.  1.987-11(e) and 
(f), and also applies as the starting point for net income calculations 
required for other provisions such as the high-tax exception to passive 
category income under Sec.  1.904-4(c) and the GILTI and subpart F 
high-tax exceptions under Sec. Sec.  1.954-1(d) and 1.951A-2(c)(7). 
Proposed Sec.  1.987-6(b)(2)(ii).
    Proposed Sec.  1.987-6(b)(2)(iii) would also provide that if a 
GILTI high-tax election is made under Sec.  1.951A-2(c)(7)(viii), it 
applies to all of the section 987 gain or loss in a tentative tested 
income group that is recognized by the CFC in the taxable year as if 
the section 987 gain and loss were all assigned to its own separate 
tested unit of the CFC. In other words, all section 987 gain or loss 
recognized by the CFC in that taxable year in the same section 904 
category would be treated as a single tentative tested income item for 
purposes of applying the GILTI high-tax exclusion.
    For example, if section 987 gain and loss in a section 904 category 
is initially assigned to a tentative tested income group under proposed 
Sec.  1.987-6(b)(i) and a GILTI high-tax election is in effect in the 
year in which the section 987 gain or loss is recognized, the section 
987 gain or loss in the section 904 category would be treated as its 
own tentative tested income item for purposes of determining whether it 
is excluded from tested income under Sec.  1.951A-2(c)(7), after which 
the section 987 gain or loss will be reassigned to a tested income 
group (if the item is not excluded from tested income) or to the 
residual category (if the item is excluded from tested income). Because 
foreign countries generally do not impose tax on section 987 gain, 
allocation and apportionment of a foreign income tax to section 987 
gain under Sec.  1.861-20 and proposed Sec.  1.987-6(b)(3) will likely 
be uncommon. As a result, a tentative tested income item consisting of 
section 987 gain may often have a zero percent effective rate of 
foreign tax and, therefore, would generally not qualify for the GILTI 
high-tax exclusion.
    As described above, the proposed regulations would provide that, 
for purposes of determining the source and character of section 987 
gain and loss, the initial assignment of suspended section 987 loss and 
deferred section 987 gain and loss is generally made in the taxable 
year it becomes suspended or deferred (generally in the year of a 
remittance or the year the section 987 QBU is transferred to a related 
party), rather than the taxable year in which it is recognized. 
Proposed Sec.  1.987-6(b)(1). The Treasury Department and the IRS 
anticipate that making the initial assignment in the year of suspension 
or deferral, rather than the year the section 987 gain or loss is 
recognized, will generally result in determining the source and 
character in a year closer in time to the year in which the section 987 
loss originated, and therefore will tend to be more accurate. In 
addition, making an initial assignment in the taxable year of deferral 
or suspension means that the source and character are determined by 
reference to the assets of the section 987 QBU while they are still 
owned by the owner, rather than after they have been transferred, which 
would be both administratively difficult and more likely to introduce 
distortions to the determination.
    The Treasury Department and the IRS request comments as to whether 
it would be appropriate to determine the source and character of 
unrecognized section 987 gain or loss by making the initial assignment 
in the taxable year in which the section 987 gain or loss is initially 
included in unrecognized section 987 gain or loss under Sec.  1.987-
4(d), rather than in the year of a remittance. Making the initial 
assignment on an annual basis would require more extensive tracking of 
section 987 gain or loss in separate categories. However, this approach 
could avoid distortions that could arise from changes in the bases of a 
section 987 QBU's assets or shifts in the character of its income or 
assets between the time unrecognized section 987 gain or loss is added 
to the pool and the time it is recognized. In addition, this approach 
could align more closely with the character of income generated by the 
section 987 QBU's assets at the time of the exchange rate fluctuations 
that give rise to section 987 gain or loss.
    The proposed regulations would not change the rule in the final 
regulations that section 987 gain or loss that is assigned to a subpart 
F income group is treated as foreign currency gain or loss attributable 
to section 988 transactions not directly related to the business needs 
of the CFC. See proposed Sec.  1.987-6(b)(2)(i)(C). The Treasury 
Department and the IRS request comments as to whether it would be 
appropriate to eliminate this rule and characterize section 987 gain or 
loss by reference to subpart F income groups (as defined in Sec.  
1.960-1(d)(2)(ii)(B)) or whether to retain this rule generally but 
apply a different rule to taxpayers that make a current rate election 
(under which section 987 gain or loss can arise with respect to assets 
that would not generate section 988 gain or loss in the hands of the 
owner).
    A qualified business unit that produces income or loss that is, or 
is treated as, ECI is required to use the dollar as its functional 
currency. See Sec.  1.985-1(b)(1)(v). The 2016 proposed regulations 
would provide an election under which a qualified business unit with a 
dollar functional currency may be treated as a section 987 QBU. See 
Sec.  1.987-1(b)(6)(iii) of the 2016 proposed regulations. The Treasury 
Department and the IRS also request comments as to whether, and in what 
circumstances, section 987 gain or loss should be treated as ECI.

VII. Expansion of Entities Covered

    In general, the final regulations do not apply to a bank, insurance 
company, leasing company, finance coordination center, regulated 
investment company, or real estate investment trust (a ``specified 
entity''), unless it engages in

[[Page 78145]]

transactions primarily with related persons within the meaning of 
section 267(b) or section 707(b) that are not themselves specified 
entities. Additionally, the final regulations do not apply to trusts, 
estates, S corporations, and partnerships other than section 987 
aggregate partnerships. See Sec.  1.987-1(b)(1)(ii).
    The Treasury Department and the IRS are concerned that excluding 
these entities from the application of the regulations under section 
987 would not provide taxpayers with sufficient guidance to ensure 
these entities are using an appropriate method to calculate their 
section 987 gain or loss. Furthermore, if these entities are not 
subject to the regulations under section 987, they may use different 
methods of applying section 987 that vary in material ways. Applying a 
consistent set of rules to all taxpayers facilitates the fair and 
effective administration of the tax law by treating similarly situated 
taxpayers similarly as well as eliminating subjectivity and 
uncertainty.
    In addition, the Treasury Department and the IRS anticipate that 
the new current rate election and annual recognition election described 
in parts II and IV of this Explanation of Provisions would provide 
sufficient flexibility to permit the entities excluded under the 2016 
final regulations to apply the proposed regulations. As discussed in 
part VIII of this Explanation of Provisions, the proposed regulations 
also provide new rules relating to partnerships (other than section 987 
aggregate partnerships) and S corporations. See part VIII of this 
Explanation of Provisions. These rules are expected to significantly 
reduce the administrative burden and complexity of applying section 987 
to partnerships as compared to the aggregate rules. Accordingly, 
proposed Sec.  1.987-1(b)(1)(ii) generally removes the exclusion for 
entities excluded from the 2016 final regulations, making them subject 
to the proposed regulations.
    The proposed regulations generally continue to exclude foreign non-
grantor trusts and foreign estates if the aggregate interests of 
beneficiaries that are United States persons is less than 10 percent, 
and foreign partnerships if the aggregate interests of the partners 
that are United States persons is less than 10 percent of the capital 
and profits interests. Proposed Sec.  1.987-1(b)(1)(ii). The Treasury 
Department and the IRS are concerned that the shareholders, partners, 
and beneficiaries of these entities may not be able to obtain the 
information needed to apply the regulations to these entities, and it 
would be difficult for the IRS to administer the regulations with 
respect to these entities. For the same reason, the proposed 
regulations generally exclude foreign corporations that are not CFCs 
and foreign corporations that are CFCs but which have no U.S. 
shareholders (which are not excluded under the final regulations). 
Foreign individuals are also generally excluded as they are typically 
not subject to U.S. tax.
    The Treasury Department and the IRS request comments on whether any 
additional rules are needed to facilitate the application of the 
proposed regulations to the entities that were excluded from the 2016 
final regulations. See also part VIII of this Explanation of 
Provisions, requesting comments on the application of the proposed 
regulations to partnerships and S corporations.

VIII. Partnerships

A. Background
    As explained in part II.C of the Background section, the 2006 
proposed regulations and 2016 final regulations applied aggregate 
theory to partnerships. As explained in the preamble to the 2006 
proposed regulations, the 2006 proposed regulations applied the FEEP 
method directly at the partner level under aggregate theory with the 
goal of more appropriately preserving the correct amounts of exchange 
gain or loss as measured from the perspective of the partner. Measuring 
the currency gain or loss by reference to the partner, rather than the 
partnership, was considered preferable because the partners would 
generally bear the economic risk from the exposure.
    Comments to the 2006 proposed regulations requested that the 
Treasury Department and the IRS reconsider the aggregate approach and 
instead treat a partnership as a separate entity with its own 
functional currency. The comments indicated that the aggregate approach 
was overly complex and that minority partners would not have the power 
to compel a partnership to provide them with the information needed to 
make the calculations required under the aggregate approach. One 
comment acknowledged the economic rationale for the aggregate approach 
but, in light of its complexity, recommended that it apply only in 
cases in which a partner's interest in partnership capital or profits 
exceeds a certain threshold, such as 10 percent.
    In the preamble to the 2016 final regulations, the Treasury 
Department and the IRS acknowledged concerns regarding the complexity 
of the applying the aggregate approach to partnerships, but determined 
that it would be feasible to apply an aggregate approach to 
partnerships that are wholly owned by related persons. Furthermore, the 
aggregate approach was preserved in order to prevent a group of related 
parties from holding eligible QBUs through partnerships instead of 
directly, and thereby altering the section 987 treatment of the 
eligible QBU without meaningfully altering the group's economic 
position.
    As a result, the 2016 final regulations retained the aggregate 
approach to partnerships, but applied it only to section 987 aggregate 
partnerships, as discussed in Part II.C of the Background section. The 
2016 final regulations did not address other partnerships.
    Under the aggregate approach set forth in the 2016 final 
regulations, assets and liabilities reflected on the books and records 
of an eligible QBU of a section 987 aggregate partnership are allocated 
to each partner, which is considered an indirect owner of the eligible 
QBU. If the eligible QBU has a different functional currency than its 
indirect owner, then the assets and liabilities of the eligible QBU 
that are allocated to the partner are treated as a section 987 QBU of 
the indirect owner.
B. Method for Determining Share of Assets and Liabilities
    The 2006 proposed regulations provided that a partner's share of 
assets and liabilities reflected on the books and records of an 
eligible QBU is determined in a manner consistent with how the partners 
had agreed to share the economic benefits and burdens corresponding to 
partnership assets and liabilities, taking into account the rules and 
principles of subchapter K.\7\
---------------------------------------------------------------------------

    \7\ A partner's basis in the partnership was adjusted to take 
into account any section 987 gain or loss that it recognized on any 
section 987 QBUs owned indirectly through the partnership.
---------------------------------------------------------------------------

    A comment noted that the rules in the 2006 proposed regulations for 
allocating assets and liabilities to a partner's indirectly owned 
section 987 QBU were ambiguous and that the rules and principles of 
subchapter K do not provide sufficient guidance in this regard. The 
Treasury Department and the IRS acknowledged the ambiguity in the 
preamble to the 2016 final regulations, and the 2016 temporary 
regulations provided more specific rules for determining a partner's 
share of the assets and liabilities reflected on the books and records 
of an eligible QBU owned indirectly through a section 987 aggregate 
partnership.

[[Page 78146]]

    In particular, the temporary regulations provided that, in any 
taxable year, a partner's share of each asset and liability of a 
section 987 aggregate partnership was proportional to the partner's 
liquidation value percentage with respect to the aggregate partnership. 
A partner's liquidation value percentage was defined as the ratio of 
the liquidation value of the partner's interest in the partnership to 
the aggregate liquidation value of all the partners' interests in the 
partnership. The liquidation value of the partner's interest in the 
partnership was defined as the amount of cash the partner would receive 
with respect to its interest if, immediately following the applicable 
determination date, the partnership sold all of its assets for cash 
equal to the fair market value of such assets (taking into account 
section 7701(g)), satisfied all of its liabilities (other than those 
described in Sec.  1.752-7), paid an unrelated third party to assume 
all of its Sec.  1.752-7 liabilities in a fully taxable transaction, 
and then liquidated.
    Comments recommended alternative approaches for determining a 
partner's share of the assets and liabilities of a section 987 
aggregate partnership. Some comments recommended that Sec.  1.987-7 be 
withdrawn and replaced with the approach of the 2006 proposed 
regulations under section 987, which provided that a partner's share of 
assets and liabilities reflected on the books and records of an 
eligible QBU held indirectly through the partnership must be determined 
in a manner consistent with how the partners have agreed to share the 
economic benefits and burdens corresponding to those partnership assets 
and liabilities, taking into account the rules and principles of 
subchapter K. A comment indicated that the liquidation value percentage 
approach was inconsistent with certain principles of subchapter K, 
resulting in distortions in the calculation of section 987 gain or loss 
in certain cases.
    The Treasury Department and the IRS determined that, in the absence 
of a more comprehensive set of rules for determining a partner's share 
of assets and liabilities reflected on the books and records of an 
eligible QBU held indirectly through the partnership that also 
articulates the interaction of those rules with applicable rules in 
subchapter K, a more flexible approach was warranted. Moreover, the 
Treasury Department and the IRS determined that, in certain instances, 
the liquidation value percentage methodology set forth in the 2016 
temporary regulations could be interpreted as applying in a way that 
inappropriately distorts the computation of section 987 gain or loss. 
Specifically, under such an interpretation, certain changes in a 
partner's liquidation value percentage could introduce distortions in 
the calculation of net unrecognized section 987 gain or loss under 
Sec.  1.987-4, giving rise to net unrecognized section 987 gain or loss 
that is not attributable to fluctuations in exchange rates. For 
example, an appreciation or depreciation in property value could result 
in a change in liquidation value percentage that causes a change in 
owner functional currency net value for purposes of step 1 of the Sec.  
1.987-4(d) calculation of unrecognized section 987 gain or loss for a 
taxable year without creating an offsetting adjustment under step 6 or 
otherwise that would prevent the change in liquidation value percentage 
from distorting the calculation of unrecognized section 987 gain or 
loss. As a result, such unrecognized appreciation or depreciation 
generally could result in unrecognized section 987 gain or loss for a 
taxable year being allocated to each partner that indirectly owned a 
section 987 QBU even when there was no change in exchange rates.
    Accordingly, the Treasury Department and the IRS withdrew Sec.  
1.987-7T in the 2019 final regulations. The preamble to the 2019 final 
regulations stated that, until new regulations are proposed and 
finalized, taxpayers may use any reasonable method for determining a 
partner's share of assets and liabilities reflected on the books and 
records of an eligible QBU held indirectly through the partnership. For 
this purpose, taxpayers may rely on subchapter K principles (consistent 
with the 2006 proposed regulations) or an approach similar to the 
liquidation value percentage method set forth in Sec.  1.987-7T. 
However, it would not be reasonable to apply the liquidation value 
percentage method in Sec.  1.987-7T without corresponding adjustments 
to the determination of net unrecognized section 987 gain or loss. 
Thus, for example, a taxpayer using the liquidation value percentage 
method may be required to adjust its determination of net unrecognized 
section 987 gain or loss of a section 987 QBU that is owned indirectly 
through a partnership to prevent the determination of unrecognized 
section 987 gain or loss that is not attributable to fluctuations in 
exchange rates. These adjustments may include, for example, treating 
any change in a partner's owner functional currency net value that is 
attributable to a change in the partner's liquidation value percentage 
as resulting in a transfer to or from an indirectly owned section 987 
QBU.
C. The Proposed Regulations Apply Entity Theory to Non-Section 987 
Aggregate Partnerships
    As previously discussed in part VIII.A of this Explanation of 
Provisions, although the final regulations applied the aggregate 
approach to section 987 aggregate partnerships, the final regulations 
did not provide rules for applying section 987 to other partnerships. 
The preamble to the 2016 final regulations stated that section 987 
regulations would be developed for these other partnerships in a 
separate project and indicated that a different approach might be 
taken. To that end, the preamble requested comments on how an entity 
approach should work for non-section 987 aggregate partnerships.
    Several comments were received asserting that the aggregate 
approach to partnerships under the 2016 final regulations was overly 
complex. Comments recommended that a partnership be treated as a 
separate entity with its own functional currency that can be the owner 
of a section 987 QBU. Comments also indicated that entity treatment 
would be more consistent with the principles of subchapter K.
    The Treasury Department and the IRS agree that treating non-section 
987 aggregate partnerships as an entity and therefore potentially an 
``owner'' of section 987 QBUs would be more administrable than an 
aggregate approach and would reduce the compliance burden on taxpayers 
and the IRS. However, the Treasury Department and the IRS continue to 
study whether partners might be able to achieve inappropriate outcomes 
under entity theory. For example, the Treasury Department and the IRS 
are concerned that if partnerships maintained section 987 gain and loss 
pools under a ``pure'' entity theory paradigm, partners would 
effectively be able to transfer their share of net unrecognized section 
987 gain or loss to another partner, thereby avoiding gain recognition 
or trafficking in losses. To prevent a partner from transferring its 
share of net unrecognized section 987 gain or loss to another partner, 
the proposed regulations would generally apply a hybrid approach to 
entity theory, under which a partnership's net unrecognized section 987 
gain or loss with respect to its section 987 QBUs is allocated to its 
partners on an annual basis (the ``hybrid approach to entity theory''), 
as described in part VIII.D of this Explanation of Provisions.
    The hybrid approach to entity theory may reduce concerns about 
inappropriate outcomes that might otherwise arise from the transfer of

[[Page 78147]]

partnership interests under an entity theory approach. However, as 
described in part VIII.D and E of this Explanation of Provisions, while 
the Treasury Department and the IRS study whether the hybrid approach 
to entity theory (or a variation thereof) is suitable for all 
partnerships, the proposed regulations maintain the aggregate approach 
to section 987 aggregate partnerships in the final regulations, as 
modified by the 2019 final regulations, with minimal changes. Special 
rules are provided in proposed Sec.  1.987-7C for partnerships that 
become (or cease to be) section 987 aggregate partnerships. In 
addition, for consistency with other transfers of a section 987 QBU, 
the proposed regulations would treat a change in the form of ownership 
from direct to indirect as a termination of the section 987 QBU under 
proposed Sec.  1.987-8(b)(6), subject to the deferral rules pursuant to 
proposed Sec.  1.987-12(g)(1)(i)(A). The Treasury Department and the 
IRS anticipate publishing a subsequent notice of proposed rulemaking 
that more thoroughly addresses the application of section 987 to 
partnerships.
D. The Hybrid Approach to Entity Theory
    Under the proposed regulations, a partnership (other than a section 
987 aggregate partnership) would be treated as a qualified business 
unit having its own functional currency. See Sec.  1.989(a)-
1(b)(2)(i)(C); see also Sec.  1.985-1(a)(1). If a partnership owns an 
eligible QBU with a functional currency that is different from the 
functional currency of the partnership, the eligible QBU would be 
treated as a section 987 QBU and the partnership (and not the partner) 
would generally be treated as the owner of the eligible QBU. See 
proposed Sec. Sec.  1.987-1(b)(4) through (5) and 1.987-7A(b).
    A partnership that owns a section 987 QBU would determine its 
unrecognized section 987 gain or loss for a taxable year under proposed 
Sec.  1.987-4(d) by reference to the functional currency of the 
partnership and the section 987 QBU. Proposed Sec.  1.987-7A(b). Under 
the hybrid approach, the partnership would allocate to each partner a 
share of the unrecognized section 987 gain or loss for the taxable year 
with respect to each section 987 QBU owned by the partnership on an 
annual basis. The partnership would determine a partner's share of the 
unrecognized section 987 gain or loss for the taxable year for each 
section 987 QBU based on the partner's distributive share of profits 
and losses attributable to that section 987 QBU for the taxable year. 
At the partner level, each partner would translate its share of the 
unrecognized section 987 gain or loss into its functional currency at 
the yearly average exchange rate and calculate its net unrecognized 
section 987 gain or loss with respect to each section 987 QBU of the 
partnership based on this share. Proposed Sec.  1.987-7A(c)(1).
    Section 987 gain or loss attributable to a section 987 QBU owned by 
a partnership would be recognized and taken into account at the partner 
level. Notwithstanding that the section 987 gain or loss pools are 
allocated to the partners and maintained at the partner level, the 
portion of the net unrecognized section 987 gain or loss that a partner 
would recognize (or suspend) each year under proposed Sec.  1.987-5(a) 
would be determined by reference to the partnership's remittance 
proportion with respect to the section 987 QBU. Proposed Sec.  1.987-
7A(c)(3). In other words, if the section 987 QBU is treated as 
remitting 20 percent of its gross assets to its owner, the partnership, 
in a taxable year of the partnership, each partner that has net 
unrecognized section 987 gain or loss with respect to the section 987 
QBU would recognize (or suspend) 20 percent of the net unrecognized 
section 987 gain or loss.
    The proposed regulations provide a framework for adjusting a 
partner's basis in its partnership interest based on the principles of 
section 705 when a partner recognizes section 987 gain or loss, defers 
section 987 gain or loss, or suspends section 987 loss attributable to 
a partnership. See proposed Sec.  1.987-7A(d). Similarly, if a partner 
in an upper-tier partnership (UTP) recognizes section 987 gain or loss, 
defers section 987 gain or loss, or suspends section 987 loss 
attributable to a lower-tier partnership (LTP), then the proposed 
regulations would provide that UTP makes a corresponding basis 
adjustment to its interest in LTP, with similar rules applying to each 
successive partnership through which the section 987 gain or loss is 
attributable. The basis adjustment between UTP and LTP or between LTPs 
constitutes a basis adjustment solely with respect to the partner that 
recognizes section 987 gain or loss, defers section 987 gain or loss, 
or suspends section 987 loss attributable to the partnership. The 
Treasury Department and the IRS request comments on the coordination of 
these proposed regulations applicable to partnerships with rules for 
capital accounts determined and maintained in accordance with Sec.  
1.704-1(b)(2)(iv). Additionally, the Treasury Department and the IRS 
request comments on the appropriate currency in which section 743(b) 
basis adjustments with respect to assets of a section 987 QBU of a 
partnership should be maintained.
    The proposed regulations would also provide rules for applying 
proposed Sec. Sec.  1.987-11 through 1.987-13 (regarding deferred 
section 987 gain or loss and suspended section 987 loss) to partners 
and partnerships. Specifically, the application of the loss-to-the-
extent-of-gain rule to suspended section 987 loss of the partner is 
done at the partner level. Proposed Sec.  1.987-7A(c)(4). As a result, 
any section 987 gain recognized by a partner is taken into account in 
determining the suspended section 987 loss that may be recognized by 
the partner under proposed Sec.  1.987-11(e), without regard to whether 
the section 987 gain was allocated to the partner from that partnership 
(or any other partnership) or was attributable to a section 987 QBU 
owned directly by the partner. Other rules under proposed Sec. Sec.  
1.987-11 through 1.987-13 would generally apply with respect to a 
partnership, but may be applied with respect to a partner that ceases 
to be a partner in the partnership.
    In general, the section 987 elections would be made by the 
partnership. However, if a partner terminates its partnership interest, 
any annual recognition election in effect with respect to the partner 
would apply with respect to its deferred section 987 gain or loss or 
suspended section 987 loss that had been allocated to the partner by 
the partnership. The partner would also be permitted to make the 
election to recognize pretransition section 987 gain or loss ratably 
over the transition period under the transition rules. See proposed 
Sec. Sec.  1.987-7A(c)(5)(ii) and 1.987-10(e)(5)(ii).
    The Treasury Department and the IRS are studying the appropriate 
method for determining the portion of a partner's net unrecognized 
section 987 gain or loss, deferred section 987 gain or loss, and 
suspended section 987 loss that should be recognized, deferred, or 
suspended when a portion of a partner's interest in a partnership is 
transferred or redeemed (or the partner's interest in the partnership 
is otherwise reduced) and whether any special rules are needed in 
respect of a transfer or redemption of a partnership interest to 
account for the recognition of section 987 gain or loss at the partner 
level. Accordingly, the proposed regulations reserve on the treatment 
of transfers and redemptions of a partner's partnership interest. The 
Treasury Department and the IRS request comments on the appropriate 
method of determining the partner's interest in the partnership and the 
reduction to its interest in the

[[Page 78148]]

partnership, as well as how increases to a partner's partnership 
interest during the year should be taken into account. In addition, the 
Treasury Department and the IRS request comments on the appropriate 
treatment of transfers of a partnership interest between related 
parties or between member of a consolidated group.
    In general, proposed Sec.  1.987-6 would provide rules governing 
the character and source of section 987 gain or loss. See part VI of 
this Explanation of Provisions. The proposed regulations reserve on 
whether any special rules are needed in addition to proposed Sec.  
1.987-6 for purposes of determining the character and source of section 
987 gain or loss of a partner with respect to a section 987 QBU owned 
by a partnership. Proposed Sec.  1.987-7A(e). Comments are requested on 
whether special rules are needed.
    The proposed regulations would treat S corporations in the same 
manner as partnerships. Proposed Sec.  1.987-7A(f). Comments are 
requested on whether additional guidance is needed with regard to S 
corporations and whether there are instances in which the rules for S 
corporations should differ from the rules for partnerships.
    The Treasury Department and the IRS also request comments as to 
whether, under an entity theory of partnerships, section 987 gain or 
loss could be recognized at the partnership level and then allocated to 
the partners while preventing the transfer of unrecognized section 987 
gain or loss among the partners or between a transferor and transferee 
partner. Under the hybrid approach in the proposed regulations, a 
partner's recognition of section 987 gain or loss upon a sale or other 
disposition of a partnership interest results in the conversion of 
capital gain or loss to ordinary gain or loss without any remittance 
from the partnership QBU and without any change in the relationship 
between the QBU and its owner. Comments are requested on whether 
special rules are needed to prevent the conversion of capital gain or 
loss to ordinary gain or loss. In addition, comments are requested on 
whether the recognition of section 987 gain or loss upon a transfer or 
redemption of a partnership interest should be limited to the gain or 
loss that would otherwise be recognized on transfer or redemption, 
under rules similar to Sec.  1.988-2(b)(8).
E. Expanding the Application of Entity Theory
    The Treasury Department and the IRS continue to study the 
application of entity theory and aggregate theory to partnerships in 
the section 987 context, including whether it would be appropriate to 
apply a hybrid approach to entity theory to all partnerships, 
regardless of whether the partners are related parties. Such an 
approach would generally result in a partnership generating the same 
amount of section 987 gain or loss as it would if it were a corporation 
or an individual.
    In connection with these considerations, the Treasury Department 
and the IRS are studying the concerns expressed in the 2006 proposed 
regulations and the final regulations that parties could achieve a 
substantially different section 987 result by owning a section 987 QBU 
through a partnership, rather than owning the section 987 QBU directly, 
without meaningfully changing the economic relationship of the parties.
    Consider, for example, a domestic corporation that wholly owns two 
CFCs, each of which use the euro as their functional currency, and 
which each own fifty percent of an entity treated as a foreign 
partnership (``P'') that operates a British trade or business for which 
books and records are maintained in pounds. P also has a smaller 
separate French trade or business that is an eligible QBU that 
maintains books and records in euros. If just one CFC owned P, then P 
would be treated as an entity disregarded from its owner, and the CFC 
would have section 987 gain or loss with respect to its interest in P's 
pound operations. However, if an election was made to treat P as a 
corporation under Sec.  301.7701-3, P would be treated as a CFC that 
uses the pound as its functional currency and section 987 gain or loss 
with respect to P's euro operations would be measured against the 
pound, rather than against the functional currency of P's partners. 
Accordingly, it could be argued that, for section 987 purposes, when a 
partnership is held by CFCs, aggregate theory achieves a result that is 
more akin to treating P as a disregarded entity and entity theory 
achieves a result more akin to treating P as a corporation.
    However, if instead of being owned by two CFCs, P were owned by two 
domestic corporations that use the dollar as their functional currency, 
aggregate theory would achieve a result akin to treating P as a 
disregarded entity, while entity theory may provide a means of allowing 
the domestic corporations to avoid the application of section 987 to 
P's pound trade or business without needing to contribute the trade or 
business to a CFC, which might have other tax consequences. See, e.g., 
section 367(a) and (d). Accordingly, the Treasury Department and the 
IRS are concerned that if only entity theory is applied to 
partnerships, there may be instances in which the business of the 
partnership should be subject to section 987 but is not, such as when 
two domestic corporations own a partnership doing business in the 
pound.
    When a partner's functional currency differs from that of the 
partnership, creating a separate layer of currency exposure, the 
Treasury Department and the IRS are studying whether it might be 
possible to achieve a result consistent with aggregate theory without 
the administrative burden of allocating a portion of a partnership's 
assets and liabilities to each partner and calculating the income and 
balance sheets of the partnership in the functional currency of each 
partner. One such approach might determine a partner's section 987 gain 
or loss with respect to the partnership by reference to the partner's 
outside basis in the partnership, rather than its share of the inside 
asset basis and liabilities (the ``outside basis approach'').
    The outside basis approach would be layered on top of the hybrid 
approach to entity theory taken by the proposed regulations. Under this 
system, a partnership would first determine its section 987 gain or 
loss with respect to any section 987 QBUs of the partnership, and 
allocate the pool to the partners, as described in Sec.  1.987-7A of 
the proposed regulations. If a partner has the same functional currency 
as the partnership, no additional steps are taken.
    If a partner has a different functional currency than the 
partnership, under one alternative (``alternative 1''), the partner 
would calculate its section 987 gain or loss with respect to its 
interest in the partnership (including its interest in the functional 
currency trade or business of the partnership and its interest in each 
of the partnership's section 987 QBUs) using a method similar to the 
calculation of unrecognized section 987 gain or loss for an owner 
applying the current rate election under proposed Sec.  1.987-4(d) 
(that is, steps 1 through 5 and 10), but by reference to the partner's 
adjusted basis in its partnership interest (``outside basis'') in the 
partnership.
    Specifically, the partner's annual section 987 gain or loss 
attributable to its share of the partnership as a whole would be equal 
to its outside basis determined as of the end of the partnership's 
taxable year (after taking into account other adjustments prescribed 
under section 705 but before any adjustments for section 987 gain or 
loss recognized under the outside basis approach) and translated into 
the

[[Page 78149]]

partnership's functional currency reduced by its outside basis 
determined as of the beginning of the same partnership taxable year and 
translated into the partnership's functional currency (the 
``partnership functional currency change in value'') (step 1). The 
partnership functional currency change in value would then be adjusted 
to subtract the partnership functional currency amounts of 
contributions to the partnership from the partner and add the 
partnership functional currency amounts of distributions from the 
partnership to the partner (steps 2 through 5). The result would then 
be adjusted to back out the partnership functional currency amount of 
the partner's allocable share of income, gain, deduction, and loss of 
the partnership (step 10). The result is the partner's unrecognized 
section 987 gain or loss attributable to its partnership interest. 
Under alternative 1, the partner's unrecognized section 987 gain or 
loss attributable to its partnership interest would be recognized 
annually and its basis in the partnership would be increased or 
decreased accordingly. Alternative 1 approximates the result a partner 
would achieve under aggregate theory if it applied the current rate 
election and the annual recognition election.
    Annual recognition is necessary under alternative 1 to prevent 
differences in the partnership's adjusted bases in its assets (``inside 
basis'') attributable to fluctuations in the functional currency of the 
partnership itself or any section 987 QBUs owned by the partnership and 
the partners' outside bases (an ``inside-outside basis disparity''). By 
adjusting outside basis for these currency fluctuations, the partner's 
section 987 gain or loss with respect to the partnership will include 
section 987 gain or loss on the partnership's owner functional currency 
net value of the partnership's section 987 QBUs. As a result, the sum 
of the owner's section 987 gain or loss attributable to its partnership 
interest under the outside basis approach, plus its allocable share of 
the partnership's net unrecognized section 987 gain or loss 
attributable to the partnership's section 987 QBUs should generally be 
equivalent to the sum of its unrecognized section 987 gain or loss 
attributable to section 987 QBUs indirectly owned by the partner 
through the partnership under the aggregate approach (assuming there 
are no other inside-outside basis disparities).
    Alternatively, under another alternative (``alternative 2''), it 
may not be necessary to require recognition of the partner's section 
987 gain or loss annually. Under this approach, the same method is used 
to determine the partner's section 987 gain or loss with respect to its 
partnership interest as in alternative 1, except that the partnership 
functional currency change in value would be determined, not just by 
reference to the partner's outside basis in the partnership, but to the 
sum of its outside basis and its net accumulated unrecognized section 
987 gain or loss attributable to the partnership and the partnership's 
section 987 QBUs (that is, the amount that would have been recognized 
if the partner had been recognizing its section 987 gain and loss 
attributable to the partnership annually as under alternative 1). Under 
alternative 2, the partner's unrecognized section 987 gain or loss 
attributable to its partnership interest might be recognized when it 
receives a distribution from the partnership or disposes of a portion 
of its partnership interest.
    Both alternative 1 and alternative 2 approximate the result a 
partner would achieve under aggregate theory if it applied the current 
rate election to its partnership interest. However, alternative 1, but 
not alternative 2, requires annual recognition of the partner's net 
unrecognized section 987 gain or loss. Accordingly, no additional loss 
limitations may be needed for alternative 1. See part IV.C of this 
Explanation of Provisions. However, it may be appropriate for the 
partner's net accumulated unrecognized section 987 gain or loss under 
alternative 2 to be subject to the loss-to-the-extent-of-gain rule in 
Sec.  1.987-11(e) of the proposed regulations.
    Under one variation to these alternative approaches, the partner's 
net accumulated unrecognized section 987 gain or loss attributable to 
its partnership interest would net with the partner's net unrecognized 
section 987 gain or loss with respect to the partnership's section 987 
QBUs when one amount reflects section 987 gain and the other reflects 
section 987 loss.
    Comments are requested on whether the outside basis approach or a 
similar system would achieve results consistent with aggregate theory 
in a more administrable manner. Furthermore, comments are requested on 
instances in which this system might inappropriately diverge from 
aggregate theory and how such divergences might be addressed. For 
example, if inside basis and outside basis are not equivalent (for 
example, because a partner acquires a partnership interest in a year in 
which a section 754 election is not in effect), how the resulting 
mismatch might be minimized or eliminated for purposes of measuring the 
partner's currency exposure with respect to the partnership. Comments 
are also requested on whether the outside basis approach or a similar 
system should apply to partners of (i) all partnerships, (ii) only 
those partnerships currently treated as section 987 aggregate 
partnerships, or (iii) only those partnerships in which the partner 
owns more than 50 percent of the partnership interest (taking into 
account constructive ownership).
    In addition, comments are also requested on any additional rules 
that might be necessary to coordinate the outside basis approach or a 
similar system with the section 987 regulations or with subchapter K, 
when the functional currency of a partner, the partnership, and the 
partnership's section 987 QBU differ.

IX. Attribution of Items to the Section 987 QBU

    The final regulations provide rules regarding when assets and 
liabilities, as well as items of income, gain, deduction, and loss are 
attributable to an eligible QBU, and when a section 987 QBU is treated 
as making a contribution or distribution to its owner or another 
eligible QBU of the owner. See Sec.  1.987-2. In general, the proposed 
regulations retain the rules in the final regulations with minor or 
clarifying revisions. However, in a change from the final regulations, 
the proposed regulations would treat a change in the form of ownership 
of a section 987 QBU as a termination, as discussed above.
    In general, the final regulations provide that items are 
attributable to an eligible QBU if they are reflected on the separate 
set of books and records of the eligible QBU, as defined in Sec.  
1.989(a)-1(d). Sec.  1.987-2(b)(1). The proposed regulations would 
revise the cross-reference to refer to Sec.  1.989(a)-1(d)(1) or (2), 
as Sec.  1.989(a)-1(d)(3) refers back to Sec.  1.987-2(b). Proposed 
Sec.  1.987-2(b)(1).
    In addition, the final regulations provide that an eligible QBU is 
not treated as owning stock of a corporation unless the owner of the 
eligible QBU owns less than 10 percent of the value of the corporation 
(after taking into account certain attribution rules). Sec.  1.987-
2(b)(2)(i). In order to generally prevent an eligible QBU from owning 
stock of a CFC, the proposed regulations would expand the exclusion to 
cover all stock unless the owner owns less 10 percent of both the vote 
and value of the corporation, and to revise the relevant attribution 
rules. Proposed Sec.  1.987-2(b)(2)(i). The proposed regulations also 
provide that any type of basis that does not affect the income and loss 
of the

[[Page 78150]]

eligible QBU, such as section 743(b) basis, would not be treated as 
included on the books and records of the eligible QBU. Proposed Sec.  
1.987-2(b)(5).
    Similarly, the final regulations provide rules regarding when a 
transaction or the recording of an asset or liability as on (or not on) 
the books and records of a section 987 QBU is treated as a disregarded 
transaction between the section 987 QBU and its owner or another 
eligible QBU of the owner. Sec.  1.987-2(c). The proposed regulations 
generally retain the substance of these rules but make minor revisions 
for clarity. See proposed Sec.  1.987-2(c).

X. Transition Rules

    As explained in part II.C of the Background section, the 2016 final 
regulations require all owners of section 987 QBUs to apply the fresh 
start transition method. Under this method, unrecognized section 987 
gain or loss determined for years before the transition date generally 
would not be taken into account under section 987. In addition, for 
purposes of applying the FEEP method in the first year in which the 
regulations apply, the assets and liabilities of the section 987 QBU 
must be translated using historic rates.
    Comments stated that the fresh start transition method is difficult 
to apply because taxpayers did not track historic rates before the 
transition date and the data needed to determine historic rates for 
items acquired in prior taxable years is not readily available. In 
addition, comments asserted that the fresh start transition method 
imposes an undue financial burden by permanently eliminating 
unrecognized section 987 losses determined before the transition date.
    The Treasury Department and the IRS acknowledge that the fresh 
start transition method could increase the compliance burden on 
taxpayers for the initial year in which the regulations apply and would 
fail to account for section 987 gain or loss that arose before the 
transition date (to the extent attributable to assets and liabilities 
that are no longer reflected on the books and records of the section 
987 QBU on the transition date). Therefore, the proposed regulations 
provide a new transition rule that would replace the fresh start 
transition method.
    The new transition rule would account for unrecognized section 987 
gain or loss accrued before the transition date. In addition, the new 
transition rule would not require taxpayers to retrospectively 
determine historic rates for items acquired before the transition date. 
As explained in the Applicability Dates section, the fresh start 
transition method can no longer be applied to any taxable year for 
which the tax return or information return is filed on or after 
November 9, 2023.
A. Translation of a Section 987 QBU's Assets and Liabilities at the 
Spot Rate
    The transition rules under proposed Sec.  1.987-10 would apply in 
the taxable year beginning on the transition date (that is, the first 
day of the first taxable year in which the regulations apply). For 
purposes of determining unrecognized section 987 gain or loss in the 
first taxable year in which the regulations apply, the assets and 
liabilities reflected on a section 987 QBU's balance sheet at the end 
of the previous year would be translated into the owner's functional 
currency at the spot rate on the day before the transition date. 
Proposed Sec.  1.987-10(d)(1). Similarly, for taxpayers that do not 
make a current rate election, the historic rate for historic assets and 
liabilities would generally be the spot rate on the day before the 
transition date. Proposed Sec.  1.987-10(d)(2). These rules are 
intended to simplify the application of the FEEP method by eliminating 
the need to determine actual historic rates in the first taxable year 
in which the regulations apply.
B. Pretransition Gain or Loss
    Under the proposed regulations, an owner of a section 987 QBU must 
determine the amount of section 987 gain or loss that has accrued 
before the transition date (``pretransition gain or loss''). Proposed 
Sec.  1.987-10(e). By default, in the first taxable year in which the 
regulations apply, pretransition gain is treated as net unrecognized 
section 987 gain, and pretransition loss is treated as suspended 
section 987 loss. Proposed Sec.  1.987-10(e)(5)(i). This proposed rule 
is intended to prevent taxpayers from selectively recognizing 
pretransition loss (which, like section 987 loss generated under a 
current rate election, may be computed using a method that results in 
large section 987 pools) while deferring pretransition gain until a 
remittance. Alternatively, taxpayers can elect to amortize 
pretransition gain or loss over a period of ten years beginning on the 
transition date. Proposed Sec.  1.987-10(e)(5)(ii).
    In order to prevent owners subject to this election from offshoring 
pretransition gain or importing pretransition loss, proposed Sec.  
1.987-10(e)(5)(ii)(B) provides that, immediately before an inbound or 
outbound transaction described in section 381(a), any unrecognized 
pretransition gain is recognized and any unrecognized pretransition 
loss is suspended. As a result, the suspended section 987 loss may be 
recognized, subject to the loss-to-the-extent-of-gain-rule under Sec.  
1.987-11(e). In the case of an inbound section 381(a) transaction of a 
foreign owner with pretransition loss, any suspended section 987 loss 
that is not recognized before the transaction would not carry over to 
the domestic acquiring corporation under proposed Sec.  1.987-13(g). 
See part III.C of this Explanation of Provisions.
C. Computation of Pretransition Gain or Loss
    Under proposed Sec.  1.987-10(e)(2), a taxpayer that applied 
section 987 before the transition date using an ``eligible 
pretransition method'' (described in part X.D of this Explanation of 
Provisions) would use that method to compute pretransition gain or 
loss. Pretransition gain or loss generally is equal to the amount of 
section 987 gain or loss that would have been recognized under the 
eligible pretransition method if the QBU terminated on the day before 
the transition date. Proposed Sec.  1.987-10(e)(2)(i)(A). The amount of 
pretransition gain or loss must be adjusted to reflect any change to 
the basis of the section 987 QBU's assets (net of liabilities) that 
occurs as a result of the transition (for example, where the taxpayer 
previously used a method that would determine the owner's basis in 
distributed assets using historic rates). Proposed Sec.  1.987-
10(e)(2)(i)(B).
    A taxpayer that did not apply an eligible pretransition method 
before the transition date would determine pretransition gain or loss 
using the method provided in Sec.  1.987-10(e)(3). Under this method, 
pretransition gain or loss is equal to the sum of the annual amounts of 
unrecognized section 987 gain or loss for each taxable year since the 
section 987 QBU's inception, reduced by any section 987 gain or loss 
recognized before the transition date. Proposed Sec.  1.987-
10(e)(3)(ii).
    The amount of unrecognized section 987 gain or loss for each 
taxable year would be computed using a simplified version of the method 
provided in Sec.  1.987-4(d). Proposed Sec.  1.987-10(e)(3)(iii). The 
only information needed to apply this simplified method is the 
information reflected in the section 987 QBU's opening and closing 
balance sheets for each year. Because this method does not require the 
translation of contributions and distributions at the applicable spot 
rate, it would only approximate the actual amount of section 987 gain 
or loss accrued before the transition date.

[[Page 78151]]

D. Eligible Pretransition Method
1. In General
    An eligible pretransition method includes any reasonable method of 
applying section 987 before the transition date that fully accounts for 
foreign currency gain or loss attributable to the assets and 
liabilities of a section 987 QBU (including foreign currency gain or 
loss that is recognized in computing taxable income with respect to the 
section 987 QBU or its owner). The method provided in the 1991 proposed 
regulations, which determines section 987 gain or loss based on 
currency fluctuations with respect to the earnings and capital of a 
section 987 QBU (an ``earnings and capital'' method) is considered an 
eligible pretransition method, provided that it is applied in a 
reasonable manner. Proposed Sec.  1.987-10(e)(4)(i). In addition, any 
other reasonable method of applying section 987 is an eligible 
pretransition method if it produces the same total amount of income 
over the life of the owner (taking into account the aggregate of 
section 987 gain or loss, section 987 taxable income or loss, and gain 
or loss on the disposition of assets and liabilities transferred by a 
section 987 QBU to the owner) as a reasonable earnings and capital 
method. Proposed Sec.  1.987-10(e)(4)(ii). However, a method under 
which the owner does not recognize section 987 gain or loss at the time 
of a remittance because the recognition of all section 987 gain or loss 
is deferred until the section 987 QBU terminates is not considered an 
eligible pretransition method because it is inconsistent with the 
statutory requirements under section 987(3). Proposed Sec.  1.987-
10(e)(4)(iv).
2. Earnings Only Method
    An earnings only method can qualify as an eligible pretransition 
method under proposed Sec.  1.987-10(e)(4)(ii) if it is applied in a 
way that produces the same total amount of income as a reasonable 
earnings and capital method. This can be accomplished by maintaining a 
separate set of equity and basis pools for the section 987 QBU's 
capital account and assigning a proportionate amount of the capital 
basis pool to property distributed out of capital. See proposed Sec.  
1.987-10(l)(2) (Example 2).
    The Treasury Department and the IRS are aware that certain 
taxpayers apply an earnings only method in a manner that creates a 
permanent difference in their income (as compared to the earnings and 
capital method). Under this approach, when a section 987 QBU makes a 
distribution (whether out of earnings or capital), the owner determines 
its basis in the distributed assets by translating the section 987 
QBU's basis into the owner's functional currency at the spot rate 
applicable on the distribution date (``spot-rate basis''). See proposed 
Sec.  1.987-10(l)(3) (Example 3). As a result, the owner's basis may be 
higher or lower than the actual cost of acquiring the assets (in the 
owner's functional currency) due to exchange rate fluctuations.
    When a section 987 QBU makes a distribution out of earnings, which 
triggers the recognition of section 987 gain or loss under an earnings 
only method, the use of a spot-rate basis is appropriate. However, when 
a section 987 QBU makes a distribution out of capital (on which no 
section 987 gain or loss is recognized under an earnings only method), 
the use of a spot-rate basis artificially steps up (or steps down) the 
basis of the distributed assets in the absence of a recognition event. 
As a result, if a spot-rate basis is used for capital distributions 
under an earnings only method, the owner would not recognize the same 
total amount of income as it would under an earnings and capital 
method.
    The Treasury Department and the IRS are concerned that the use of a 
spot-rate basis for capital distributions under an earnings only method 
does not accurately measure an owner's economic income with respect to 
a section 987 QBU. However, the Treasury Department and the IRS 
acknowledge that the preamble to the 2006 proposed regulations endorsed 
the use of an earnings only method without explaining how the basis of 
distributed assets should be determined. Taxpayers may have 
misunderstood the preamble to suggest that an owner of a section 987 
QBU can take a spot-rate basis in all distributed assets under an 
earnings only method.
    Therefore, the proposed regulations provide that an earnings only 
method that does not produce the same total amount of income as a 
reasonable earnings and capital method can qualify as an eligible 
pretransition method, provided it was first applied on a tax return 
filed before November 9, 2023 and is consistently applied to all 
section 987 QBUs of the same owner. Proposed Sec.  1.987-10(e)(4)(iii). 
A taxpayer that begins applying this method on or after November 9, 
2023 or fails to apply this method consistently to all of its section 
987 QBUs will not be treated as applying an eligible pretransition 
method.

XI. Deferral Events and Outbound Loss Events

A. Final Regulations
    Section 1.987-12 of the final regulations contains rules that defer 
the recognition of section 987 gain or loss in connection with two 
categories of related party transactions: deferral events and outbound 
loss events. A deferral event is defined to include certain 
transactions in which a section 987 QBU terminates and its assets are 
reflected on the books and records of a successor QBU after the 
termination. See Sec.  1.987-12(b)(2). A successor QBU is a section 987 
QBU that is owned by a member of the same controlled group as the 
original owner (except if the original owner is a U.S. person and the 
owner of the successor QBU is a foreign person). See Sec.  1.987-
12(b)(4). Section 987 gain or loss that is not recognized in connection 
with a deferral event (``deferred section 987 gain or loss'') is 
recognized by the original owner of the section 987 QBU when the 
successor QBU makes a remittance to its owner. See Sec.  1.987-
12(c)(2).
    An outbound loss event is defined to include a termination of a 
section 987 QBU that is owned by a U.S. person and has net unrecognized 
section 987 loss in connection with a transfer of the section 987 QBU's 
assets to a related foreign person. See Sec.  1.987-12(d)(2). If the 
transfer is a transaction described in section 351 or section 361, any 
section 987 loss that is not recognized in connection with the outbound 
loss event (``outbound section 987 loss'') is added to the basis of 
stock received by the owner of the section 987 QBU. See Sec.  1.987-
12(d)(4). Otherwise, outbound section 987 loss is recognized when the 
owner of the section 987 QBU and the related foreign person cease to be 
members of the same controlled group. See Sec.  1.987-12(d)(5).
B. Proposed Regulations
1. Deferral Events
    The proposed regulations generally retain the principles of the 
final regulations relating to deferral events but modify the rules in 
several respects. For example, the final regulations provide a de 
minimis rule pursuant to which Sec.  1.987-12 would not apply to a 
section 987 QBU if the section 987 gain or loss that would not be 
recognized under Sec.  1.987-12 would not exceed $5 million. Sec.  
1.987-12(a)(3)(ii). To prevent the de minimis rule from allowing an 
owner to recognize more than the threshold by transferring multiple 
section 987 QBUs to members of its controlled group, the proposed

[[Page 78152]]

regulations would retain the de minimis rule but apply the threshold to 
the total deferred section 987 gain or loss that would otherwise be 
recognized by the owner in a single taxable year. Proposed Sec.  1.987-
12(a)(2)(ii). In addition, because the proposed regulations would apply 
the suspended section 987 loss rules to outbound loss events, any 
amount treated as a suspended section 987 loss is not taken into 
account in determining whether the threshold has been met. Id.
    The final regulations also provide that, if a deferral event 
results in multiple successor QBUs, the remittance proportion is 
determined by treating all the successor QBUs as a single successor 
QBU. Sec.  1.987-12(c)(2)(ii). The Treasury Department and the IRS are 
concerned that aggregating the contributions and distributions of 
various successor QBUs in order to treat them as the same successor QBU 
both increases the administrative burden of determining the remittance 
proportion and is less precise than determining a remittance proportion 
for each successor QBU. Therefore, the proposed regulations would 
apportion an amount of deferred section 987 gain or loss to each 
successor QBU and recognize (or suspend) a portion of deferred section 
987 gain or loss annually with respect to each successor QBU based on 
the specific successor QBU's remittance proportion and on whether that 
successor QBU is subsequently transferred. Proposed Sec.  1.987-
12(b)(2) and (c).
    Although the proposed regulations generally retain the deferral 
rules of Sec.  1.987-12(b) with respect to those circumstances in which 
they apply under the final regulations, the Treasury Department and the 
IRS recognize that this can lead to odd results in certain cases, 
because similar transactions may sometimes be subject to the deferral 
rules and other times be subject to no limitation or the suspended loss 
rules.
    For example, if a CFC (``CFC1'') with a euro functional currency 
owns a section 987 QBU (``QBU1'') with a pound functional currency, and 
CFC1 transfers QBU1 to a wholly owned subsidiary CFC (``CFC2''), the 
deferral rules would generally apply if CFC2's functional currency is 
not the pound. However, if CFC2's functional currency is the pound, the 
deferral rules would not apply because QBU1 would cease to be a section 
987 QBU upon transfer to CFC2, because it would have the same 
functional currency as its owner. As a result, if CFC1 does not have a 
current rate election in effect (or has both a current rate election 
and an annual recognition election in effect), CFC1 would recognize its 
net unrecognized section 987 gain or loss with respect to QBU1 on the 
transfer. However, if CFC1 has a current rate election in effect (and 
does not have an annual recognition election in effect), CFC1 would 
recognize net unrecognized section 987 gain on the transfer, but net 
unrecognized section 987 loss would become suspended section 987 loss.
    The Treasury Department and the IRS request comments on whether the 
deferral rules of proposed Sec.  1.987-12 should remain a separate 
deferral regime or should be modified or combined with the suspended 
loss rules of proposed Sec. Sec.  1.987-11 and 1.987-13.
2. Outbound Loss Events
    The proposed regulations generally retain the definition of an 
outbound loss event contained in the final regulations. However, the 
proposed regulations provide that outbound section 987 loss is treated 
as suspended section 987 loss, instead of being added to the basis of 
stock or recognized solely when the owner of the section 987 QBU and 
the related foreign person cease to be related. This rule is intended 
to permit the recognition of outbound section 987 loss to the extent 
the owner recognizes section 987 gain in the same recognition grouping, 
as described in part III of this Explanation of Provisions. In 
addition, applying the loss suspension rules to outbound loss events 
simplifies the proposed regulations by reducing the number of different 
types of deferral regimes that apply to section 987 losses.

XII. Making and Revoking Elections

    The final regulations contain a number of elections relating to 
section 987. The proposed regulations contain several new elections, 
including the current rate election, the annual recognition election, 
and elections under the transition rules.
    Under the final regulations, elections generally are made 
separately for each section 987 QBU. See Sec.  1.987-1(g)(1)(i). 
Elections cannot be revoked without the Commissioner's consent. See 
Sec.  1.987-1(g)(5). Under the 2016 temporary and proposed regulations, 
an annual deemed termination election generally cannot be made (except 
in the first taxable year in which the election was relevant) if the 
aggregate net loss that would be recognized by all owners to which the 
election applied exceeds $5 million. See Sec.  1.987-1T(g)(2)(i)(B). 
The annual deemed termination election provided in the 2016 temporary 
and proposed regulations is irrevocable.
    The proposed regulations would provide a consistency requirement 
that applies to both the existing elections under the final regulations 
and the new elections under the proposed regulations. Under proposed 
Sec.  1.987-1(g), these elections would be required to be made or 
revoked consistently for all members of the same consolidated group and 
all CFCs, partnerships, non-grantor trusts, and estates in which the 
ownership interests or beneficiary interests of the U.S. shareholder 
(or members of its consolidated group) exceed 50 percent. The 
consistency requirement is intended to make the application of the 
proposed rules less complex and more administrable; in most cases, 
consistent application of the regulations is also expected to reduce 
the compliance burden on taxpayers.
    The proposed regulations would permit a current rate election or an 
annual recognition election to be made or revoked without the 
Commissioner's consent. The Treasury Department and the IRS recognize 
that these elections can have important consequences for the 
substantive application of section 987 and the associated compliance 
burden, and that taxpayers may wish to change these elections in 
response to changes in the nature and size of their business 
operations.
    However, the current rate and annual recognition elections are 
proposed to be subject to timing restrictions and a loss suspension 
rule. If a current rate election or an annual recognition election is 
made, it cannot be revoked for five years without the Commissioner's 
consent. Similarly, once revoked, these elections cannot be made again 
for five years without consent. Proposed Sec.  1.987-1(g)(3)(ii)(B). 
These timing requirements are intended to make the proposed regulations 
easier to administer. In addition, because the Commissioner's consent 
is not required to make or revoke these elections, the timing 
requirements are needed to prevent taxpayers from opportunistically 
making or revoking elections in response to exchange rate fluctuations.
    Proposed Sec.  1.987-11(d)(2) provides that, in the first year in 
which a current rate election is revoked, net accumulated unrecognized 
section 987 loss is converted into suspended section 987 loss. This 
rule is needed to prevent net unrecognized section 987 loss generated 
under a current rate election from being recognized without limitation 
after the election is revoked.
    Similarly, if an annual recognition election is made, and either 
(1) a current rate election was in effect for the previous year or (2) 
the aggregate accumulated net unrecognized section 987 loss that would 
be recognized by the owner as a result of the recognition

[[Page 78153]]

election exceeds $5 million, net accumulated unrecognized section 987 
loss is converted into suspended section 987 loss. See Sec.  1.987-
11(d)(1). As discussed in part III.A of this Explanation of Provisions, 
this rule is intended to prevent a taxpayer from using an annual 
recognition election to trigger the recognition of net unrecognized 
section 987 loss that arose in years before the annual recognition 
election was made.

XIII. Removal of the Election To Use Spot Rates in Lieu of Yearly 
Average Exchange Rates

    As explained in part II.C of the Background section, the historic 
rate under Sec.  1.987-1(c)(3) of the 2016 final regulations is equal 
to the yearly average exchange rate for the year in which a historic 
asset was acquired or a historic liability was entered into. The 2016 
final regulations provide an election under Sec.  1.987-1(c)(1)(iii) to 
use spot rates in lieu of yearly average exchange rates.
    The Treasury Department and the IRS understand that this election 
may not be helpful to taxpayers, as it would increase the compliance 
burden of applying section 987 due to the need to track historic spot 
rates for each day in a taxable year on which the section 987 QBU 
acquires an asset or incurs a liability. In addition, the availability 
of this election adds to the complexity of the regulations and makes 
the rules more difficult for the IRS to administer. Accordingly, the 
proposed regulations remove the election under Sec.  1.987-1(c)(1)(iii) 
to use spot rates in lieu of yearly average exchange rates.

XIV. Consolidated Groups

A. Intercompany Transactions
    A section 987 QBU of a member of a consolidated group is a 
component of that member. Therefore, a transaction between that QBU and 
a different member of the same group constitutes an intercompany 
transaction (as defined in Sec.  1.1502-13(b)(1)(i)) and is subject to 
the intercompany transaction regulations in Sec.  1.1502-13.
    The Treasury Department and the IRS have become aware that 
achieving single entity treatment under Sec.  1.1502-13 may be 
difficult for certain intercompany transactions involving section 987 
QBUs. Accordingly, to facilitate single entity treatment, the proposed 
regulations would treat a transaction between the section 987 QBU of 
one member and any other member of the same group (including a section 
987 QBU of that other member) as a combination of (i) an intercompany 
transaction between the members, and (ii) a transfer between each 
section 987 QBU and its owner (see Sec.  1.987-2(c)) as necessary to 
take into account the effect of the transaction on the assets and 
liabilities of each section 987 QBU.
    The purpose of Sec.  1.1502-13 is to provide rules to clearly 
reflect the taxable income and tax liability of a consolidated group as 
a whole by preventing intercompany transactions from creating, 
accelerating, avoiding, or deferring consolidated taxable income (CTI) 
or consolidated tax liability. See Sec.  1.1502-13(a)(1). The matching 
rule in Sec.  1.1502-13(c) (Matching Rule) is one of the principal 
mechanisms for achieving this goal. See Sec.  1.1502-13(a)(6)(i).
    The Matching Rule is a principle-based rule that redetermines the 
attributes of a selling member's (S) intercompany item and a buying 
member's (B) corresponding item to produce the effect of transactions 
between divisions of a single corporation (single entity treatment). 
See Sec.  1.1502-13(a)(2). The Matching Rule also can affect the timing 
of these items so that, whenever possible, the effect of these items on 
the group's CTI and consolidated tax liability is the same as if S and 
B were divisions of a single corporation. See Sec.  1.1502-13(c)(1)(i).
    For example, assume that S sells land at a gain to B, which later 
sells that land at a gain to an unrelated person. To achieve the same 
result as if S and B were divisions of a single corporation, S does not 
take into account its gain or loss on the sale until B sells the land 
to the unrelated person, and S's and B's holding periods for the land 
are aggregated. See Sec.  1.1502-13(a)(2), (c)(1)(ii), and (c)(2); see 
also Example 1 in Sec.  1.1502-13(c)(7)(ii)(A).
    The Matching Rule relies on an alignment between S's and B's items 
that may be unclear in transactions involving section 987 QBUs. For 
example, assume that Lender (that is, S) and Borrower (that is, B) are 
members of a consolidated group, and Lender has a section 987 QBU 
(Lender QBU) whose functional currency is the euro. Lender QBU lends 
[euro]100 to Borrower. If Borrower and Lender were divisions of a 
single corporation, the loan would be treated as a transfer from Lender 
QBU when funded and a transfer to Lender QBU when repaid (or when 
interest is paid). These transfers would be taken into account in 
determining the amount of a remittance from Lender QBU (potentially 
triggering the recognition of section 987 gain or loss), and the single 
corporation might recognize section 988 gain or loss when the loan is 
repaid. See Sec. Sec.  1.987-5 and 1.988-1(a)(10)(ii)(A).
    However, under current law, the foreign currency gain or loss of 
Lender and Borrower in the foregoing example does not perfectly offset 
in amount on the group's consolidated return. This is the case because 
Borrower has foreign currency gain or loss under section 988 when the 
loan is repaid, whereas Lender's foreign currency gain or loss under 
section 987 will be taken into account only when Lender QBU makes a 
remittance. See Sec. Sec.  1.987-5(a) and 1.988-2(b)(6). Because these 
amounts are calculated at different times based on different exchange 
rates, and because section 988 applies to individual transactions while 
section 987 gain or loss is determined on a pooled basis by reference 
to the assets and liabilities of a section 987 QBU, achieving single 
entity treatment under Sec.  1.1502-13 may be difficult. In other 
words, under current law, it may be difficult to ``match'' Lender's 
section 987 gain or loss with Borrower's section 988 gain or loss. 
Similar mismatches would occur with regard to transactions between 
section 987 QBUs of different consolidated group members.
    The proposed regulations would address the matching issue in this 
example by treating the loan as if it were made directly between Lender 
and Borrower. See proposed Sec.  1.1502-13(j)(9). Thus, when the loan 
is made, Lender QBU would be treated as transferring [euro]100 to 
Lender, which in turn would be treated as lending [euro]100 to Borrower 
in an intercompany transaction. The loan would be treated as a section 
988 transaction with respect to both Lender and Borrower. When Borrower 
pays interest on the loan and repays the loan principal, Lender would 
be treated as transferring the interest or principal amount it receives 
from Borrower to Lender QBU. Lender's interest income and Borrower's 
interest expense, and their section 988 gain and loss with respect to 
principal and interest, would offset each other in amount, producing no 
net effect on CTI (thereby achieving single entity treatment). The 
group would report any foreign currency gain or loss (under section 987 
or 988) on the transfers between Lender and Lender QBU (for example, 
when Lender QBU loans the [euro]100 to Borrower, which is first treated 
as a remittance of the [euro]100 from Lender QBU to Lender) on the 
group's consolidated return.
    The proposed regulations also would replace Examples 4 and 15 in 
Sec.  1.987-2(c)(10) with new examples in Sec.  1.1502-13(j) to 
illustrate the application of the proposed rule. The new examples make 
clear that the proposed approach applies to reach single entity 
treatment

[[Page 78154]]

for all consolidated groups, regardless of whether the taxpayer had a 
principal purpose of avoiding tax through the use of section 987. Cf. 
Sec.  1.987-2(b)(3)(i) and (c)(10), Example 15 (providing that the IRS 
may reallocate a receivable from a section 987 QBU to its owner if a 
principal purpose of avoiding tax through the use of section 987 is 
present).
B. Separate Return Limitation Years
    When a corporation joins a consolidated group, the regulations 
under section 1502 may limit the group's ability to use the 
corporation's preexisting tax attributes. For example, Sec.  1.1502-
21(c) generally restricts the group's ability to use a member's net 
operating loss (NOL) that arose in a year when the corporation was not 
a member of the group. In general, Sec.  1.1502-21(c) allows the group 
to use only the portion of the NOL that does not exceed the member's 
``cumulative register,'' which reflects the member's items of income, 
gain, deduction, and loss that have been included in the group's CTI. 
See Sec.  1.1502-21(c)(1)(i).
    Under the proposed regulations, a corporation that is the owner of 
a section 987 QBU may have suspended or deferred section 987 losses 
when it joins a consolidated group. The Treasury Department and the IRS 
request comments about how rules similar to the rules of Sec.  1.1502-
21(c) should apply to such losses.

XV. Section 988 Transactions of a Section 987 QBU

    The temporary regulations provided special rules relating to 
section 988 transactions of a section 987 QBU, including transactions 
denominated in the owner's functional currency. Although the temporary 
regulations have expired, the corresponding provisions of the 2016 
proposed regulations remain outstanding.
    In general, under the 2016 proposed regulations, whether a 
transaction is a section 988 transaction is determined by reference to 
the section 987 QBU's functional currency, but any section 988 gain or 
loss is determined in the owner's functional currency. See Sec.  1.987-
3(b)(4)(i) of the 2016 proposed regulations. In addition, certain 
section 988 transactions of a section 987 QBU that are denominated in, 
or determined by reference to, the owner's functional currency 
(``specified owner functional currency transactions'') are not treated 
as section 988 transactions of the section 987 QBU. See Sec.  1.987-
3(b)(4)(ii) of the 2016 proposed regulations.
    The 2016 proposed regulations further provide that section 988 gain 
or loss with respect to certain short-term section 988 transactions of 
a section 987 QBU (``qualified short-term section 988 transactions'') 
that are accounted for under a mark-to-market method of accounting is 
determined in the functional currency of the section 987 QBU, and not 
the functional currency of its owner. See Sec.  1.987-3(b)(4)(iii) of 
the 2016 proposed regulations.
    Under the final regulations, a transaction denominated in a 
currency other than the section 987 QBU's functional currency is a 
historic item. See Sec.  1.987-1(d) and (e). However, the 2016 proposed 
regulations provide that a qualified short-term section 988 transaction 
for which section 988 gain or loss is determined by reference to the 
functional currency of the section 987 QBU is a marked item. See Sec.  
1.987-1(d)(3) of the 2016 proposed regulations.
    The Treasury Department and the IRS understand that the rules of 
the 2016 proposed regulations relating to nonfunctional currency 
transactions of a section 987 QBU would increase the compliance burden 
on taxpayers in certain contexts (for example, where the section 987 
QBU operates as a treasury center). This compliance burden could 
potentially be alleviated by treating all transactions (including 
specified owner functional currency transactions) denominated in a 
currency other than the functional currency of the section 987 QBU as 
marked items, determining whether those transactions are section 988 
transactions by reference to the functional currency of the section 987 
QBU, and determining the section 988 gain or loss with respect to those 
transactions in the functional currency of the section 987 QBU. 
However, the Treasury Department and the IRS are concerned that, under 
this approach, transactions denominated in the owner's functional 
currency would be treated as section 988 transactions of a section 987 
QBU. Therefore, these transactions would give rise to offsetting 
positions in that currency, enabling taxpayers to recognize losses 
while deferring the offsetting gains. For example, if a section 987 QBU 
held assets denominated in its owner's functional currency, and the 
section 987 QBU's functional currency weakened against that of its 
owner, the section 987 QBU would have section 988 gain and the owner 
would have an inverse amount of section 987 loss.
    The Treasury Department and the IRS request comments as to whether 
section 988 gain or loss on nonfunctional currency transactions 
(including specified owner functional currency transactions) of a 
section 987 QBU should be determined in the functional currency of the 
section 987 QBU when a current rate election or annual recognition 
election is in effect and, if so, what limitations should be imposed to 
prevent abuse. Comments are also requested on whether the definition of 
qualified short-term section 988 transactions should be expanded or 
modified, and whether other exceptions or special rules should be 
provided for section 987 QBUs engaged in certain activities (for 
example, treasury centers).

XVI. Definition of a Qualified Business Unit and an Eligible QBU

    Under section 985(b), the functional currency of a qualified 
business unit is generally either the dollar or the currency of the 
economic environment in which a significant part of its activities are 
conducted and in which its books and records are kept. Section 985(b); 
Sec.  1.985-1(b) through (c). Under section 989, a ``qualified business 
unit'' means a ``separate and clearly identified unit'' of a trade or 
business of a taxpayer, provided that the unit maintains separate books 
and records. Section 989(a). The regulations describe two types of 
qualified business units. The activities of a person may be a qualified 
business unit if the activities constitute a trade or business and a 
separate set of books and records are maintained with respect to the 
activities. Sec.  1.989(a)-1(b)(2)(ii). In addition, the so called 
``per se'' qualified business units include any corporation, 
partnership (other than a section 987 aggregate partnership), trust, or 
estate. Sec.  1.989(a)-1(b)(2)(i).
    A single qualified business unit may only have a single functional 
currency. Certain qualified business units, such as domestic 
corporations, are required to use the dollar as their functional 
currency unless otherwise provided by a ruling or administrative 
pronouncement. Sec.  1.985-1(b)(1)(iii). No rulings or administrative 
pronouncements have been issued under this provision other than private 
letter rulings that can be relied on only by the specific taxpayer for 
whom they were issued. Accordingly, all domestic corporations are 
required to use the dollar as their functional currency unless they 
have obtained a private letter ruling specifically allowing that entity 
to use a different functional currency.
    The Treasury Department and the IRS have become aware of 
uncertainty regarding whether a per se qualified business unit, such as 
a corporation, that has only a single trade or business for which it 
keeps a single set of books and records is one qualified business unit 
(the corporation and its single trade

[[Page 78155]]

or business) or two qualified business units (the corporation itself 
being one and its single trade or business being the other). If a 
domestic corporation with a single trade or business for which it keeps 
a single set of books and records were a single qualified business 
unit, that would effectively mean that (absent a ruling) the functional 
currency of the trade or business would be required to be the dollar, 
even if the currency of the economic environment of the trade or 
business was the euro and books and records are maintained in euros; 
whereas another domestic corporation with an identical trade or 
business may be permitted to use the euro as the functional currency of 
the trade or business, as long as it had at least one other trade or 
business that uses the dollar.
    To clarify that a per se qualified business unit, such as a 
domestic corporation, is permitted to have a single trade or business 
that maintains a single set of books and records, and which uses a 
functional currency other than the dollar, the proposed regulations 
modify the definition of eligible QBU. The revised definition clarifies 
that, if a per se QBU has only a single trade or business for which 
only a single set of books and records are maintained, only the trade 
or business (and not the entity itself) would be an eligible QBU. 
Proposed Sec.  1.987-1(b)(4). The entity itself would be the owner of 
the eligible QBU. Proposed Sec.  1.987-1(b)(5). As a result, if the 
eligible QBU has a functional currency other than the functional 
currency of the owner, the eligible QBU would be a section 987 QBU.
    The Treasury Department and the IRS request comments on whether a 
similar change should be made to Sec.  1.989(a)-1(b). Comments should 
also consider whether additional changes are needed in the regulations 
under section 985 regarding functional currency or in other provisions 
that reference the definition of a qualified business unit, such as 
Sec.  1.904-4(f)(3)(vii).

XVII. Other Changes and Revisions

    In addition to the provisions described in parts I through XVI of 
this Explanation of Provisions, the proposed regulations include other 
wording changes, additions, deletions, and organizational changes to 
the final regulations and the 2016 proposed regulations for purposes of 
clarifying, conforming, and making minor revisions.

Applicability Dates

I. Applicability Dates of the Proposed Regulations

    Once finalized, the regulations (and the parts of the final 
regulations that are not replaced or modified by the proposed 
regulations) would apply to taxable years beginning after December 31, 
2024. Proposed Sec.  1.987-14(a)(1).
    A taxpayer may also choose to apply the final version of the 
proposed regulations and the parts of the final regulations that are 
not replaced or modified by the proposed regulations (the ``new final 
regulations''), once published in the Federal Register, for taxable 
years ending after the date these regulations are published as final in 
the Federal Register. Proposed Sec.  1.987-14(b). To choose to apply 
the new final regulations, the taxpayer and each member of its 
consolidated group and section 987 electing group must consistently 
apply the new final regulations in their entirety to the taxable year 
and all subsequent taxable years beginning on or before December 31, 
2024. Id.
    The Treasury Department and the IRS are concerned that taxpayers 
may terminate certain QBUs before the general applicability date of the 
proposed regulations to avoid the application of these rules. 
Accordingly, the proposed regulations would also provide an earlier 
applicability date for terminating QBUs to prevent taxpayers from 
avoiding these rules. Specifically, the new final regulations are 
proposed to apply to a terminating QBU on the day the section 987 QBU 
terminates. Proposed Sec.  1.987-14(a)(2). The proposed regulations 
would define a terminating QBU as a section 987 QBU if both (1) the 
section 987 QBU terminates on or after November 9, 2023, or as a result 
of an entity classification election filed on or after November 9, 2023 
and effective before November 9, 2023, and (2) neither the new final 
regulations nor the 2016 and 2019 section 987 regulations would apply 
to the section 987 QBU when it terminates but for the anti-avoidance 
rule in proposed Sec.  1.987-14(a)(2). Proposed Sec.  1.987-1(h).
    In addition, if the section 987 regulations apply to a taxable year 
of a partnership and would not otherwise apply to the taxable year of a 
partner in which or with which the partnership's taxable year ends, 
then the section 987 regulations apply to that taxable year of the 
partner solely with respect to the partner's interest in the 
partnership and its section 987 gain or loss attributable to an 
eligible QBU held by the partnership.

II. Applicability Dates of the 2016 and 2019 Section 987 Regulations

    The proposed regulations also provide rules regarding the 
applicability dates of the final regulations and temporary regulations. 
Section 1.987-11(a) of the 2016 final regulations generally provides 
that the 2016 final regulations apply to taxable years beginning on or 
after one year after the first day of the first taxable year following 
December 7, 2016. However, taxpayers could choose to apply them to an 
earlier taxable year as provided in Sec.  1.987-11(b). The 2019 final 
regulations (other than Sec.  1.987-12) have the same applicability 
date as the 2016 final regulations.
    As described in part V of the Background section, following the 
publication of the 2016 final regulations, the Treasury Department and 
the IRS have issued several notices stating that future guidance would 
defer the applicability dates of most provisions of the final 
regulations and the temporary regulations. Because certain provisions 
that were originally deferred have since been revoked or expired, those 
provisions are no longer subject to deferral; other provisions were 
finalized in 2019 and deferral began at that time. The provisions 
deferred by the notices (and the respective periods for deferral) are 
as follows (collectively, the ``2016 and 2019 section 987 
regulations''):
    (i) Sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 
1.987-1 through 1.987-10; 1.988-1(a)(4), (a)(10)(ii), and (i); 1.988-
4(b)(2); and 1.989(a)-1(b)(2)(i), (b)(4), (d)(3), and (d)(4), as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    (ii) Sections 1.987-2T(c)(9), 1.987-4T(c)(2) and (f), and 1.987-7T, 
as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
were revoked on May 13, 2019).
    (iii) Sections 1.987-2(c)(9) and 1.987-4(c)(2) and (f), as 
contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on 
May 13, 2019).
    (iv) Sections 1.987-1T (other than Sec. Sec.  1.987-1T(g)(2)(i)(B) 
and (g)(3)(i)(H)), 1.987-3T, 1.987-6T, 1.988-1T, and 1.988-2T(i), as 
contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
expired on December 6, 2019).
    Pursuant to the most recent notice, the 2016 and 2019 section 987 
regulations would first apply to taxable years beginning after December 
7, 2023. Notice 2022-34, 2022-34 I.R.B. 150. The deferral notices also 
allow taxpayers to rely on the provisions of the notices before the 
section 987 regulations are amended. See id.
    Because the proposed regulations would replace or modify parts of 
the

[[Page 78156]]

final regulations, the final regulations are not expected to become 
applicable in their current form. However, some taxpayers have chosen 
to apply the 2016 and 2019 section 987 regulations in accordance with 
Sec.  1.987-11(b) and the deferral notices. The proposed regulations 
would provide rules for taxpayers who chose to apply the 2016 and 2019 
section 987 regulations before the applicability date of those 
regulations.
    Proposed Sec.  1.987-14(c)(1) would provide that a taxpayer may 
choose to apply the 2016 and 2019 section 987 regulations to a taxable 
year beginning after December 7, 2016, and beginning on or before 
December 31, 2024, in certain circumstances. Specifically, the taxpayer 
and each member of its consolidated group and section 987 electing 
group would be required to first apply the 2016 and 2019 section 987 
regulations to a taxable year ending before November 9, 2023. Proposed 
Sec.  1.987-14(c)(1)(i). In addition, the taxpayer and each member of 
its consolidated group and section 987 electing group would be required 
to consistently apply the 2016 and 2019 section 987 regulations in 
their entirety to all section 987 QBUs directly or indirectly owned by 
the taxpayer and each member of its consolidated group and section 987 
electing group on the transition date for the taxable year that 
includes the transition date and all subsequent taxable years before 
the taxable year in which the taxpayer and each member of its 
consolidated group and section 987 electing group rely on the proposed 
regulations or apply the new final regulations. Proposed Sec.  1.987-
14(c)(1)(ii). For purposes of proposed Sec.  1.987-14(c), the term 
section 987 electing group does not include foreign partnerships, 
foreign non-grantor trusts, or foreign estates. Proposed Sec.  1.987-
14(c)(3)(ii).
    If a taxpayer and each member of its consolidated group and section 
987 electing group first apply the 2016 and 2019 section 987 
regulations on their returns filed on or after November 9, 2023, they 
would be required to apply proposed Sec.  1.987-10 in lieu of Sec.  
1.987-10 of the final regulations. Proposed Sec.  1.987-
14(c)(1)(iii)(B). For these taxpayers, proposed Sec.  1.987-
14(c)(1)(iii)(B) would provide that a taxpayer and each member of its 
consolidated group and section 987 electing group must transition from 
the previous method used to comply with section 987 using the 
transition rule in proposed Sec.  1.987-10. In other words, these 
taxpayers would not be permitted to apply the fresh start method 
described in Sec.  1.987-10 of the final regulations.
    The Treasury Department and the IRS are concerned that, if the new 
proposed transition rule applied solely with respect to taxable years 
ending on or after November 9, 2023, taxpayers would effectively have 
the option to choose between two alternative transition methods. 
Taxpayers with pretransition loss could apply the transition rule of 
proposed Sec.  1.987-10 (which preserves the pretransition loss), while 
taxpayers with pretransition gain could choose to apply the 2016 and 
2109 section 987 regulations before the applicability date of the 
proposed regulations to take advantage of the fresh start transition 
method (which could eliminate the pretransition gain). Therefore, the 
proposed transition rule would apply to taxpayers who choose to apply 
the 2016 and 2019 section 987 regulations on their returns filed on or 
after November 9, 2023 with respect to a taxable year ending before 
November 9, 2023.
    Proposed Sec.  1.987-14(c)(2) describes the applicability of the 
2016 and 2019 section 987 regulations to section 987 QBUs that were not 
directly or indirectly owned by the taxpayer on the taxpayer's 
transition date. Specifically, a taxpayer that is applying the 2016 and 
2019 section 987 regulations to other section 987 QBUs may choose to 
apply the 2016 and 2019 section 987 regulations to any section 987 QBU 
that it did not directly or indirectly own on the transition date, 
provided the taxpayer applies those regulations consistently to that 
QBU for that taxable year and all subsequent taxable years before the 
taxable year in which the taxpayer relies on the proposed regulations 
or applies the new final regulations.

III. Applicability Dates of Sec.  1.987-12

    Section 1.987-12T was issued as part of the temporary regulations 
and generally applied to any deferral event (as defined in Sec.  1.987-
12T(b)(2)) or outbound loss event (as defined in Sec.  1.987-12T(d)(2)) 
that occurred on or after January 6, 2017. The 2019 final regulations 
withdrew Sec.  1.987-12T and finalized the proposed regulations under 
Sec.  1.987-12 that cross-referenced Sec.  1.987-12T. See Sec.  1.987-
12. The deferral notices did not defer the applicability dates of Sec.  
1.987-12T or Sec.  1.987-12, nor would the proposed regulations. 
Accordingly, all taxpayers to whom section 987(3) applies are currently 
subject to Sec.  1.987-12.
    The proposed regulations would replace Sec.  1.987-12 with certain 
deferral provisions generally included in proposed Sec. Sec.  1.987-11 
through 1.987-13. Accordingly, the proposed regulations would provide 
that taxpayers continue to apply Sec.  1.987-12 until the first taxable 
year to which they apply the new final regulations.

IV. Reliance on the Proposed Regulations and 2016 Proposed Regulations

    Taxpayers may rely on the proposed regulations (and so much of the 
final regulations as would not be modified by the proposed regulations) 
for taxable years ending after November 9, 2023, provided the taxpayer 
and each member of its consolidated group and section 987 electing 
group consistently follow the proposed regulations in their entirety 
and in a consistent manner.
    In addition, taxpayers may rely on the parts of the 2016 proposed 
regulations that remain outstanding for taxable years ending after 
November 9, 2023, provided that both (i) the taxpayer and each member 
of its consolidated group and section 987 electing group consistently 
follow these parts in their entirety and in a consistent manner; and 
(ii) in that taxable year, the taxpayer follows the proposed 
regulations.
    For the avoidance of doubt, any person relying on the proposed 
regulations is treated as applying them for purposes of any provision 
that refers to the application of the proposed regulations or any part 
thereof (for example, for purposes of proposed Sec.  1.987-10(b)).

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    Pursuant to the Memorandum of Agreement, Review of Treasury 
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory 
actions issued by the IRS are not subject to the requirements of 
section 6 of Executive Order 12866, as amended. Therefore, a regulatory 
impact assessment is not required.

II. Paperwork Reduction Act

    The collections of information in the proposed regulations with 
respect to section 987 are in proposed Sec. Sec.  1.987-1(g), 1.987-9, 
and 1.987-10(k). The likely respondents are individuals who file a Form 
1040 and businesses that file a Form 1065, 1066, or 1120. Additionally, 
there is a possibility that a trust or estate that files a Form 1041 
could be affected by the requirements of the proposed regulations. The 
IRS anticipates that the total number of

[[Page 78157]]

respondents could be 500,\8\ and that less than 1% of the total 
respondents would be a trust or estate filer.
---------------------------------------------------------------------------

    \8\ The estimated number of respondents is based on the number 
of taxpayers who filed a Form 8858 in 2021 that showed that the 
filer: (1) owned at least one disregarded entity or branch with a 
functional currency different from the functional currency of the 
owner, and (2) indicated that the disregarded entity was a section 
989 QBU. Although these estimates are likely to increase once these 
proposed regulations are effective, the Treasury Department and the 
IRS do not have data that would allow for an accurate estimate of 
these increases.
---------------------------------------------------------------------------

    The collection of information provided by proposed Sec.  1.987-1(g) 
is required only when a taxpayer makes or revokes certain elections for 
purposes of calculating its section 987 taxable income or loss and 
section 987 gain or loss with respect to a section 987 QBU. In the 
first year to which the section 987 regulations apply to the taxpayer, 
or the taxpayer or a member of its consolidated group or section 987 
electing group is the owner of a section 987 QBU, the taxpayer may make 
any section 987 election. Thereafter, the taxpayer may make or revoke a 
current rate election or annual recognition election only every five 
years and may make or revoke other elections only with the consent of 
the Commissioner, which may be granted with a private letter ruling. 
When a taxpayer makes or revokes an election, the collection of 
information is mandatory. The collection of information required by 
proposed Sec.  1.987-1(g) will be used by the IRS for tax compliance 
purposes.
    Proposed Sec.  1.987-9 is intended to specify how a taxpayer 
satisfies its recordkeeping obligations under section 6001 with respect 
to section 987. The recordkeeping requirements under proposed Sec.  
1.987-9 are considered general tax records under Sec.  1.6001-1(e). For 
Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (``PRA'') purposes, 
general tax records are already approved by OMB under 1545-0074 for 
individuals and under 1545-0123 for business entities, and will be 
approved under 1545-NEW for trust and estate filers. The IRS intends 
that the information collection requirements pursuant to proposed Sec.  
1.987-9 will be satisfied by the taxpayer maintaining permanent books 
and records that are adequate to verify its section 987 gain or loss 
and section 987 taxable income or loss with respect to its section 987 
QBU. Specifically, with respect to each section 987 QBU, successor 
deferral QBU, and successor suspended loss QBU for a taxable year, as 
applicable, proposed Sec.  1.987-9 requires taxpayers to maintain books 
and records related to the amount of the items of income, gain, 
deduction, or loss attributed to the section 987 QBU in the functional 
currency of the section 987 QBU and its owner; the adjusted balance 
sheet of the section 987 QBU in the functional currency of the section 
987 QBU and its owner; the exchange rates used to translate items of 
income, gain, deduction, or loss of the section 987 QBU into the 
owner's functional currency and, if a spot rate convention is used, the 
manner in which the convention is determined; the exchange rates used 
to translate the assets and liabilities of the section 987 QBU into the 
owner's functional currency and, if a spot rate convention is used, the 
manner in which the convention is determined; the amount of assets and 
liabilities transferred by the section 987 QBU to the owner determined 
in the functional currency of the owner; the amount of the unrecognized 
section 987 gain or loss for the taxable year; the amount of the net 
accumulated unrecognized section 987 gain or loss at the close of the 
taxable year; the amount of a remittance and the remittance proportion 
for the taxable year; the computations required under proposed 
Sec. Sec.  1.861-9(g) and 1.861-9T(g) for purposes of sourcing and 
characterizing section 987 gain or loss, deferred section 987 gain or 
loss, or suspended section 987 loss under proposed Sec.  1.987-6; the 
cumulative suspended section 987 loss in each recognition grouping; the 
outstanding deferred section 987 gain or loss in each recognition 
grouping; and the transition information required to be determined 
under proposed Sec.  1.987-10(k). These records are required for the 
IRS to validate that section 987 gain or loss and section 987 taxable 
income or loss have been properly determined.
    The collection of information in proposed Sec.  1.987-10(k) is 
mandatory. Specifically, proposed Sec.  1.987-10(k) would require a 
taxpayer to file a ``Section 987 Transition Information'' statement 
with its return for the taxable year beginning on the transition date 
(as defined in proposed Sec.  1.987-10(c)). The statement would contain 
information that is necessary for a taxpayer to transition to the 
proposed section 987 regulations. Specifically, the statement requires 
a taxpayer to provide information that is relevant to determining the 
taxpayer's pretransition gain or loss with respect to its section 987 
QBUs. The collection of information required by proposed Sec.  1.987-
10(k) will be used by the IRS for tax compliance purposes.
    The IRS intends that the information described in proposed Sec.  
1.987-1(g) will be collected by attaching a statement to a taxpayer's 
return (such as the appropriate Form 1040, Form 1120, Form 1065, or 
other appropriate form). With respect to proposed Sec.  1.987-10(k), 
the IRS also intends that the collection of information will be 
conducted by attaching a ``Section 987 Transition Information'' 
statement to a return. For purposes of the PRA, the reporting burden 
associated with those collections of information with respect to 
proposed Sec. Sec.  1.987-1(g) and 1.987-10(k) will be reflected in the 
Paperwork Reduction Act Submissions associated with those forms. The 
OMB Control Numbers for the forms will be approved under 1545-0074 for 
individuals, under 1545-0123 for business entities, and under 1545-NEW 
for trust and estate filers.
    To the extent that a taxpayer makes or revokes an election by 
obtaining a private letter ruling, the reporting burden associated with 
those collections of information will be reflected in the Paperwork 
Reduction Act Submissions associated with Revenue Procedure 2023-1, IRB 
2023-1 (or future revenue procedures governing private letter rulings). 
The OMB Control Number for the collection of information for Revenue 
Procedure 2023-1 is control number 1545-1522. The proposed regulation 
would only require taxpayers to follow the procedures under Revenue 
Procedure 2023-1 (or future revenue procedure governing private letter 
rulings) and would not change the collection requirements of the 
Revenue Procedure.
    The attachment to a return used for making elections with respect 
to these proposed regulations will be used by those taxpayers making or 
revoking an election for the taxable year. The ``Section 987 Transition 
Information'' statement attached to a return will be used by all 
taxpayers, but generally only with respect to the taxable year in which 
the taxpayer transitions to these proposed regulations. In certain 
cases, if the taxpayer owns a QBU that terminates after November 9, 
2023 and before the taxable year in which the taxpayer transitions to 
the proposed regulations, the ``Section 987 Transition Information'' 
statement must be filed for that taxable year too, but the statement 
would only contain information with respect to the terminating QBU. The 
Treasury Department and the IRS request comments on all aspects of 
information collection burdens related to these proposed regulations. 
If the IRS releases a form for the purposes of collecting this 
information, drafts of IRS forms will be posted for comment at https://www.irs.gov/draftforms.
    The burden will be accounted for in 1545-0074 for individuals and 
in 1545-0123 for businesses. The IRS is requesting a new OMB control 
number

[[Page 78158]]

to account for trust and estate filers' burden, as reflected below.
    A summary of paperwork burden estimates for the elections as 
provided in proposed Sec.  1.987-1(g) is as follows:
    Estimated number of respondents: 5.
    Estimated burden per response: 1.95 hours.
    Estimated frequency of response: 1 for the first year in which a 
taxpayer applies these regulations. After the first year, the current 
rate election and the annual recognition election can generally be 
changed only once every five years and other elections can be changed 
with the consent of the Commissioner.
    Estimated total burden hours: 9.75 burden hours.
    A summary of paperwork burden estimates for the ``section 987 
transition information'' statement as provided in proposed Sec.  1.987-
10(k) is as follows:
    Estimated number of respondents: 5.
    Estimated burden per response: 1.95 hours.
    Estimated frequency of response: 1 for the initial transition year.
    Estimated total burden hours: 9.75 burden hours.
    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. Commenters 
are strongly encouraged to submit public comments electronically. 
Written comments and recommendations for the proposed information 
collection should be sent to www.reginfo.gov/public/do/PRAMain, with 
copies to the Internal Revenue Service. Find this particular 
information collection by selecting ``Currently under Review--Open for 
Public Comments'' then by using the search function. Submit electronic 
submissions for the proposed information collection to the IRS via 
email at [email protected] (indicate REG-132422-17 on the subject 
line). Comments on the collection of information should be received by 
February 12, 2024.
    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 (including underlying assumptions and 
methodology);
    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.
    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.

III. Regulatory Flexibility Act

    Generally, the proposed regulations affect U.S. corporations that 
have foreign operations. The number of small entities potentially 
affected by the proposed regulations is unknown; however, it is 
unlikely to be a substantial number because taxpayers with foreign 
operations are typically larger businesses. In accordance with the 
Regulatory Flexibility Act (5 U.S.C. 601 et seq.) the Secretary hereby 
certifies that these proposed regulations will not have a significant 
economic impact on a substantial number of small entities.

IV. Section 7805(f)

    Pursuant to section 7805(f), this proposed regulation will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

V. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a State, 
local, or Tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. The proposed regulations do not include any Federal mandate 
that may result in expenditures by State, local, or Tribal governments, 
or by the private sector in excess of that threshold.

VI. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on State and local 
governments, and is not required by statute, or preempts State law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. The proposed regulations do not have 
federalism implications and do not impose substantial direct compliance 
costs on State and local governments or preempt State law within the 
meaning of the Executive order.

Comments and Request for Public Hearing

    Before these proposed amendments to the final regulations are 
adopted as final regulations, consideration will be given to comments 
that are submitted timely to the IRS as prescribed in this preamble 
under the ADDRESSES heading. The Treasury Department and the IRS 
request comments on all aspects of the proposed regulations. Any 
comments submitted will be made available at https://www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits written comments. Requests for a public 
hearing are also encouraged to be made electronically. If a public 
hearing is scheduled, notice of the date and time for the public 
hearing will be published in the Federal Register.

Drafting Information

    The principal authors of the proposed regulations are Raphael J. 
Cohen, D. Peter Merkel, Jack Zhou, and Azeka J. Abramoff of the Office 
of Associate Chief Counsel (International); and Jeremy Aron-Dine and 
Julie Wang of the Office of Associate Chief Counsel (Corporate). 
However, other personnel from the Treasury Department and the IRS 
participated in their development.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices, and other 
guidance cited in this document are published in the Internal Revenue 
Bulletin or Cumulative Bulletin and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.

Partial Withdrawal of Proposed Regulations

    Under the authority of 26 U.S.C. 7805, proposed Sec. Sec.  1.987-
1(g)(2)(i)(B) and (C) and (g)(3)(i)(G) and (H), 1.987-3(d), 1.987-7, 
and 1.987-8, contained in the

[[Page 78159]]

notice of proposed rulemaking that was published in the Federal 
Register on December 8, 2016 (81 FR 88882) is withdrawn.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, the Treasury Department and the IRS propose to amend 
26 CFR part 1 as follows:

PART 1--INCOME TAXES

0
1. The authority citation for part 1 is amended by:
0
a. Removing the entry for Sec. Sec.  1.861-9 and 1.861-9T and 
Sec. Sec.  1.861-8T through 1.861-14T;
0
b. Adding entries for Sec. Sec.  1.861-8T, 1.861-9, 1.861-9T, 1.861-
10T, 1.861-11T, 1.861-12T, 1.861-13T, and 1.861-14T in numerical order;
0
c. Removing the entry for Sec. Sec.  1.985-0 through 1.985-5;
0
d. Adding entries for Sec. Sec.  1.985-0 through 1.985-5 in numerical 
order;
0
e. Removing the entry for Sec. Sec.  1.987-1 through 1.987-5;
0
f. Adding entries for Sec. Sec.  1.987-1 through 1.987-6, 1.987-7A, 
1.987-7B, 1.987-7C, and 1.987-8 through 1.987-11 in numerical order;
0
g. Revising the entry for Sec.  1.987-12;
0
h. Adding entries for Sec. Sec.  1.987-13 and 1.987-14 in numerical 
order;
0
i. Removing the entry for Sec. Sec.  1.988-0 through 1.988-5;
0
j. Adding entries for Sec. Sec.  1.988-0 through 1.988-5 and 1.989(a)-1 
in numerical order.
0
k. Revising the entry for Sec.  1.1502-13.
    The revisions and additions read as follows:

    Authority: 26 U.S.C. 7805 * * *
* * * * *
    Section 1.861-8T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
    Section 1.861-9 also issued under 26 U.S.C. 861, 863(a), 864(e), 
864(e)(7), 865(i), 987, and 989(c), and 7701(f).
    Section 1.861-9T also issued under 26 U.S.C. 861, 863(a), 
864(e), 864(e)(7), 865(i), and 7701(f).
* * * * *
    Section 1.861-10T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-11T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-12T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-13T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-14T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.985-0 also issued under 26 U.S.C. 985.
    Section 1.985-1 also issued under 26 U.S.C. 985.
    Section 1.985-2 also issued under 26 U.S.C. 985.
    Section 1.985-3 also issued under 26 U.S.C. 985.
    Section 1.985-4 also issued under 26 U.S.C. 985.
    Section 1.985-5 also issued under 26 U.S.C. 985, 987, and 
989(c).
* * * * *
    Section 1.987-1 also issued under 26 U.S.C. 987, 989(c), and 
1502.
    Section 1.987-2 also issued under 26 U.S.C. 987, 989(c), and 
1502.
    Section 1.987-3 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-4 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-5 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-6 also issued under 26 U.S.C. 904, 987, and 
989(c).
    Section 1.987-7A also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-7B also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-7C also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-8 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-9 also issued under 26 U.S.C. 987, 989(c), and 
6001.
    Section 1.987-10 also issued under 26 U.S.C. 987, 989(c), and 
6001.
    Section 1.987-11 also issued under 26 U.S.C. 987, 989(c), and 
1502.
    Section 1.987-12 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-13 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.987-14 also issued under 26 U.S.C. 987 and 989(c).
    Section 1.988-0 also issued under 26 U.S.C. 988.
    Section 1.988-1 also issued under 26 U.S.C. 988 and 989(c).
    Section 1.988-2 also issued under 26 U.S.C. 988.
    Section 1.988-3 also issued under 26 U.S.C. 988.
    Section 1.988-4 also issued under 26 U.S.C. 988 and 989(c).
    Section 1.988-5 also issued under 26 U.S.C. 988.
* * * * *
    Section 1.989(a)-1 also issued under 26 U.S.C. 989 and 989(c).
* * * * *
    Section 1.1502-13 also issued under 26 U.S.C. 250(c), 987, 
989(c), and 1502.
* * * * *
0
2. Section 1.861-9 is amended by:
0
a. Revising paragraphs (g)(2)(ii)(A) introductory text, 
(g)(2)(ii)(A)(1), and (g)(2)(ii)(B).
0
b. Adding paragraph (g)(2)(v).
    The revisions and addition read as follows:


Sec.  1.861-9   Allocation and apportionment of interest expense and 
rules for asset-based apportionment.

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (A) Tax book value method. In the case of taxpayers using the tax 
book value method of apportionment, the following rules apply to 
determine the value of the assets of a qualified business unit (as 
defined in section 989(a)) of a domestic corporation with a functional 
currency other than the dollar.
    (1) Section 987 QBU. In the case of a section 987 QBU (as defined 
in Sec.  1.987-1(b)(3)), the tax book value is determined by applying 
the rules of paragraph (g)(2)(i) of this section and Sec.  1.861-
9T(g)(3) to the beginning-of-year and end-of-year owner functional 
currency amount of assets. The beginning-of-year owner functional 
currency amount of assets is determined by reference to the owner 
functional currency amount of assets computed under Sec.  1.987-
4(d)(1)(i)(B) and (e) on the last day of the preceding taxable year. 
The end-of-year owner functional currency amount of assets is 
determined by reference to the owner functional currency amount of 
assets computed under Sec.  1.987-4(d)(1)(i)(A) and (e) on the last day 
of the current taxable year. The beginning-of-year and end-of-year 
owner functional currency amount of assets, as so determined within 
each grouping, are then averaged as provided in paragraph (g)(2)(i) of 
this section.
* * * * *
    (B) Fair market value method. In the case of taxpayers using the 
fair market value method of apportionment, the beginning-of-year and 
end-of-year fair market values of branch assets within each grouping is 
computed in dollars and averaged as provided in this paragraph (g)(2) 
and Sec.  1.861-9T(g)(2).
* * * * *
    (v) Applicability date. Generally, paragraph (g)(2)(ii)(A)(1) of 
this section applies to taxable years beginning after December 31, 
2024. However, if pursuant to Sec.  1.987-14(b), a taxpayer chooses to 
apply Sec. Sec.  1.987-1 through 1.987-14 to a taxable year before the 
first taxable year described in Sec.  1.987-14(a)(1), then paragraph 
(g)(2)(ii)(A)(1) of this section applies to that taxable year and 
subsequent years.
* * * * *


Sec.  1.861-9T   [Amended]

0
3. Section 1.861-9T is amended by removing and reserving paragraph 
(g)(2)(ii) and removing paragraph (g)(2)(vi).

[[Page 78160]]

0
4. Section 1.904-4 is amended by revising paragraph (c)(5)(iii)(B) to 
read as follows:


Sec.  1.904-4   Separate application of section 904 with respect to 
certain categories of income.

* * * * *
    (c) * * *
    (5) * * *
    (iii) * * *
    (B) Section 987. For special rules relating to the allocation and 
apportionment of foreign income taxes to section 987 items, see Sec.  
1.987-6(b)(3)(iii).
* * * * *
0
5. Section 1.985-5 is amended by:
0
a. In paragraph (a) removing the language ``Sec.  1.987-1(b)(2)'' and 
adding the language ``Sec.  1.987-1(b)(3)'' in its place.
0
b. In paragraph (d)(1)(i) removing the language ``1.987-11'' and adding 
the language ``1.987-14'' in its place.
0
c. Revising the last sentence of paragraph (d)(2).
0
d. Removing the second sentence of paragraph (e)(1).
0
e. In paragraph (e)(4)(i) removing the language ``1.987-11'' and adding 
the language ``1.987-14'' in its place.
0
f. In paragraph (e)(4)(i)(C) adding the language ``, cumulative 
suspended section 987 loss determined under Sec.  1.987-11(b), and 
deferred section 987 gain or loss determined under Sec.  1.987-12'' 
after ``Sec.  1.987-4''.
0
g. In paragraph (e)(4)(ii) removing the language ``subsequent years'' 
and adding the language ``subsequent taxable years'' in its place.
0
h. Revising the last sentence of paragraph (e)(4)(iii).
0
i. Revising paragraphs (f) through (g).
    The revisions read as follows:


Sec.  1.985-5   Adjustments required upon change in functional 
currency.

* * * * *
    (d) * * *
    (2) * * * See Sec. Sec.  1.987-5, 1.987-8, 1.987-12, and 1.987-13 
for the effect of a termination of a section 987 QBU that is subject to 
Sec. Sec.  1.987-1 through 1.987-14.
    (e) * * *
    (4) * * *
    (iii) * * * See Sec. Sec.  1.987-5, 1.987-8, 1.987-12, and 1.987-13 
for the consequences of a termination of a section 987 QBU that is 
subject to Sec. Sec.  1.987-1 through 1.987-14.
    (f) Example. The provisions of this section are illustrated by the 
following example:
    (1) Facts. FC, a foreign corporation, is wholly owned by DC, a 
domestic corporation. The Commissioner granted permission to change 
FC's functional currency from the British pound to the euro beginning 
January 1, year 2. The EUR/GBP exchange rate on December 31, year 1, is 
[euro]1:[pound]0.50.
    (2) Analysis--(i) Determining new functional currency basis of 
property and liabilities. The following table shows how FC must convert 
the items on its balance sheet from the British pound to the euro on 
December 31, year 1.

 Table 1 to Paragraph (f)(2)(i)--Conversion of FC's Balance Sheet Items
------------------------------------------------------------------------
                                           GBP                EUR
------------------------------------------------------------------------
Assets:
    Cash on hand..................      [pound]40,000       [euro]80,000
    Accounts Receivable...........      [pound]10,000       [euro]20,000
    Inventory.....................     [pound]100,000      [euro]200,000
    [euro]100,000 Euro Bond             [pound]50,000      [euro]100,000
     ([pound]100,000 historical
     basis).......................
Fixed assets:
    Property......................     [pound]200,000      [euro]400,000
    Plant.........................     [pound]500,000    [euro]1,000,000
        Accumulated Depreciation..   ([pound]200,000)    ([euro]400,000)
    Equipment.....................   [pound]1,000,000    [euro]2,000,000
        Accumulated Depreciation..   ([pound]400,000)    ([euro]800,000)
                                   -------------------------------------
            Total Assets..........   [pound]1,300,000    [euro]2,600,000
Liabilities and Equity:
    Accounts Payable..............      [pound]50,000      [euro]100,000
    Long-term Liabilities.........     [pound]400,000      [euro]800,000
    Paid-in-Capital...............     [pound]800,000    [euro]1,600,000
    Retained Earnings.............      [pound]50,000      [euro]100,000
                                   -------------------------------------
        Total Liabilities and        [pound]1,300,000    [euro]2,600,000
         Equity...................
------------------------------------------------------------------------

    (ii) Exchange gain or loss on section 988 transactions. Under 
paragraph (b) of this section, FC will recognize a [pound]50,000 loss 
([pound]50,000 current value minus [pound]100,000 historical basis) on 
the Euro Bond resulting from the change in functional currency because, 
after the change, the Euro Bond will no longer be an asset denominated 
in a non-functional currency. The amount of FC's retained earnings on 
its December 31, year 1, balance sheet reflects the [pound]50,000 loss 
on the Euro Bond.
    (g) Applicability date. Generally, this regulation applies to 
taxable years beginning after December 31, 2024. However, if pursuant 
to Sec.  1.987-14(b), a taxpayer chooses to apply Sec. Sec.  1.987-1 
through 1.987-14 to a taxable year before the first taxable year 
described in Sec.  1.987-14(a)(1), then this section applies to that 
taxable year and subsequent years.
0
6. Section 1.987-1, as proposed to be amended by 81 FR 88882 (December 
8, 2016), is further amended by:
0
a. Revising paragraph (a);
0
b. Revising the paragraph (b) heading, paragraph (b)(1) heading, 
paragraphs (b)(1)(i) and (ii), (2) through (5) and (7);
0
c. Revising paragraphs (c) introductory text, (c)(1)(i) and 
(c)(1)(ii)(A) and removing paragraph (c)(1)(iii);
0
d. Revising paragraphs (c)(2), (c)(3)(i) introductory text, 
(c)(3)(i)(A) through (D) and adding paragraph (c)(3)(i)(F);
0
g. Revising paragraphs (c)(3)(ii) through (iv);
0
h. Removing the introductory text in paragraph (d);
0
i. Redesignating paragraphs (d)(1) through (3) as paragraphs (d)(1)(i) 
through (iii);
0
j. Adding paragraph (d)(1) introductory text;
0
k. Revising newly redesignated paragraphs (d)(1)(i) and (ii);
0
l. Adding paragraph (d)(2);

[[Page 78161]]

0
m. Revising paragraph (e);
0
n. Adding paragraph (g) introductory text;
0
o. Revising paragraphs (g)(1) and (2);
0
p. Revising paragraph (g)(3) heading and adding (g)(3) introductory 
text;
0
q. Revising paragraph (g)(3)(i) heading and introductory text;
0
r. Revising paragraphs (g)(3)(i)(A) through (D), (G), and (H);
0
s. Adding paragraphs (g)(3)(i)(I) and (J);
0
t. Revising paragraph (g)(3)(ii);
0
u. Adding paragraph (g)(3)(iii);
0
v. Revising paragraphs (g)(4) and (5); and
0
w. Adding paragraph (h).
    The revisions and additions read as follows:


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

    (a) In general. Sections 1.987-1 through 1.987-14 (the section 987 
regulations) provide rules for determining the taxable income or loss 
and earnings and profits of a taxpayer with respect to a section 987 
QBU. Further, the section 987 regulations provide rules for determining 
the timing, amount, character, and source of section 987 gain or loss 
recognized with respect to a section 987 QBU. This section addresses 
the scope of the section 987 regulations and provides certain 
definitions, special rules, and procedures for making elections. 
Section 1.987-2 provides rules for attributing assets and liabilities 
and items of income, gain, deduction, and loss to an eligible QBU. It 
also provides rules regarding the translation of items transferred to a 
section 987 QBU. Section 1.987-3 provides rules for determining and 
translating the taxable income or loss of a taxpayer with respect to a 
section 987 QBU. Section 1.987-4 provides rules for determining net 
unrecognized section 987 gain or loss. Section 1.987-5 provides rules 
regarding the recognition of section 987 gain or loss. It also provides 
rules regarding the translation of items transferred from a section 987 
QBU to its owner. Section 1.987-6 provides rules regarding the 
character and source of section 987 gain or loss. Section 1.987-7A 
provides rules regarding partnerships (other than section 987 aggregate 
partnerships) and S corporations that own section 987 QBUs and their 
partners and shareholders. Section 1.987-7B provides rules regarding 
section 987 aggregate partnerships. Section 1.987-7C provides 
transition rules that apply when a partnership becomes, or ceases to 
be, a section 987 aggregate partnership. Section 1.987-8 provides rules 
regarding the termination of a section 987 QBU. Section 1.987-9 
provides rules regarding the recordkeeping required under section 987. 
Section 1.987-10 provides transition rules. Section 1.987-11 provides 
rules relating to suspended losses in connection with certain elections 
and the loss-to-the-extent-of-gain rule. Section 1.987-12 provides 
rules regarding when section 987 gain or loss is deferred, as well as 
when such amounts are recognized. Section 1.987-13 provides rules 
relating to suspended section 987 loss of an owner with respect to a 
section 987 QBU that terminates. Section 1.987-14 provides the 
applicability date of the section 987 regulations.
    (b) Scope of section 987 and certain rules relating to QBUs--(1) 
Persons subject to section 987--(i) In general. Except as provided in 
paragraphs (b)(1)(ii) and (b)(6) of this section, any person (including 
an individual, corporation, partnership, S corporation, non-grantor 
trust, or estate) is subject to the section 987 regulations.
    (ii) Inapplicability to certain entities--(A) In general. Except as 
otherwise provided in paragraph (b)(1)(iii) of this section, section 
987(3) and the section 987 regulations do not apply to foreign 
corporations that either are not controlled foreign corporations or 
that are controlled foreign corporations in which no United States 
shareholders own (within the meaning of section 958(a)) stock; foreign 
non-grantor trusts, foreign estates, or foreign partnerships (other 
than section 987 aggregate partnerships) if the aggregate beneficial 
interest or partnership interest of all U.S. persons that are 
beneficiaries or partners in the non-grantor trust, estate, or 
partnership is de minimis under paragraph (b)(1)(ii)(B) of this 
section; and individuals who are not United States persons.
    (B) De minimis interest in a foreign non-grantor trust, foreign 
estate, or foreign partnership--(1) General rules. The total 
partnership interests of all U.S. persons that own (within the meaning 
of section 958(a)) an interest in a partnership is de minimis if their 
aggregate partnership interests represent less than ten percent of the 
capital and less than ten percent of the profits of the partnership at 
all times during the partnership's taxable year. The aggregate 
beneficial interests of all U.S. persons in a foreign non-grantor trust 
or foreign estate is de minimis if it constitutes less than ten percent 
of all of the beneficial interests. For purposes of this paragraph, a 
partner's interest in a partnership or partnership item and a 
beneficiary's interest in a non-grantor trust or estate is treated as 
including the interests of the partner or beneficiary and any related 
party (determined under section 267(b) or 707(b)).
    (2) Foreign partnerships. For purposes of this paragraph 
(b)(1)(ii)(B), a partner's interest in the profits of a partnership is 
determined in accordance with the rules and principles of Sec.  1.706-
1(b)(4)(ii), and a partner's interest in the capital of a partnership 
is determined in accordance with the rules and principles of Sec.  
1.706-1(b)(4)(iii).
    (3) Foreign trusts and estates. For purposes of this paragraph 
(b)(1)(ii)(B), a person holds a beneficial interest in a foreign trust 
or in a foreign estate if the person has the right to receive directly 
or indirectly (for example, through a nominee) a mandatory distribution 
from the foreign trust or estate, or may receive, directly or 
indirectly, a discretionary distribution from the foreign trust. For 
purposes of this section, a mandatory distribution means a distribution 
that is required to be made pursuant to the terms of the trust's or 
estate's governing documents. A discretionary distribution means a 
distribution that is made to a person at the discretion of the trustee 
or a person with a limited power of appointment of such trust. The 
aggregate beneficial interests of all U.S. persons in a foreign non-
grantor trust or foreign estate will be treated as equaling 10 percent 
or more of the beneficial interest in a foreign trust or a foreign 
estate if--
    (i) The beneficiaries receive, directly or indirectly, only 
discretionary distributions from the trust and the fair market value of 
the currency or other property distributed, directly or indirectly, 
from the trust to such beneficiaries during the prior calendar year 
exceeds, in the aggregate, 10 percent of the value of either all of the 
distributions made by the trust during that year or all of the assets 
held by the trust at the end of that year;
    (ii) The beneficiaries are entitled to receive, directly or 
indirectly, mandatory distributions from the trust or estate and the 
value of the beneficiaries' aggregate interest in the trust or estate, 
as determined under section 7520, exceeds 10 percent of the value of 
all the assets held by the trust; or
    (iii) The beneficiaries are entitled to receive, directly or 
indirectly, mandatory distributions and may receive, directly or 
indirectly, discretionary distributions from the trust, and the value 
of the beneficiaries' aggregate interest in the trust (determined as 
the sum of the fair market value of all of the currency or other 
property distributed from the trust at the discretion of the trustee 
during

[[Page 78162]]

the prior calendar year to the beneficiaries and the value of the 
beneficiaries' interest in the trust as determined under section 7520 
at the end of that year) exceeds either 10 percent of the value of all 
distributions made by such trust during the prior calendar year or 10 
percent of the value of all the assets held by the trust at the end of 
that year.
* * * * *
    (2) Application of the section 987 regulations to earnings and 
profits--(i) In general. The rules and principles of the section 987 
regulations also apply to the determination of earnings and profits, 
and any elections that apply pursuant to the section 987 regulations 
also apply for purposes of determining earnings and profits.
    (ii) Timing. Earnings and profits are increased when section 987 
gain is recognized and decreased when section 987 loss is recognized. 
As a result, converting net unrecognized section 987 gain or loss to 
deferred section 987 gain or loss or suspended section 987 loss does 
not affect earnings and profits because the amounts have not yet been 
recognized.
    (3) Definition of a section 987 QBU--(i) In general. For purposes 
of section 987, a section 987 QBU is an eligible QBU that has a 
functional currency different from its owner. A section 987 QBU also 
includes the assets and liabilities of an eligible QBU that are 
considered under paragraph (b)(5)(ii) of this section to be a section 
987 QBU of a partner in a section 987 aggregate partnership. A section 
987 QBU will continue to be treated as a section 987 QBU of the owner 
until a sale or other termination of the section 987 QBU as described 
in Sec.  1.987-8(b) and (c). See Sec.  1.985-1 for rules determining 
the functional currency of an eligible QBU.
    (ii) Section 987 QBU grouping election--(A) In general. Solely for 
purposes of section 987, an owner may elect to treat all section 987 
QBUs with the same functional currency as a single section 987 QBU 
except to the extent provided in paragraph (b)(2)(ii)(B) of this 
section.
    (B) Special grouping rules for section 987 QBUs owned indirectly 
through a section 987 aggregate partnership. An owner making the 
section 987 QBU grouping election treats all section 987 QBUs with the 
same functional currency owned indirectly through a single section 987 
aggregate partnership as a single section 987 QBU. However, an owner 
may not treat section 987 QBUs as a single section 987 QBU if such QBUs 
are owned indirectly through different section 987 aggregate 
partnerships. Additionally, an owner may not treat section 987 QBUs 
that are owned both directly and indirectly through a section 987 
aggregate partnership as a single section 987 QBU.
    (4) Definition of an eligible QBU--(i) In general. For purposes of 
section 987, an eligible QBU means a qualified business unit that is 
not subject to the United States dollar approximate separate 
transactions method rules of Sec.  1.985-3.
    (ii) Qualified business unit. For purposes of this paragraph 
(b)(4), a qualified business unit is defined in Sec.  1.989(a)-1(b), 
except that a corporation, partnership, section 987 aggregate 
partnership, trust, estate, or DE is not itself a qualified business 
unit, but the activities of such entity may be a qualified business 
unit if they meet the requirements of Sec.  1.989(a)-1(b)(1) and 
(b)(2)(ii). For example, if a corporation is solely engaged in 
activities that constitute a trade or business within the meaning of 
Sec.  1.989(a)-1(b)(2)(ii)(A), and the corporation maintains only one 
set of books and records, the activities (but not the corporation) are 
a qualified business unit.
    (5) Definition of an owner. For purposes of section 987, an owner 
is any person having direct or indirect ownership in an eligible QBU 
(including ownership through DEs). The term owner does not include an 
eligible QBU. For example, a section 987 QBU (QBU1) is not an owner of 
another section 987 QBU (QBU2) even if QBU1 wholly owns the DE that 
owns QBU2. A person that is not subject to the section 987 regulations 
under paragraph (b)(1)(ii) of this section can meet the definition of 
an owner under this paragraph (b)(5) for purposes of applying the 
section 987 regulations to other persons.
    (i) Direct ownership. A person is a direct owner of an eligible QBU 
if the person is the owner for Federal income tax purposes of the 
assets and liabilities of the eligible QBU.
    (ii) Indirect ownership. A person that is a partner in a section 
987 aggregate partnership and is allocated, under Sec.  1.987-7B, all 
or a portion of the assets and liabilities of an eligible QBU of such 
partnership is an indirect owner of the eligible QBU.
* * * * *
    (7) Examples illustrating paragraph (b) of this section. The 
following examples illustrate the principles of this paragraph (b). The 
following facts are assumed for purposes of the examples. U.S. Corp is 
a domestic corporation, has the U.S. dollar as its functional currency, 
and uses the calendar year as its taxable year. Except as otherwise 
provided: Business A and Business B are eligible QBUs and have the euro 
and the Japanese yen, respectively, as their functional currencies; and 
DE1 and DE2 are DEs, have no assets or liabilities, and conduct no 
activities.
    (i) Example 1--(A) Facts. U.S. Corp owns Business A and all of the 
interests in DE1. DE1 maintains a separate set of books and records 
that are kept in British pounds. DE1 owns pounds and all of the stock 
of a foreign corporation, FC. DE1 is liable to a lender on a pound-
denominated obligation that was incurred to acquire the stock of FC. 
The FC stock, the pounds, and the liability incurred to acquire the FC 
stock are recorded on DE1's separate books and records. DE1 has no 
other assets or liabilities and conducts no activities (other than 
holding the FC stock and pounds and servicing its liability).
    (B) Analysis--(1) Pursuant to paragraph (b)(5) of this section, 
U.S. Corp is the owner of Business A because it has direct ownership of 
Business A, an eligible QBU. Because Business A is an eligible QBU with 
a functional currency that is different from the functional currency of 
its owner, U.S. Corp, Business A is a section 987 QBU under paragraph 
(b)(3)(i) of this section. As a result, U.S. Corp and its section 987 
QBU, Business A, are subject to section 987.
    (2) Holding the stock of FC and pounds and servicing a liability 
does not constitute a trade or business within the meaning of Sec.  
1.989(a)-1(c). Because the activities of DE1 do not constitute a trade 
or business within the meaning of Sec.  1.989(a)-1(c), such activities 
are not an eligible QBU. In addition, pursuant to paragraph (b)(4)(ii) 
of this section, DE1 itself is not an eligible QBU. As a result, 
neither DE1 nor its activities qualify as a section 987 QBU of U.S. 
Corp. Therefore, neither the activities of DE1 nor DE1 itself is 
subject to section 987. For the foreign currency treatment of payments 
on DE1's pound-denominated liability, see Sec.  1.988-2(b).
    (ii) Example 2--(A) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and all of the interests in DE2. The only 
activities of DE1 are Business A activities and holding the interests 
in DE2. DE2 owns Business B and Business C. For purposes of this 
example, Business B does not maintain books and records that are 
separate from DE2. Instead, the activities of Business B are reflected 
on the books and records of DE2, which are maintained in Japanese yen. 
In addition, Business C has the U.S. dollar as its functional currency, 
maintains books and records

[[Page 78163]]

that are separate from the books and records of DE2, and is an eligible 
QBU.
    (B) Analysis--(1) Pursuant to paragraph (b)(4)(ii) of this section, 
DE1 and DE2 are not eligible QBUs. Moreover, pursuant to paragraph 
(b)(5) of this section, DE1 is not the owner of the Business A, 
Business B, or Business C eligible QBUs, and DE2 is not the owner of 
the Business B or Business C eligible QBUs. Instead, pursuant to 
paragraph (b)(5) of this section, U.S. Corp is the owner of the 
Business A, Business B, and Business C eligible QBUs.
    (2) Because Business A and Business B are eligible QBUs with 
functional currencies that are different than the functional currency 
of U.S. Corp, Business A and Business B are section 987 QBUs under 
paragraph (b)(3)(i) of this section.
    (3) The Business C eligible QBU has the same functional currency as 
U.S. Corp, the U.S. dollar. Therefore, the Business C eligible QBU is 
not a section 987 QBU under paragraph (b)(3)(i) of this section.
    (iii) Example 3--(A) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and Business B. For purposes of this example, 
assume Business B has the euro as its functional currency.
    (B) Analysis--(1) Pursuant to paragraph (b)(4)(ii) of this section, 
DE1 is not an eligible QBU. Moreover, pursuant to paragraph (b)(5) of 
this section, DE1 is not the owner of the Business A or Business B 
eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, 
U.S. Corp is the owner of the Business A and Business B eligible QBUs.
    (2) Business A and Business B constitute two separate eligible 
QBUs, each with the euro as its functional currency. Accordingly, 
Business A and Business B are section 987 QBUs of U.S. Corp under 
paragraph (b)(3)(i) of this section. U.S. Corp may elect to treat 
Business A and Business B as a single section 987 QBU pursuant to 
paragraph (b)(3)(ii) of this section. If such election is made, 
pursuant to paragraph (b)(5) of this section, U.S. Corp would be the 
owner of the Business AB section 987 QBU that would include the 
activities of both the Business A section 987 QBU and the Business B 
section 987 QBU. In addition, pursuant to paragraph (b)(5) of this 
section, DE1 would not be treated as the owner of the Business AB 
section 987 QBU.
    (iv) Example 4--(A) Facts. U.S. Corp and FC, an unrelated foreign 
corporation, are the only partners in P, a foreign partnership with the 
euro as its functional currency. P owns DE1 and Business A. DE1 owns 
Business B.
    (B) Analysis--(1) P is not a section 987 aggregate partnership 
under paragraph (h) of this section because its partners are not 
related to each other within the meaning of sections 267(b) and 707(b). 
Therefore, pursuant to paragraph (b)(5) of this section and Sec.  
1.987-7A(b), P is the owner of Business A because it is the owner of 
the assets and liabilities of Business A. Because Business A is an 
eligible QBU with the same functional currency as its owner, P (the 
euro), Business A is not a section 987 QBU under paragraph (b)(3)(i) of 
this section.
    (2) Pursuant to paragraph (b)(4)(ii) of this section, DE1 is not an 
eligible QBU. Moreover, pursuant to paragraph (b)(5) of this section 
and Sec.  1.987-7A(b), P (rather than DE1) is the owner of the Business 
B eligible QBU. The Business B eligible QBU has a different functional 
currency than P. Therefore, the Business B eligible QBU is a section 
987 QBU under paragraph (b)(3)(i) of this section. As a result, P and 
its section 987 QBU, Business B, are subject to section 987.
    (v) Example 5--(A) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and all of the interests in DE2. DE2 owns 
Business B and all of the interests in DE3, a DE. DE3 owns Business C, 
which is an eligible QBU with the Mexican peso as its functional 
currency.
    (B) Analysis. Pursuant to paragraph (b)(4)(ii) of this section, 
DE1, DE2, and DE3 are not eligible QBUs. Pursuant to paragraph (b)(5) 
of this section, an eligible QBU is not an owner of another eligible 
QBU. Accordingly, the Business A eligible QBU is not the owner of the 
Business B eligible QBU or the Business C eligible QBU, and the 
Business B eligible QBU is not the owner of the Business C eligible 
QBU. Instead, pursuant to paragraph (b)(5) of this section, U.S. Corp 
is the owner of the Business A, Business B, and Business C eligible 
QBUs. Because each of the Business A, Business B, and Business C 
eligible QBUs has a different functional currency than U.S. Corp, such 
eligible QBUs are section 987 QBUs of U.S. Corp under paragraph 
(b)(3)(i) of this section.
    (c) Exchange rates. Solely for purposes of section 987, the spot 
rate, the yearly average exchange rate, and the historic rate are 
determined as provided in paragraphs (c)(1) through (3) of this 
section.
    (1) Spot rate--(i) In general. Except as otherwise provided in this 
section, the spot rate means the rate determined under the rules of 
Sec.  1.988-1(d)(1), (2), and (4) on the relevant date.
    (ii) Election to use a spot rate convention--(A) In general--spot 
rate convention. An owner may elect to use a spot rate convention that 
reasonably approximates the spot rate determined in paragraph (c)(1)(i) 
of this section. A spot rate convention may be based on the spot rate 
at the beginning of a reasonable period, the spot rate at the end of a 
reasonable period, the average of spot rates for a reasonable period, 
or spot and forward rates for a reasonable period. For this purpose, a 
reasonable period may not exceed three months. For example, in lieu of 
the spot rate determined in paragraph (c)(1)(i) of this section, the 
spot rate for all transactions during a monthly period may be 
determined pursuant to one of the following conventions: the spot rate 
at the beginning of the current month or at the end of the preceding 
month; the monthly average of daily spot rates for the current or 
preceding month; or an average of the beginning and ending spot rates 
for the current or preceding month. Similarly, in lieu of the spot rate 
determined in paragraph (c)(1)(i) of this section, the spot rate may be 
determined pursuant to an average of the spot rate and the 30-day 
forward rate on a day of the preceding month. Use of a spot rate 
convention that is consistent with the convention used for financial 
accounting purposes is generally presumed to reasonably approximate the 
rate in paragraph (c)(1)(i) of this section. However, the Commissioner 
may prescribe the spot rate as determined in paragraph (c)(1)(i) of 
this section or an appropriate spot rate pursuant to this paragraph 
(c)(1)(ii) if the Commissioner determines that the use of the 
convention would not clearly reflect income based on the facts and 
circumstances available at the time of the election. The election or 
revocation of a spot rate convention does not change the spot rate with 
respect to any day of a taxable year before the election or revocation 
becomes effective. See paragraph (g) of this section for rules relating 
to section 987 elections.
* * * * *
    (2) Yearly average exchange rate. For purposes of section 987, the 
yearly average exchange rate is a rate that represents an average 
exchange rate for the taxable year (or, if the section 987 QBU existed 
for less than the full taxable year, the portion of the year during 
which the 987 QBU existed) computed under any reasonable method. For 
example, an owner may determine the yearly average exchange rate based 
on a daily, monthly, or quarterly averaging convention, whether 
weighted or unweighted, and may take

[[Page 78164]]

into account forward rates for a period not to exceed three months. Use 
of an averaging convention that is consistent with the convention used 
for financial accounting purposes is generally presumed to be a 
reasonable method. However, the Commissioner may prescribe an 
appropriate yearly average exchange rate if the Commissioner determines 
that the use of the convention would not have been expected to clearly 
reflect income based on the facts and circumstances available at the 
time of the election.
    (3) Historic rate--(i) In general. Except as otherwise provided in 
the section 987 regulations, the historic rate is determined as 
described in paragraphs (c)(3)(i)(A) through (F) of this section. In a 
taxable year in which an annual recognition election is in effect (and 
a current rate election is not in effect), paragraphs (c)(3)(i)(B) and 
(C) of this section are applied as if Sec.  1.987-3(c)(2)(iv)(A) and 
(B) were applicable.
    (A) Assets generally. In the case of an asset other than inventory 
that is acquired by a section 987 QBU (including through a transfer), 
the historic rate is the yearly average exchange rate applicable to the 
year of acquisition.
    (B) Inventory under the simplified inventory method. In the case of 
inventory with respect to which a taxpayer uses the simplified 
inventory method described in Sec.  1.987-3(c)(2)(iv)(A), the historic 
rate for inventory accounted for under the last-in, first-out (LIFO) 
method of accounting is the yearly average exchange rate applicable to 
the year in which the inventory's LIFO layer arose. The historic rate 
for all other inventory of such a taxpayer is the yearly average 
exchange rate for the taxable year for which the determination of the 
historic rate for such inventory is relevant.
    (C) Inventory under the historic inventory method. In the case of 
inventory with respect to which a taxpayer has elected under Sec.  
1.987-3(c)(2)(iv)(B) to use the historic inventory method, each 
inventoriable cost with respect to such inventory may have a different 
historic rate. The historic rate for each inventoriable cost is the 
exchange rate at which such item would be translated under Sec.  1.987-
3 if it were not an inventoriable cost.
    (D) Liabilities generally. In the case of a liability that is 
incurred or assumed by a section 987 QBU, the historic rate is the 
yearly average exchange rate applicable to the year the liability is 
incurred or assumed.
* * * * *
    (F) Determination of historic rates after revocation of current 
rate election. Except as provided in paragraph (c)(3)(i)(B) of this 
section with respect to non-LIFO inventory subject to the simplified 
inventory method, if a current rate election is revoked or otherwise 
ceases to be in effect, the historic rate of all historic items that 
were properly reflected on the books and records of a section 987 QBU 
under Sec.  1.987-2(b) on the last day of the last taxable year to 
which the current rate election was in effect is the spot rate 
applicable to that day.
    (ii) [Reserved]
    (iii) Date placed in service for depreciable or amortizable 
property. In the case of depreciable or amortizable property, an owner 
may determine the historic rate by reference to the date such property 
is placed in service by the section 987 QBU rather than the date the 
property was acquired, provided that this convention is consistently 
applied for all such property attributable to that section 987 QBU.
    (iv) Changed functional currency. In the case of a section 987 QBU 
or an owner of a section 987 QBU that previously changed its functional 
currency, Sec.  1.985-5(d)(1)(ii)(A) and (e)(4)(i)(A), respectively, 
are taken into account in determining the historic rate for an item 
reflected on the balance sheet of the section 987 QBU immediately 
before the year of change.
    (d) Marked item--(1) In general. Except as provided in paragraph 
(d)(2) of this section, a marked item is an asset (marked asset) or 
liability (marked liability) that is properly reflected on the books 
and records of a section 987 QBU under Sec.  1.987-2(b) and that--
    (i) Is denominated in, or determined by reference to, the 
functional currency of the section 987 QBU, is not a section 988 
transaction of the section 987 QBU, and would be a section 988 
transaction if such item were held or entered into directly by the 
owner of the section 987 QBU; or
    (ii) Is a prepaid expense or a liability for an advance payment of 
unearned income, in either case having an original term of one year or 
less on the date the prepaid expense or liability for an advance 
payment of unearned income arises.
* * * * *
    (2) Current rate election. A taxpayer may elect to treat all assets 
and liabilities that are properly reflected on the books and records of 
a section 987 QBU under Sec.  1.987-2(b) as marked items (a current 
rate election). See Sec.  1.987-11(c) for rules suspending section 987 
loss if a current rate election is in effect.
    (e) Historic item. A historic item is an asset (historic asset) or 
liability (historic liability) that is properly reflected on the books 
and records of a section 987 QBU under Sec.  1.987-2(b) and that is not 
a marked item.
* * * * *
    (g) Elections. This paragraph (g) provides rules for making and 
revoking elections under the section 987 regulations (the section 987 
elections). A section 987 election is made for the owner and for a 
taxable year and applies to every section 987 QBU owned by the owner 
while the election is in effect. Once made, a section 987 election 
remains in effect until revoked.
    (1) Persons making the election. A section 987 election is made or 
revoked by the authorized person. The authorized person is described in 
paragraph (g)(1)(i), (ii), (iii), or (iv) of this section. If there are 
multiple controlling domestic shareholders, references to ``the 
authorized person'' refer to all authorized persons.
    (i) United States persons. Except as provided in paragraph 
(g)(1)(iii) or (iv) of this section, if the owner of a section 987 QBU 
is a United States person, the election is made or revoked by the 
owner.
    (ii) CFCs and other foreign entities--(A) In general. Except as 
provided in paragraph (g)(1)(iv) of this section, if the owner of a 
section 987 QBU is a controlled foreign corporation or other foreign 
entity, the election is made or revoked by the controlling domestic 
shareholders of the controlled foreign corporation or other foreign 
entity.
    (B) Controlling domestic shareholders. For purposes of this 
paragraph (g), the controlling domestic shareholders of a controlled 
foreign corporation are determined under Sec.  1.964-1(c)(5)(i) and the 
controlling domestic shareholders of a foreign entity other than a 
controlled foreign corporation are determined by applying the rules and 
principles of Sec.  1.964-1(c)(5)(i) as if the foreign entity were a 
controlled foreign corporation and, if the entity is a trust or estate, 
the beneficial interests in the entity were stock.
    (iii) Consolidated groups. If the owner is a member of a 
consolidated group, see Sec.  1.1502-77.
    (iv) Partnerships. If the owner of a section 987 QBU is a 
partnership, the election is made or revoked by the partnership. For a 
partnership that is not otherwise required to file a partnership 
return, see Sec.  1.6031(a)-1(b)(5) for elections that can only be made 
by a partnership under section 703.
    (2) Consistency rules--(i) Consolidated groups. A section 987 
election is made or revoked by a

[[Page 78165]]

consolidated group and applies to all members of the group. Therefore, 
the same section 987 elections will be in effect for all members of a 
consolidated group at all times. If a corporation becomes a member of a 
consolidated group, it is deemed to make or revoke any section 987 
election as necessary to be consistent with the consolidated group. If 
a corporation ceases to be a member of a consolidated group and does 
not join another group, its section 987 elections are unaffected by its 
departure from the group.
    (ii) United States shareholders, CFCs, foreign partnerships, 
foreign non-grantor trusts, and foreign estates. If the authorized 
person makes or revokes an election on behalf of any person (including 
the authorized person) described in paragraphs (g)(2)(ii)(A) through 
(D) of this section (the section 987 electing group), then the election 
must be made or revoked on behalf of all members of the section 987 
electing group for the first taxable year of each entity that ends with 
or within the taxable year of the United States person described in 
paragraph (g)(2)(ii)(A) of this section in which the election or 
revocation became effective. If an entity that was not previously a 
member of the section 987 electing group becomes a member (for example, 
upon formation or acquisition), it is deemed to make or revoke any 
section 987 election as necessary to be consistent with the other 
members (without regard to the requirements of paragraph (g)(3)(ii) of 
this section). The following persons are described in this paragraph 
(g)(2)(ii):
    (A) A United States person (the relevant United States person).
    (B) Each controlled foreign corporation in which the relevant 
United States person owns (within the meaning of section 958(a)) more 
than fifty percent (by vote or value).
    (C) Each foreign partnership in which the relevant United States 
person owns (directly or indirectly) more than fifty percent of the 
capital and profits interest.
    (D) Each foreign non-grantor trust or estate in which the relevant 
United States person's beneficial interests in the trust or estate 
exceed fifty percent.
    (iii) Section 381(a) transactions. If a corporation (acquiring 
corporation) acquires the assets of another corporation in a 
transaction described in section 381(a), the acquiring corporation's 
election status applies to all section 987 QBUs owned by the acquiring 
corporation after the transaction.
    (3) Manner of making or revoking elections. The section 987 
elections must be made in accordance with this paragraph (g)(3), except 
as provided in forms and instructions or other guidance as provided by 
the Secretary.
    (i) Statement must be attached to a return. An authorized person 
that makes or revokes a section 987 election in accordance with this 
paragraph (g) must attach to its return the statement described in this 
paragraph (g)(3)(i). Each statement must include an identification of 
the election that is made or revoked; the name, address, and functional 
currency of each owner (or if the owner is a member of a consolidated 
group, the common parent of the consolidated group) for which the 
election is made or revoked; and the name, address, functional 
currency, and owner of each section 987 QBU owned by each owner.
    (A) Section 987 grouping election. The election provided in 
paragraph (b)(3)(ii) of this section is titled ``Section 987 Grouping 
Election Under Sec.  1.987-1(b)(3)(ii)'' and must provide the name, 
address, and functional currency of each section 987 QBU of each owner 
that is being grouped together.
    (B) Election to use a spot rate convention. An election under 
paragraph (c)(1)(ii) of this section to use a spot rate convention is 
titled ``Section 987 Election to Use a Spot Rate Convention Under Sec.  
1.987-1(c)(1)(ii)'' and must describe the convention.
    (C) [Reserved]
    (D) Election to use the historic inventory method. An election 
under Sec.  1.987-3(c)(2)(iv)(B) to use the historic inventory method 
is titled ``Section 987 Election to Use the Historic Inventory Method 
Under Sec.  1.987-3(c)(2)(iv)(B).''
* * * * *
    (G) Annual recognition election. An annual recognition election 
under Sec.  1.987-5(b)(2) is titled ``Section 987 Election for Annual 
Recognition Under Sec.  1.987-5(b)(2).''
    (H) Current rate election. A current rate election under paragraph 
(d)(2) of this section is titled ``Section 987 Election to Use Current 
Rates Under Sec.  1.987-1(d)(2).''
    (I) [Reserved]
    (J) Elections related to the transition rules. The elections 
provided in Sec.  1.987-10 are made by reporting the election on the 
statement described in Sec.  1.987-10(k).
    (ii) Election requirements--(A) Consent required. Except as 
provided in paragraph (g)(3)(ii)(B) or (C) of this section, a section 
987 election may not be made or revoked without the consent of the 
Commissioner. A copy of the consent must be attached to the statement 
described in paragraph (g)(3)(i) of this section. For purposes of this 
paragraph (g)(3)(ii), the Commissioner's consent may be obtained only 
with a ruling or administrative pronouncement. See Revenue Procedure 
2023-1, I.R.B. 2023-1 (or superseding guidance).
    (B) Current rate election and annual recognition election. Except 
as provided in paragraph (g)(3)(ii)(C) of this section, the authorized 
person may make a current rate election or an annual recognition 
election without the Commissioner's consent by filing the statement 
prescribed in paragraph (g)(3)(i) of this section with the Internal 
Revenue Service in accordance with the prescribed form or its 
instructions (or other guidance) on or before the first day of the 
taxable year to which the election applies, and attaching a copy of the 
statement to its return. Once made, a current rate election or annual 
recognition election may not be revoked without the Commissioner's 
consent for any taxable year beginning within 60 months of the first 
day of the taxable year for which it was made. Once revoked, a new 
current rate election or annual recognition election may not be made 
without the Commissioner's consent for any taxable year beginning 
within 60 months of the first day of the taxable year for which it was 
revoked.
    (C) First year to which the section 987 regulations apply. The 
authorized person may make a section 987 election without the consent 
of the Commissioner on its original, timely filed (including 
extensions) return for the first taxable year of the owner in which 
both--
    (1) The section 987 regulations apply (other than by applying 
solely to one or more terminating QBUs pursuant to Sec.  1.987-
14(a)(2)); and
    (2) Either the owner or any member of its consolidated group or 
section 987 electing group is the owner of a section 987 QBU.
    (iii) Elections made under the 2016 and 2019 section 987 
regulations. Each section 987 election must be made by the authorized 
person under the rules of this section without regard to whether the 
election was in effect under the 2016 and 2019 final regulations or 
under prior Sec.  1.987-8T. In the first taxable year in which the 
section 987 regulations apply, any elections made under the 2016 and 
2019 final regulations cease to be effective.
    (4) No change in method of accounting. An election under section 
987 is not governed by the general rules concerning changes in methods 
of accounting.
    (5) Principles of Sec.  1.964-1(c)(3) applicable to section 987 
elections. Except as otherwise provided in this

[[Page 78166]]

paragraph (g), if the authorized person makes or revokes a section 987 
election on behalf of a controlled foreign corporation or other foreign 
entity, the authorized person must make or revoke the section 987 
election in accordance with the rules and principles of Sec.  1.964-
1(c)(3) (determined by treating the foreign entity as a foreign 
corporation if it is not one).
    (h) Definitions. The definitions in this paragraph (h) apply for 
purposes of the section 987 regulations.
    1991 proposed regulations. The term 1991 proposed regulations means 
proposed sections 1.987-1 through 1.987-3 as contained in 56 FR 48457-
01 (September 25, 1991).
    2006 proposed regulations. The term 2006 proposed regulations 
means: proposed sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 
1.985-5; 1.987-1 through 1.987-11; 1.988-1(a)(3), (a)(4), (a)(10)(ii), 
and (i); 1.988-4(b)(2); and 1.989(a)-1(b)(2)(i), and (b)(4) as 
contained in 71 FR 52876-01 (September 7, 2006).
    2016 and 2019 section 987 regulations. The term 2016 and 2019 
section 987 regulations means the following regulations:
    (i) Sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 
1.987-1 through 1.987-10; 1.988-1(a)(4), (a)(10)(ii), and (i); 1.988-
4(b)(2); and 1.989(a)-1(b)(2)(i), (b)(4), (d)(3), and (d)(4), as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    (ii) Sections 1.987-2T(c)(9), 1.987-4T(c)(2) and (f), and 1.987-7T, 
as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
were revoked on May 13, 2019).
    (iii) Sections 1.987-2(c)(9) and 1.987-4(c)(2) and (f), as 
contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on 
May 13, 2019).
    (iv) Sections 1.987-1T (other than Sec. Sec.  1.987-1T(g)(2)(i)(B) 
and (g)(3)(i)(H)), 1.987-3T, 1.987-6T, 1.988-1T, and 1.988-2T(i), as 
contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
expired on December 6, 2019).
    Adjusted balance sheet. The term adjusted balance sheet means a tax 
basis balance sheet in the functional currency of the eligible QBU, 
determined by--
    (i) Preparing a balance sheet for the relevant date from the 
eligible QBU's books and records (within the meaning of Sec.  1.989(a)-
1(d)) recorded in the eligible QBU's functional currency and showing 
all assets and liabilities attributable to the eligible QBU as provided 
in Sec.  1.987-2(b) (the preliminary balance sheet); and
    (ii) Making adjustments necessary to conform the items reflected on 
the preliminary balance sheet to United States tax accounting 
principles.
    Annual recognition election. The term annual recognition election 
has the meaning provided in Sec.  1.987-5(b)(2).
    Authorized person. The term authorized person has the meaning 
provided in paragraph (g)(1) of this section.
    Combination. The term combination has the meaning provided in Sec.  
1.987-2(c)(9)(i).
    Combined QBU. The term combined QBU has the meaning provided in 
Sec.  1.987-2(c)(9)(i).
    Combining QBU. The term combining QBU has the meaning provided in 
Sec.  1.987-2(c)(9)(i).
    Consolidated group. The term consolidated group has the meaning 
provided in Sec.  1.1502-1(h).
    Controlled group. A controlled group means all persons with the 
relationships to each other specified in sections 267(b) or 707(b).
    Controlled foreign corporation. The term controlled foreign 
corporation (or CFC) has the meaning provided in section 957.
    Cumulative suspended section 987 loss. The term cumulative 
suspended section 987 loss has the meaning provided in Sec.  1.987-
11(b).
    Current rate election. The term current rate election has the 
meaning provided in Sec.  1.987-1(d)(2).
    Deferral event. The term deferral event has the meaning provided in 
Sec.  1.987-12(g)(1).
    Deferred section 987 gain or loss. The term deferred section 987 
gain or loss has the meaning provided in Sec.  1.987-12(b)(2).
    Disregarded entity. The term disregarded entity (or DE) means an 
entity disregarded as an entity separate from its owner for Federal 
income tax purposes, including an entity described in Sec.  301.7701-
2(c)(2), a qualified subchapter S subsidiary under section 1361(b)(3), 
a qualified REIT subsidiary within the meaning of section 856(i)(2), 
and a wholly-owned grantor trust.
    Disregarded transactions. The term disregarded transactions has the 
meaning provided in Sec.  1.987-2(c)(2)(ii).
    ECI. The term ECI means income that is effectively connected with 
the conduct of a trade or business within the United States.
    Eligible pretransition method. The term eligible pretransition 
method has the meaning provided in Sec.  1.987-10(e)(4).
    Eligible QBU. The term eligible QBU has the meaning provided in 
paragraph (b)(4) of this section.
    Historic asset. The term historic asset has the meaning provided in 
paragraph (e) of this section.
    Historic item. The term historic item has the meaning provided in 
paragraph (e) of this section.
    Historic liability. The term historic liability has the meaning 
provided in paragraph (e) of this section.
    Historic rate. The term historic rate has the meaning provided in 
paragraph (c)(3) of this section.
    Liability. The term liability means the amount of a liability on 
the adjusted balance sheet (or the amount that would be on the adjusted 
balance sheet if an adjusted balance sheet were prepared for that day).
    Loss-to-the-extent-of-gain rule. The term loss-to-the-extent-of-
gain rule has the meaning provided in Sec.  1.987-11(e)(1).
    Marked asset. The term marked asset has the meaning provided in 
paragraph (d) of this section.
    Marked item. The term marked item has the meaning provided in 
paragraph (d) of this section.
    Marked liability. The term marked liability has the meaning 
provided in paragraph (d) of this section.
    Net accumulated unrecognized section 987 gain or loss. The term net 
accumulated unrecognized section 987 gain or loss has the meaning 
provided in Sec.  1.987-4(c).
    Net unrecognized section 987 gain or loss. The term net 
unrecognized section 987 gain or loss has the meaning provided in Sec.  
1.987-4(b).
    Non-grantor trust. The term non-grantor trust means a trust (or the 
portion of a trust) that is not a grantor trust. A grantor trust is a 
trust with respect to which one or more persons are treated as owners 
of all or a portion of the trust under sections 671 through 679. If 
only a portion of a trust is treated as owned by a person, that portion 
is a grantor trust with respect to that person.
    Original deferral QBU. The term original deferral QBU has the 
meaning provided in Sec.  1.987-12(b).
    Original deferral QBU owner. The term original deferral QBU owner 
has the meaning provided in Sec.  1.987-12(g)(3).
    Original suspended loss QBU owner. The term original suspended loss 
QBU owner has the meaning provided in Sec.  1.987-13(l)(1).
    Outbound loss event. The term outbound loss event has the meaning 
provided in Sec.  1.987-13(h)(2).
    Outbound loss QBU. The term outbound loss QBU has the meaning 
provided in Sec.  1.987-13(h)(1).
    Outbound section 987 loss. The term outbound section 987 loss has 
the meaning provided in Sec.  1.987-13(h)(4).
    Owner. The term owner has the meaning provided in paragraph (b)(5) 
of this section.

[[Page 78167]]

    Prior Sec.  1.987-1. The term prior Sec.  1.987-1 means Sec.  
1.987-1, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-4. The term prior Sec.  1.987-4 means Sec.  
1.987-4, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-5. The term prior Sec.  1.987-5 means Sec.  
1.987-5, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-8T. The term prior Sec.  1.987-8T means Sec.  
1.987-8T, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-10. The term prior Sec.  1.987-10 means Sec.  
1.987-10, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-12. The term prior Sec.  1.987-12 means Sec.  
1.987-12, as contained in 26 CFR in part 1 in effect on April 1, 2020.
    Prior Sec.  1.987-12T. The term prior Sec.  1.987-12T means Sec.  
1.987-12T, as contained in 26 CFR in part 1 in effect on April 1, 2017.
    Recognition grouping. The term recognition grouping has the meaning 
provided in Sec.  1.987-11(f).
    Remittance. The term remittance has the meaning provided in Sec.  
1.987-5(c).
    S corporation. The term S corporation has the meaning provided in 
section 1361(a)(1).
    Section 904 category. The term section 904 category means a 
separate category of income described in Sec.  1.904-5(a)(4)(v).
    Section 987 aggregate partnership--(i) In general. The term section 
987 aggregate partnership means a partnership if both:
    (A) All of the interests in partnership capital and profits are 
owned, directly or indirectly, by persons related to each other within 
the meaning of sections 267(b) or 707(b). For this purpose, ownership 
of an interest in partnership capital or profits is determined in 
accordance with the rules for constructive ownership provided in 
section 267(c), other than section 267(c)(3).
    (B) The partnership has one or more eligible QBUs, at least one of 
which would be a section 987 QBU with respect to a partner if the 
partner owned the eligible QBU directly.
    (ii) Section 987 QBU of a partner. The assets and liabilities of an 
eligible QBU owned through a section 987 aggregate partnership and 
allocated to a partner under the principles of Sec.  1.987-7B are 
considered to be a section 987 QBU of such partner if the partner has a 
functional currency different from that of the eligible QBU.
    (iii) Certain unrelated partners disregarded. In determining 
whether a partnership is a section 987 aggregate partnership, the 
interest of an unrelated partner is disregarded if the acquisition of 
such interest has as a principal purpose the avoidance of treatment as 
a section 987 aggregate partnership.
    (iv) Cross-reference. See Sec.  1.987-7A(a)(2) for a rule providing 
that references to ``partnerships'' in the section 987 regulations are 
treated as references to partnerships that are not section 987 
aggregate partnerships, except where the context otherwise requires.
    Section 987 electing group. The term section 987 electing group has 
the meaning provided in paragraph (g)(2)(ii) of this section.
    Section 987 elections. The term section 987 elections has the 
meaning provided in paragraph (g) of this section.
    Section 987 QBU. The term section 987 QBU has the meaning provided 
in paragraph (b)(3) of this section.
    Section 987 regulations. The term section 987 regulations has the 
meaning provided in paragraph (a) of this section.
    Section 987 taxable income or loss. The term section 987 taxable 
income or loss has the meaning provided in Sec.  1.987-3(a).
    Separated QBU. The term separated QBU has the meaning provided in 
Sec.  1.987-2(c)(9)(iii).
    Separation. The term separation has the meaning provided in Sec.  
1.987-2(c)(9)(iii).
    Separation fraction. In the case of a separated QBU, the term 
separation fraction means a fraction, the numerator of which is the 
aggregate adjusted basis of the gross assets properly reflected on the 
books and records of the separated QBU immediately after the 
separation, and the denominator of which is the aggregate adjusted 
basis of the gross assets properly reflected on the books and records 
of all separated QBUs immediately after the separation.
    Separating QBU. The term separating QBU has the meaning provided in 
Sec.  1.987-2(c)(9)(iii).
    Spot rate. The term spot rate has the meaning provided in paragraph 
(c)(1) of this section.
    Successor deferral QBU. The term successor deferral QBU has the 
meaning provided in Sec.  1.987-12(g)(2).
    Successor deferral QBU owner. The term successor deferral QBU owner 
has the meaning provided in Sec.  1.987-12(c)(1).
    Successor suspended loss QBU. The term successor suspended loss QBU 
has the meaning provided in Sec.  1.987-13(l)(2).
    Successor suspended loss QBU owner. The term successor suspended 
loss QBU owner has the meaning provided in Sec.  1.987-13(l)(3).
    Suspended section 987 loss. The term suspended section 987 loss 
means section 987 loss that is subject to the limitations on 
recognition described in Sec.  1.987-11(e). See Sec. Sec.  1.987-
10(e)(5), 1.987-11(c) and (d), 1.987-12(c), and 1.987-13(h) for rules 
regarding when net unrecognized section 987 loss or deferred section 
987 loss becomes suspended section 987 loss.
    Tentative tested income group. The term tentative tested income 
group has the meaning provided in Sec.  1.987-6(b)(2)(i)(D)(1).
    Terminating QBU. The term terminating QBU means a section 987 QBU, 
if both--(i) The section 987 QBU terminates on any date on or after 
November 9, 2023, or the section 987 QBU terminates as a result of an 
entity classification election made under Sec.  301.7701-3 that is 
filed on or after November 9, 2023, and that is effective before 
November 9, 2023; and
    (ii) When the section 987 QBU terminates, neither the section 987 
regulations nor the 2016 and 2019 section 987 regulations would apply 
with respect to the section 987 QBU but for Sec.  1.987-14(a)(2).
    Termination. With respect to a section 987 QBU, the term 
termination has the meaning provided in Sec.  1.987-8(b) and (c). With 
respect to a successor suspended loss QBU, the term termination has the 
meaning provided in Sec.  1.987-13(j).
    Transfer. The term transfer has the meaning provided in Sec.  
1.987-2(c).
    Transition date. The term transition date has the meaning provided 
in Sec.  1.987-10(b).
    United States person. The term United States person (or U.S. 
person) has the meaning provided in section 7701(a)(30).
    United States shareholder. The term United States shareholder (or 
U.S. shareholder) has the meaning provided in section 951(b) (or, if 
applicable, section 953(c)(1)(A)).
    Yearly average exchange rate. The term yearly average exchange rate 
has the meaning provided in paragraph (c)(2) of this section.
0
7. Section 1.987-2 is revised to read as follows:


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

    (a) Scope. This section provides rules regarding when items are 
attributed to

[[Page 78168]]

eligible QBUs and when they are treated as transferred to or from 
section 987 QBUs. Paragraph (b) of this section provides rules for 
attributing assets and liabilities, and items of income, gain, 
deduction, and loss, to an eligible QBU. Paragraph (c) of this section 
defines a transfer to or from a section 987 QBU. Paragraph (d) of this 
section provides translation rules for transfers to a section 987 QBU. 
Paragraph (e) of this section provides a cross-reference relating to 
the treatment of section 987 QBUs owned by consolidated groups.
    (b) Attribution of items to an eligible QBU--(1) General rules. 
Except as provided in paragraphs (b)(2) and (3) of this section, items 
are attributable to an eligible QBU to the extent they are reflected on 
the separate set of books and records, as defined in Sec.  1.989(a)-
1(d)(1) and (2), of the eligible QBU. In the case of a section 987 
aggregate partnership, items reflected on the books and records of the 
partnership and deemed allocated to an eligible QBU of such partnership 
are considered to be reflected on the books and records of such 
eligible QBU. For purposes of this section, the term item refers to any 
asset or liability, and any item of income, gain, deduction, or loss. 
Items that are attributed to an eligible QBU pursuant to this section 
must be adjusted to conform to Federal income tax principles. Except as 
provided in Sec.  1.989(a)-1(d)(3), these attribution rules apply 
solely for purposes of section 987. For example, the allocation and 
apportionment of interest expense under section 864(e) is independent 
of these rules.
    (2) Exceptions for non-portfolio stock, interests in partnerships, 
and certain acquisition indebtedness. The following items are not 
considered to be on the books and records of an eligible QBU:
    (i) Stock of a corporation (whether domestic or foreign), other 
than stock of a corporation if the owner of the eligible QBU owns less 
than 10 percent of the total combined voting power of all classes of 
stock entitled to vote and less than 10 percent of the total value of 
all classes of stock of such corporation. For this purpose, section 958 
(other than section 958(b)(1)) applies in determining ownership of a 
controlled foreign corporation and section 318(a) applies in 
determining ownership of other corporations, except that in applying 
section 318(a)(2)(C), the phrase ``10 percent'' is used instead of the 
phrase ``50 percent.''
    (ii) An interest in a partnership (whether domestic or foreign).
    (iii) A liability that was incurred to acquire stock described in 
paragraph (b)(2)(i) of this section or that was incurred to acquire a 
partnership interest described in paragraph (b)(2)(ii) of this section.
    (iv) Income, gain, deduction, or loss arising from the items 
described in paragraphs (b)(2)(i) through (iii) of this section. For 
example, if a dividend is received with respect to stock of a 
corporation described in paragraph (b)(2)(i) of this section, the 
dividend is excluded from the income of the eligible QBU. See also 
paragraph (c)(2)(ii) of this section, treating the payment as received 
by the owner and contributed to the eligible QBU.
    (3) Adjustments to items reflected on the books and records--(i) 
General rule. If a principal purpose of recording (or not recording) an 
item on the books and records of an eligible QBU is the avoidance of 
Federal income tax under, or through the use of, section 987, the item 
must be allocated between or among the eligible QBU, the owner of such 
eligible QBU, and any other persons, entities (including DEs), or other 
QBUs within the meaning of Sec.  1.989(a)-1(b) (including eligible 
QBUs) in a manner that reflects the substance of the transaction. For 
purposes of this paragraph (b)(3)(i), relevant factors for determining 
whether such Federal income tax avoidance is a principal purpose of 
recording (or not recording) an item on the books and records of an 
eligible QBU include the factors set forth in paragraphs (b)(3)(ii) and 
(iii) of this section. The presence or absence of any factor or factors 
is not determinative. The weight given to any factor (whether or not 
set forth in paragraphs (b)(3)(ii) and (iii) of this section) depends 
on the facts and circumstances.
    (ii) Factors indicating no tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that recording (or 
not recording) an item on the books and records of an eligible QBU did 
not have as a principal purpose the avoidance of Federal income tax 
under, or through the use of, section 987 include the recording (or not 
recording) of an item:
    (A) For a significant and bona fide business purpose;
    (B) In a manner that is consistent with the economics of the 
underlying transaction;
    (C) In accordance with generally accepted accounting principles (or 
similar comprehensive accounting standard);
    (D) In a manner that is consistent with the treatment of similar 
items from year to year;
    (E) In accordance with accepted conditions or practices in the 
particular trade or business of the eligible QBU;
    (F) In a manner that is consistent with an explanation of existing 
internal accounting policies that is evidenced by documentation 
contemporaneous with the timely filing of a return for the taxable 
year; and
    (G) As a result of a transaction between legal entities (for 
example, the transfer of an asset or the assumption of a liability), 
even if such transaction is not regarded for Federal income tax 
purposes (for example, a transaction between a DE and its owner).
    (iii) Factors indicating tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that a principal 
purpose of recording (or not recording) an item on the books and 
records of an eligible QBU is the avoidance of Federal income tax 
under, or through the use of, section 987 include:
    (A) The presence or absence of an item on the books and records 
that is the result of one or more transactions that are transitory, for 
example, due to a circular flow of cash or other property;
    (B) The presence or absence of an item on the books and records 
that is the result of one or more transactions that do not have 
substance; and
    (C) The presence or absence of an item on the books and records 
that results in the taxpayer (or a person related to the taxpayer 
within the meaning of section 267(b) or section 707(b)) having 
offsetting positions with respect to the functional currency of a 
section 987 QBU.
    (4) Assets and liabilities of a section 987 aggregate partnership 
or DE that are not attributed to an eligible QBU. Neither a section 987 
aggregate partnership nor a DE is an eligible QBU and, thus, neither 
entity can be a section 987 QBU. See Sec.  1.987-1(b)(4). As a result, 
a section 987 aggregate partnership or DE may have assets and 
liabilities that are not attributed to an eligible QBU as provided 
under this paragraph (b) and, therefore, are not subject to section 
987. For the foreign currency treatment of such assets or liabilities, 
see Sec.  1.988-1(a)(4).
    (5) Special types of basis. Any type of basis that does not affect 
the income or loss of the section 987 QBU is not considered to be on 
the books and records of the section 987 QBU. Thus, for example, 
section 743(b) basis is not considered to be on the books and records 
of the section 987 QBU.
    (c) Transfers to and from section 987 QBUs--(1) In general. The 
following rules apply for purposes of determining whether there is a 
transfer of an asset or a liability from an owner to a section 987 QBU, 
or from a section 987 QBU to

[[Page 78169]]

an owner. These rules apply solely for purposes of section 987.
    (2) Disregarded transactions--(i) General rule. An asset or 
liability is treated as transferred to a section 987 QBU from its owner 
if, as a result of a disregarded transaction, such asset or liability 
is reflected on the books and records of (or attributed to) the section 
987 QBU within the meaning of paragraph (b) of this section. Similarly, 
an asset or liability is treated as transferred from a section 987 QBU 
to its owner if, as a result of a disregarded transaction, such asset 
or liability is no longer reflected on the books and records of (or 
attributed to) the section 987 QBU within the meaning of paragraph (b) 
of this section.
    (ii) Definition of a disregarded transaction. For purposes of this 
section, a disregarded transaction means a transaction that is not 
regarded for Federal income tax purposes (for example, any transaction 
between separate section 987 QBUs of the same owner). For purposes of 
this paragraph (c), a disregarded transaction is treated as including 
events described in paragraphs (c)(2)(ii)(A) through (E) of this 
section.
    (A) If the recording (or not recording) of an asset or liability on 
the books and records of a section 987 QBU of an owner is the result of 
such asset or liability being removed from (or included on) the books 
and records of the owner or another eligible QBU of the owner, the 
asset or liability is treated as transferred from (or to) the owner or 
other eligible QBU to (or from) the section 987 QBU in a disregarded 
transaction (including through a DE or a section 987 aggregate 
partnership).
    (B) If an asset or liability that was previously treated as being 
on the books and records of a section 987 QBU of an owner begins to be 
treated as being on the books and records of the owner or a separate 
eligible QBU of the owner as a result of the application of paragraph 
(b)(2) or (3) of this section, the asset or liability is treated as 
having been transferred from the section 987 QBU to the owner or 
separate eligible QBU in a disregarded transaction. If an asset or 
liability that was previously treated as being on the books and records 
of the owner or a separate eligible QBU of the same owner begins to be 
treated as being on the books and records of the section 987 QBU as a 
result of the application of paragraph (b)(2) or (3) of this section, 
the asset or liability is treated as transferred from the owner or 
separate eligible QBU to the section 987 QBU in a disregarded 
transaction.
    (C) If an asset or liability that is attributable to a section 987 
QBU within the meaning of paragraph (b) of this section is sold or 
exchanged (including in a nonrecognition transaction, such as an 
exchange under section 351) for an asset or liability that is not 
attributable to the section 987 QBU immediately after the sale or 
exchange, the sold or exchanged asset or liability that was 
attributable to the section 987 QBU immediately before the transaction 
is treated as transferred from the section 987 QBU to its owner in a 
disregarded transaction immediately before the sale or exchange for 
purposes of section 987 (including for purposes of recognizing section 
987 gain or loss under Sec.  1.987-5) and subsequently sold or 
exchanged by the owner.
    (D) If an asset or liability of an owner of a section 987 QBU that 
is not attributable to a section 987 QBU within the meaning of 
paragraph (b) of this section is sold or exchanged (including in a 
nonrecognition transaction, such as an exchange under section 351) for 
an asset or liability that is attributable to the section 987 QBU 
immediately after the sale or exchange, the asset or liability that is 
attributable to the section 987 QBU immediately after the transaction 
is treated as received or assumed by the owner and transferred from the 
owner to the section 987 QBU in a disregarded transaction immediately 
after the sale or exchange for purposes of section 987 (including for 
purposes of recognizing section 987 gain or loss under Sec.  1.987-5).
    (E) If an asset or liability that is properly attributable to a 
section 987 QBU was received, assumed, or accrued in a regarded 
transaction (including the making or receiving of a payment) in which 
the related item of income, gain, deduction, or loss is not 
attributable to the section 987 QBU, the asset or liability is treated 
as though it was received, assumed, or accrued by the owner or another 
eligible QBU and transferred to the section 987 QBU in a disregarded 
transaction. Similarly, if an asset or liability that is not properly 
attributable to a section 987 QBU was received, assumed, or accrued in 
a regarded transaction (including the making or receiving of a payment) 
in which the related item of income, gain, deduction, or loss is 
attributable to the section 987 QBU, the asset or liability is treated 
as though it was received, assumed, or accrued by the section 987 QBU 
and transferred to the owner or another eligible QBU in a disregarded 
transaction. For example, if a section 987 QBU receives a dividend on 
an interest in stock that would be attributable to the section 987 QBU 
but for paragraph (b)(2)(i) of this section, or pays interest on a 
liability that would be attributable to the section 987 QBU but for 
paragraph (b)(2)(iii) of this section, the owner would be treated as 
receiving the dividend and transferring to the section 987 QBU the 
amount of the dividend, or the section 987 QBU would be treated as 
transferring to the owner the amount of the interest expense and the 
owner would be treated as paying the interest expense. See also 
paragraph (c)(7) of this section (application of general tax law 
principles).
    (iii) Items derived from disregarded transactions ignored. For 
purposes of section 987, disregarded transactions do not give rise to 
items of income, gain, deduction, or loss that are taken into account 
in determining section 987 taxable income or loss under Sec.  1.987-3.
    (3) Transfers of assets to and from section 987 QBUs owned through 
section 987 aggregate partnerships--(i) Contributions to section 987 
aggregate partnerships. Solely for purposes of section 987, an asset is 
treated as transferred by an indirect owner to a section 987 QBU of a 
partner to the extent the indirect owner contributes the asset to the 
section 987 aggregate partnership that carries on the activities of the 
section 987 QBU, provided that, immediately before the contribution, 
the asset is not reflected on the books and records of the section 987 
QBU within the meaning of paragraph (b) of this section and the asset 
is reflected on the books and records of the section 987 QBU 
immediately after the contribution. For purposes of this paragraph 
(c)(3)(i), deemed contributions of money described under section 752 
are disregarded. See paragraph (c)(4)(ii) of this section for rules 
governing the assumption by a partner of liabilities of a section 987 
aggregate partnership.
    (ii) Distributions from section 987 aggregate partnerships. Solely 
for purposes of section 987, an asset is treated as transferred from a 
section 987 QBU of a partner to its indirect owner to the extent the 
section 987 aggregate partnership that carries on the activities of the 
section 987 QBU distributes the asset to the indirect owner, provided 
that, immediately before the distribution, the asset is reflected on 
the books and records of the section 987 QBU within the meaning of 
paragraph (b) of this section, and the asset is not reflected on the 
books and records of the section 987 QBU immediately after the 
distribution. For purposes of this paragraph (c)(3)(ii), deemed 
distributions of money described under section 752 are disregarded. See 
paragraph (c)(4)(i) of this section for rules governing the assumption 
by a section 987 aggregate partnership of liabilities of a partner.

[[Page 78170]]

    (4) Transfers of liabilities to and from section 987 QBUs owned 
through section 987 aggregate partnerships--(i) Assumptions of partner 
liabilities. Solely for purposes of section 987, a liability of the 
owner of a section 987 aggregate partnership is treated as transferred 
to a section 987 QBU of a partner if, and to the extent, the section 
987 aggregate partnership assumes the liability, provided that, 
immediately before the transfer, the liability is not reflected on the 
books and records of the section 987 QBU within the meaning of 
paragraph (b) of this section, and the liability is reflected on the 
books and records of the section 987 QBU immediately after the 
transfer.
    (ii) Assumptions of section 987 aggregate partnership liabilities. 
Solely for purposes of section 987, a liability of a section 987 
aggregate partnership is treated as transferred from a section 987 QBU 
of a partner to its indirect owner if, and to the extent, the indirect 
owner assumes the liability of the section 987 aggregate partnership, 
provided that, immediately before the assumption, the liability is 
reflected on the books and records of the section 987 QBU within the 
meaning of paragraph (b) of this section, and the liability is not 
reflected on the books and records of the section 987 QBU immediately 
after the transfer.
    (5) Acquisitions and dispositions of interests in DEs and section 
987 aggregate partnerships. Solely for purposes of section 987, an 
asset or liability is treated as transferred to a section 987 QBU from 
its owner if, as a result of an acquisition (including by contribution) 
or disposition of an interest in a section 987 aggregate partnership or 
DE, the asset or liability is reflected on the books and records of the 
section 987 QBU. Similarly, an asset or liability is treated as 
transferred from a section 987 QBU to its owner if, as a result of an 
acquisition or disposition of an interest in a section 987 aggregate 
partnership or DE, the asset or liability is not reflected on the books 
and records of the section 987 QBU. See paragraph (c)(10)(xviii) of 
this section (Example 18) for an illustration of this rule.
    (6) Changes in form of ownership treated as terminations. See 
Sec. Sec.  1.987-8(b)(6) (treating a change in the form of ownership of 
an eligible QBU from direct ownership to indirect ownership or from 
indirect ownership to direct ownership as a termination) and 1.987-
12(g)(1)(i)(A) (subjecting the termination to the deferral rules).
    (7) Application of general tax law principles. General tax law 
principles, including the circular cash flow, step-transaction, 
economic substance, and substance-over-form doctrines, apply for 
purposes of determining whether there is a transfer of an asset or 
liability under this paragraph (c), including a transfer of an asset or 
liability pursuant to a disregarded transaction.
    (8) Interaction with Sec.  1.988-1(a)(10). See Sec.  1.988-1(a)(10) 
for rules regarding the treatment of an intra-taxpayer transfer of a 
section 988 transaction.
    (9) Certain disregarded transactions not treated as transfers--(i) 
Combinations of section 987 QBUs. The combination (a combination) of 
two or more separate section 987 QBUs (combining QBUs) that are 
directly owned by the same owner, or that are indirectly owned by the 
same partner through a single section 987 aggregate partnership, into 
one section 987 QBU (combined QBU) does not give rise to a transfer of 
any combining QBU's assets or liabilities to the owner under Sec.  
1.987-2(c). In addition, transactions between the combining QBUs 
occurring in the taxable year of the combination do not result in a 
transfer of the combining QBUs' assets or liabilities to the owner 
under Sec.  1.987-2(c). For this purpose, a combination occurs when the 
assets and liabilities that are properly reflected on the books and 
records of two or more combining QBUs begin to be properly reflected on 
the books and records of a combined QBU and the separate existence of 
the combining QBUs ceases. A combination may result from any 
transaction or series of transactions in which the combining QBUs 
become a combined QBU. A combination may also result when an owner of 
two or more section 987 QBUs with the same functional currency becomes 
subject to a grouping election under Sec.  1.987-1(b)(3)(ii) or when a 
section 987 QBU of an owner subject to a grouping election changes its 
functional currency to that of another section 987 QBU of the same 
owner. For purposes of determining net unrecognized section 987 gain or 
loss, deferred section 987 gain or loss, and cumulative suspended 
section 987 loss of a combined QBU, the combining QBUs are treated as 
having combined immediately before the beginning of the taxable year of 
combination. See Sec. Sec.  1.987-4(f)(1), 1.987-11(b)(2), and 1.987-
12(f)(1).
    (ii) Change in functional currency from a combination. If, 
following a combination of section 987 QBUs described in paragraph 
(c)(9)(i) of this section, the combined section 987 QBU has a different 
functional currency than one or more of the combining section 987 QBUs, 
any such combining section 987 QBU is treated as changing its 
functional currency and the owner of the combined section 987 QBU must 
comply with the regulations under section 985 regarding the change in 
functional currency. See Sec. Sec.  1.985-1(c)(6) and 1.985-5.
    (iii) Separation of section 987 QBUs. The separation (a separation) 
of a section 987 QBU (separating QBU) into two or more section 987 QBUs 
(separated QBUs) that, after the separation, are directly owned by the 
same owner, or that are indirectly owned by the same partner through a 
single section 987 aggregate partnership, does not result in a transfer 
of the separating QBU's assets or liabilities to the owner under Sec.  
1.987-2(c). Additionally, transactions that occurred between the 
separating QBUs in the taxable year of the separation before the 
completion of the separation do not result in transfers for purposes of 
section 987. For this purpose, a separation occurs when the assets and 
liabilities that are properly reflected on the books and records of a 
separating QBU begin to be properly reflected on the books and records 
of two or more separated QBUs and each of the separated QBUs continues 
to perform a significant portion of the separating QBU's activities 
immediately after the separation. A separation may result from any 
transaction or series of transactions in which a separating QBU becomes 
two or more separated QBUs described in the preceding sentence. A 
separation may also result when a section 987 QBU that is subject to a 
grouping election under Sec.  1.987-1(b)(3)(ii) changes its functional 
currency or when the grouping election is revoked. For purposes of 
determining net unrecognized section 987 gain or loss, deferred section 
987 gain or loss, or cumulative suspended section 987 loss of a 
separated QBU, the separating QBU is treated as having separated 
immediately before the beginning of the taxable year of separation. See 
Sec. Sec.  1.987-4(f)(2), 1.987-11(b)(3), and 1.987-12(f)(2).
    (iv) Special rules for successor suspended loss QBUs. For purposes 
of determining whether a combination or separation has occurred with 
respect to a successor suspended loss QBU, the rules of paragraphs 
(c)(9)(i) and (iii) of this section are applied without regard to 
whether any of the combining QBUs, the combined QBU, the separating 
QBU, or the separated QBUs are section 987 QBUs. A combined QBU is a 
successor suspended loss QBU if either combining QBU was a successor 
suspended loss QBU, and a separated QBU is a successor suspended loss 
QBU if the separating QBU was a successor suspended loss QBU.
    (10) Examples. The following examples illustrate the principles of 
this

[[Page 78171]]

paragraph (c). For purposes of the examples, X and Y are domestic 
corporations, have the U.S. dollar as their functional currencies, and 
use the calendar year as their taxable years. Furthermore, except as 
otherwise provided, Business A and Business B are eligible QBUs that 
have the euro and the Japanese yen, respectively, as their functional 
currencies, and DE1 and DE2 are DEs. For purposes of determining 
whether any of the transfers in these examples result in remittances, 
see Sec.  1.987-5.
    (i) Example 1. Transfer to a directly owned section 987 QBU--(A) 
Facts. X owns all of the interests in DE1. DE1 owns Business A, which 
is a section 987 QBU of X. X owns [euro]100 that are not reflected on 
the books and records of Business A. Business A is in need of 
additional capital and, as a result, X lends the [euro]100 to DE1 for 
use in Business A in exchange for a note.
    (B) Analysis--(1) The loan from X to DE1 is not regarded for 
Federal income tax purposes (because it is an interbranch transaction) 
and therefore is a disregarded transaction (as defined in paragraph 
(c)(2)(ii) of this section). Because DE1 is a DE, the DE1 note held by 
X and the liability of DE1 under the note are not taken into account 
under this section.
    (2) As a result of the disregarded transaction, the [euro]100 is 
reflected on the books and records of Business A. Therefore, X is 
treated as transferring [euro]100 to its Business A section 987 QBU for 
purposes of section 987. This transfer is taken into account in 
determining the amount of any remittance for the taxable year under 
Sec.  1.987-5(c). See Sec.  1.988-1(a)(10)(ii) for the application of 
section 988 to X as a result of the transfer of nonfunctional currency 
to its section 987 QBU.
    (ii) Example 2. Transfer to a directly owned section 987 QBU--(A) 
Facts. X owns Business A and Business B, both of which are section 987 
QBUs of X. X owns equipment that is used in Business A and is reflected 
on the books and records of Business A. Because Business A has excess 
manufacturing capacity and X intends to expand the manufacturing 
capacity of Business B, the equipment formerly used in Business A is 
transferred to Business B for use by Business B. As a result of the 
transfer, the equipment is removed from the books and records of 
Business A and is recorded on the books and records of Business B.
    (B) Analysis. The transfer of the equipment from the books and 
records of Business A to the books and records of Business B is not 
regarded for Federal income tax purposes (because it is an interbranch 
transaction) and therefore is a disregarded transaction (as defined in 
paragraph (c)(2)(ii) of this section). Therefore, for purposes of 
section 987, the Business A section 987 QBU is treated as transferring 
the equipment to X, and X is subsequently treated as transferring the 
equipment to the Business B section 987 QBU. These transfers are taken 
into account in determining the amount of any remittance for the 
taxable year under Sec.  1.987-5(c).
    (iii) Example 3. Intracompany sale of property between two section 
987 QBUs-- (A) Facts. X owns all of the interests in DE1 and DE2. DE1 
and DE2 own Business A and Business B, respectively, both of which are 
section 987 QBUs of X. DE1 owns equipment that is used in Business A 
and is reflected on the books and records of Business A. For business 
reasons, DE1 sells a portion of the equipment used in Business A to DE2 
in exchange for a fair market value amount of Japanese yen. The yen 
used by DE2 to acquire the equipment was generated by Business B and 
was reflected on Business B's books and records. Following the sale, 
the yen and the equipment will be used in Business A and Business B, 
respectively. As a result of such sale, the equipment is removed from 
the books and records of Business A and is recorded on the books and 
records of Business B. Similarly, as a result of the sale, the yen is 
removed from the books and records of Business B and is recorded on the 
books and records of Business A.
    (B) Analysis--(1) The sale of equipment between DE1 and DE2 is a 
transaction that is not regarded for Federal income tax purposes 
(because it is an interbranch transaction) and therefore the 
transaction is a disregarded transaction (as defined in paragraph 
(c)(2)(ii) of this section). Pursuant to paragraph (c)(2)(iii) of this 
section, the sale does not give rise to an item of income, gain, 
deduction, or loss for purposes of determining section 987 taxable 
income or loss under Sec.  1.987-3. However, the yen and equipment 
exchanged by DE1 and DE2 in connection with the sale must be taken into 
account as a transfer under paragraph (c)(2)(i) of this section.
    (2) As a result of the disregarded transaction, the equipment 
ceases to be reflected on the books and records of Business A and 
becomes reflected on the books and records of Business B. Therefore, 
the Business A section 987 QBU is treated as transferring the equipment 
to X, and X is subsequently treated as transferring the equipment to 
the Business B section 987 QBU.
    (3) Additionally, as a result of the disregarded transaction, the 
yen currency ceases to be reflected on the books and records of 
Business B and becomes reflected on the books and records of Business 
A. Therefore, the Business B section 987 QBU is treated as transferring 
the yen to X, and X is subsequently treated as transferring the yen 
from X to the Business A section 987 QBU. The transfers among Business 
A, Business B and X are taken into account in determining the amount of 
any remittance for the taxable year under Sec.  1.987-5(c).
    (iv) through (ix) [Reserved]
    (x) Example 10. Contribution of assets to a corporation--(A) Facts. 
X owns Business A. X forms Z, a domestic corporation, contributing 50 
percent of its Business A assets and liabilities to Z in exchange for 
all of the stock of Z. X and Z do not file a consolidated tax return.
    (B) Analysis. Pursuant to paragraph (b)(2) of this section, the Z 
stock received in exchange for 50 percent of Business A's assets and 
liabilities is not reflected on the books and records of, and therefore 
is not attributable to, Business A for purposes of section 987 
immediately after the exchange. As a result, pursuant to paragraphs 
(c)(2)(i) and (ii) of this section, 50 percent of the assets and 
liabilities of Business A are treated as transferred from Business A to 
X in a disregarded transaction immediately before the exchange. See 
Sec.  1.1502-13(j)(9) if X and Z file a consolidated return.
    (xi) Example 11. Circular transfers--(A) Facts. X owns Business A. 
On December 30, year 1, Business A purports to transfer [euro]100 to X. 
On January 2, year 2, X purports to transfer [euro]50 to Business A. On 
January 4, year 2, X purports to transfer another [euro]50 to Business 
A. As of the end of year 1, X has an unrecognized section 987 loss with 
respect to Business A, such that a remittance, if respected, would 
result in recognition of a foreign currency loss under section 987.
    (B) Analysis. Because the transfer by Business A to X is offset by 
the transfers from X to Business A that occurred in close temporal 
proximity, the Internal Revenue Service may disregard the purported 
transfers to and from Business A for purposes of section 987 pursuant 
to general tax principles under paragraph (c)(7) of this section.
    (xii) Example 12. Transfers without substance--(A) Facts. X owns 
Business A and Business B. On January 1, year 1, Business A purports to 
transfer [euro]100 to X. On January 4, year 1, X purports to transfer 
[euro]100 to Business B. The account in which Business B deposited

[[Page 78172]]

the [euro]100 is used to pay the operating expenses and other costs of 
Business A. As of the end of year 1, X has an unrecognized section 987 
loss with respect to Business A, such that a remittance, if respected, 
would result in recognition of a foreign currency loss under section 
987.
    (B) Analysis. Because Business A continues to have use of the 
transferred property, the IRS may disregard the [euro]100 purported 
transfer from Business A to X for purposes of section 987 pursuant to 
general tax principles under paragraph (c)(7) of this section.
    (xiii) Example 13. Offsetting positions in section 987 QBUs--(A) 
Facts. X owns Business A and Business B. Business A and Business B each 
have the euro as its functional currency. X has not made a grouping 
election under Sec.  1.987-1(b)(3)(ii). On January 1, year 1, X borrows 
[euro]1,000 from a third-party lender, records the liability with 
respect to the borrowing on the books and records of Business A, and 
records the borrowed [euro]1,000 on the books and records of Business 
B. On December 31, year 2, when Business A has $100 of net unrecognized 
section 987 loss and Business B has $100 of net unrecognized section 
987 gain resulting from the change in exchange rates with respect to 
the liability and the [euro]1,000, X terminates the Business A section 
987 QBU.
    (B) Analysis. Because Business A and Business B have offsetting 
positions in the euro, the IRS will scrutinize the transaction under 
paragraph (b)(3) of this section to determine if a principal purpose of 
recording the euro-denominated liability on the books and records of 
Business A and the borrowed euros on the books and records of Business 
B was the avoidance of tax under section 987. If such a principal 
purpose is present, the items must be reallocated (that is, the euros 
and the euro-denominated liability) between Business A, Business B, and 
X, under paragraph (b)(3) of this section to reflect the substance of 
the transaction.
    (xiv) Example 14. Offsetting positions with respect to a section 
987 QBU and a section 988 transaction--(A) Facts. X owns all of the 
interests in DE1, and DE1 owns Business A. On January 1, year 1, X 
borrows [euro]1,000 from a third-party lender and records the liability 
with respect to the borrowing on its books and records. X contributes 
the [euro]1,000 loan proceeds to DE1 and the [euro]1,000 are reflected 
on the books and records of Business A. On December 31, year 2, when 
Business A has $100 of net unrecognized section 987 loss resulting from 
the change in exchange rates with respect to the [euro]1,000 received 
from the borrowing, and when the euro-denominated borrowing, if repaid, 
would result in $100 of gain under section 988, X terminates the 
Business A section 987 QBU.
    (B) Analysis. Because X and Business A have offsetting positions in 
the euro, the IRS will scrutinize the transaction under paragraph 
(b)(3) of this section to determine whether a principal purpose of 
recording the borrowed euros on the books and records of Business A, or 
not recording the corresponding euro-denominated liability on the books 
and records of Business A, was the avoidance of tax under section 987. 
If such a principal purpose is present, the items (that is, the euros 
and the euro-denominated liability) must be reallocated between 
Business A and X under paragraph (b)(3) of this section to reflect the 
substance of the transaction.
    (xv) Example 15. Offsetting positions with respect to a section 987 
QBU and a section 988 transaction--(A) Facts. X owns all of the stock 
of Y and all of the interests in DE1. DE1 owns Business A. X and Y do 
not file a consolidated return. On January 1, year 1, DE1 lends 
[euro]1,000 to Y. X records the receivable with respect to the loan on 
Business A's books and records. On December 31, year 2, when Business A 
has $100 of net unrecognized section 987 gain resulting from the loan, 
Y repays the [euro]1,000 liability. The repayment of the euro-
denominated borrowing results in $100 of loss to Y under section 988. X 
claims a $100 loss on its consolidated return under section 988. 
Business A does not make any remittances to X in year 2, so the 
offsetting gain with respect to the loan receivable has not been 
recognized by X.
    (B) Analysis. Y, a related party to X, and Business A have 
offsetting positions in the euro. The IRS will scrutinize the 
transaction under paragraph (b)(3) of this section to determine whether 
a principal purpose of recording the euro-denominated receivable on the 
books and records of Business A, rather than on the books and records 
of X, was to avoid Federal income tax under, or through the use of, 
section 987. If such a principal purpose is present, the euro-
denominated receivable must be reallocated between Business A and X 
under paragraph (b)(3) of this section to reflect the substance of the 
transaction. Other provisions may also apply to defer or disallow the 
loss. See e.g., Sec.  1.1502-13(j)(9) if X and Y file a consolidated 
return.
    (xvi) Example 16. Loan by section 987 QBU followed by immediate 
distribution to owner--(A) Facts. X owns all of the interests in DE1. 
DE1 owns Business A. On January 1, year 1, Business A borrows 
[euro]1,000 from a bank. On January 2, year 1, Business A distributes 
the [euro]1,000 it received from the bank to X. There are no other 
transfers between X and Business A during the year. At the end of the 
year, X has net unrecognized section 987 loss with respect to Business 
A such that a remittance would result in the recognition of foreign 
currency loss under section 987.
    (B) Analysis. Because the proceeds from the loan to Business A are 
immediately transferred to X and the distribution from Business A to X 
could result in the recognition of section 987 loss, the IRS will 
scrutinize the transaction under paragraph (b)(3) of this section to 
determine whether a principal purpose of recording of the loan on the 
books and records of Business A, rather than on the books and records 
of X, was to avoid Federal income tax under, or through the use of, 
section 987. If such a principal purpose is present, the items must be 
reallocated to reflect the substance of the transaction, potentially 
including by moving the loan onto the books of X, resulting in the 
transfer not being taken into account for purposes of section 987 under 
paragraph (b)(3) of this section.
    (xvii) Example 17. Payment of interest by section 987 QBU on 
obligation of owner--(A) Facts. X owns all of the interests in DE1. DE1 
owns Business A. On January 1, X borrows [euro]1,000 from a bank. On 
July 1, DE1 pays [euro]20 in interest on X's [euro]1,000 obligation to 
the bank, which is treated as a payment by Business A.
    (B) Analysis. Under general tax law principles as provided in 
paragraph (c)(7) of this section, on July 1, year 1, Business A is 
treated for purposes of section 987 as making a transfer of [euro]20 to 
X, and X is treated as making a [euro]20 interest payment to the bank. 
See also paragraph (c)(2)(ii)(E) for interest payments on loans that 
are not attributable to a section 987 QBU pursuant to paragraph (b)(2) 
or (3) of this section.
    (xviii) Example 18. Sale of the interests in a DE--(A) Facts. X 
owns all of the interests in DE1, a disregarded entity. DE1 owns 
Business A, which is a section 987 QBU of X. X has made a current rate 
election under Sec.  1.987-1(d)(2) but not an annual recognition 
election under Sec.  1.987-5(b)(2). On December 31, year 1, X sells all 
of the interests in DE1 to FC, an unrelated foreign corporation, for 
$150,000, when the exchange rate is [euro]1=$1.2. At the time of the 
sale, all of DE1's assets are used in Business A and are reflected on 
the books and records of Business A. The assets have a basis of 
[euro]100,000 and Business A has no liabilities. In year 1,

[[Page 78173]]

X has net unrecognized section 987 gain with respect to Business A of 
$20,000.
    (B) Analysis--(1) Under paragraph (c)(5) of this section, solely 
for purposes of section 987, an asset or liability is treated as 
transferred from a section 987 QBU to its owner if, as a result of a 
disposition of an interest in a DE, the asset or liability is not 
reflected on the books and records of the section 987 QBU. As a result 
of the sale of DE1, the assets of Business A are no longer reflected on 
the books and records of the Business A section 987 QBU. Therefore, the 
assets of Business A are treated as transferred from the Business A 
section 987 QBU to X in connection with the sale of X's interests in 
DE1.
    (2) The transfer of all of Business A's assets to X under paragraph 
(c)(5) of this section results in a termination of the Business A 
section 987 QBU under Sec.  1.987-8(b)(2) (substantially all assets 
transferred). Under Sec.  1.987-5(c)(3) and Sec.  1.987-8(e), a 
termination of a section 987 QBU is treated as a remittance of all the 
gross assets of the section 987 QBU to the owner on the date of the 
termination. Therefore, the owner's remittance proportion is one, and X 
recognizes all of its net unrecognized section 987 gain with respect to 
Business A, or $20,000.
    (3) Because a current rate election was in effect, all of the 
assets of Business A are marked items. Therefore, under Sec.  1.987-
5(f)(2), X's basis in the assets transferred from Business A is 
determined by translating Business A's functional currency basis in the 
assets into X's functional currency at the spot rate applicable to the 
date of the transfer, [euro]1=$1.2. Consequently, immediately before 
the sale of the interests in DE1, X's functional currency basis in 
Business A's assets (which Business A held with a basis of 
[euro]100,000) is $120,000. X recognizes $30,000 of gain under section 
1001(a) on the sale of DE1.
    (d) Translation of items transferred to a section 987 QBU--(1) 
Marked items. The adjusted basis of a marked asset, or the amount of a 
marked liability, transferred to a section 987 QBU is translated into 
the section 987 QBU's functional currency at the spot rate applicable 
to the date of transfer. If, and to the extent that, exchange gain or 
loss is recognized on the asset or liability transferred under Sec.  
1.988-1(a)(10)(ii), the adjusted basis of the marked asset, or the 
amount of the marked liability, is adjusted to take into account the 
exchange gain or loss recognized.
    (2) Historic items. The adjusted basis of a historic asset, or the 
amount of a historic liability, transferred to a section 987 QBU is 
translated into the section 987 QBU's functional currency at the rate 
provided in Sec.  1.987-1(c)(3). If, and to the extent that, exchange 
gain or loss is recognized on the asset or liability transferred under 
Sec.  1.988-1(a)(10)(ii), the adjusted basis of the historic asset, or 
the amount of the historic liability, is adjusted to take into account 
the exchange gain or loss recognized.
    (e) Cross-reference. See also Sec.  1.1502-13(j)(9) regarding the 
treatment of intercompany transactions involving section 987 QBUs owned 
by a member of a consolidated group.
0
8. Section 1.987-3, as proposed to be amended by 81 FR 88882 (December 
8, 2016), is further amended by:
0
a. Revising paragraphs (a), (b)(1), (b)(2)(i), (b)(3) and (c)(1);
0
b. Adding paragraph (c)(2) introductory text.
0
c. Revising paragraphs (c)(2)(i), (c)(2)(iii) and (iv), (c)(3), (d) and 
(e).
    The revisions and addition read as follows:


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

    (a) In general. This section provides rules for determining the 
taxable income or loss of an owner of a section 987 QBU (section 987 
taxable income or loss). Paragraph (b) of this section provides rules 
for determining items of income, gain, deduction, and loss, which 
generally are determined in the section 987 QBU's functional currency. 
Paragraph (c) of this section provides rules for translating each item 
determined under paragraph (b) of this section into the functional 
currency of the owner of the section 987 QBU, if necessary. Paragraph 
(d) of this section is reserved. Paragraph (e) of this section provides 
examples illustrating the application of the rules of this section.
    (b) * * *
    (1) In general. Except as otherwise provided in this paragraph (b), 
a section 987 QBU must determine each item of income, gain, deduction, 
or loss of such section 987 QBU in its functional currency under 
Federal income tax principles.
    (2) * * *
    (i) In general. Except as otherwise provided in paragraphs 
(b)(2)(ii) and (b)(4) of this section, an item of income, gain, 
deduction, or loss (or the item's components and related items, such as 
gross receipts and amount realized) that is denominated in (or 
determined by reference to) a nonfunctional currency (including the 
functional currency of the owner) is translated into the section 987 
QBU's functional currency at the spot rate on the date such item is 
properly taken into account, subject to the limitation under Sec.  
1.987-1(c)(1)(ii)(B) regarding the use of a spot rate convention. 
Paragraphs (e)(1) and (2) of this section (Examples 1 and 2) illustrate 
the application of this paragraph (b)(2)(i).
* * * * *
    (3) Determination in the case of a section 987 QBU owned through a 
section 987 aggregate partnership--(i) In general. Except as otherwise 
provided in this paragraph (b)(3), the taxable income or loss of a 
section 987 aggregate partnership, and the distributive share of any 
owner that is a partner in such partnership, are determined in 
accordance with the provisions of subchapter K of the Internal Revenue 
Code.
    (ii) Determination of each item of income, gain, deduction, or loss 
in the eligible QBU's functional currency. A section 987 aggregate 
partnership generally must determine each item of income, gain, 
deduction, or loss reflected on the books and records of each of its 
eligible QBUs under Sec.  1.987-2(b) in the functional currency of each 
such QBU.
    (iii) Allocation of items of income, gain, deduction, or loss of an 
eligible QBU. A section 987 aggregate partnership must allocate the 
items of income, gain, deduction, or loss of each eligible QBU among 
its partners in accordance with each partner's distributive share of 
such income, gain, deduction, or loss as determined under subchapter K 
of the Internal Revenue Code.
    (iv) Translation of items into the owner's functional currency. To 
the extent the items referred to in paragraph (b)(3)(iii) of this 
section are allocated to a partner, the partner must adjust the items 
to conform to Federal income tax principles and translate the items 
into the partner's functional currency, if necessary, as provided in 
paragraph (c) of this section.
* * * * *
    (c) * * *
    (1) In general. Except as otherwise provided in this section, the 
exchange rate to be used by an owner in translating an item of income, 
gain, deduction, or loss attributable to a section 987 QBU (or the 
item's components and related items, such as gross receipts, amount 
realized, basis, and cost of goods sold) into the owner's functional 
currency, if necessary, is the yearly average exchange rate for the 
taxable year.
    (2) Exceptions. This paragraph (c)(2) applies to taxable years for 
which neither the annual recognition election nor the current rate 
election is in effect.

[[Page 78174]]

    (i) Recovery of basis with respect to historic assets. Except as 
otherwise provided in this paragraph (c)(2), the exchange rate to be 
used by the owner in translating any recovery of basis (whether through 
a sale or exchange; deemed sale or exchange; cost recovery deduction 
such as depreciation, depletion or amortization; or otherwise) with 
respect to a historic asset is the historic rate for the property to 
which such recovery of basis is attributable.
* * * * *
    (iii) [Reserved]
    (iv) Cost of goods sold computation--(A) General rule--simplified 
inventory method. Except as otherwise provided in paragraph 
(c)(2)(iv)(B) of this section, cost of goods sold (COGS) for a taxable 
year is translated into the functional currency of the owner at the 
yearly average exchange rate for the taxable year in which the sale 
occurred (or the COGS was otherwise taken into account in computing 
taxable income) and adjusted as provided in paragraph (c)(3) of this 
section.
    (B) Election to use the historic inventory method. In lieu of using 
the simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section, the owner of a section 987 QBU may elect under this 
paragraph (c)(2)(iv)(B) to translate inventoriable costs (including 
current-year inventoriable costs and costs that were capitalized into 
inventory in prior years) that are included in COGS at the historic 
rate for each such cost.
* * * * *
    (3) Adjustments to COGS required under the simplified inventory 
method. This paragraph (c)(3) applies to taxable years for which 
neither the annual recognition election nor the current rate election 
is in effect.
    (i) In general. An owner of a section 987 QBU that uses the 
simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section must make the adjustment described in paragraph (c)(3)(ii) 
of this section. In addition, the owner must make the adjustment 
described in paragraph (c)(3)(iii) of this section with respect to any 
inventory for which the section 987 QBU does not use the LIFO inventory 
method (as described in section 472) and must make the adjustment 
described in paragraph (c)(3)(iv) of this section with respect to any 
inventory for which the section 987 QBU uses the LIFO inventory method. 
An owner of a section 987 QBU that uses the simplified inventory method 
must make all of the applicable adjustments described in paragraphs 
(c)(3)(ii) through (iv) of this section with respect to the section 987 
QBU even in taxable years in which the amount of COGS is zero.
    (ii) Adjustment for cost recovery deductions included in 
inventoriable costs. The translated COGS amount computed under 
paragraph (c)(2)(iv)(A) of this section is increased or decreased (as 
appropriate) to reflect the difference between the historic rates 
appropriate for translating cost recovery deductions attributable to 
other historic assets and the exchange rate used to translate COGS 
under paragraph (c)(2)(iv)(A) of this section, to the extent any such 
cost recovery deductions are included in inventoriable costs for the 
taxable year. The adjustment is included as an adjustment to translated 
COGS computed under paragraph (c)(2)(iv)(A) of this section in full in 
the year to which the adjustment relates and is not allocated between 
COGS and ending inventory. The adjustment for each cost recovery 
deduction is computed as the product of:
    (A) The cost recovery deduction, expressed in the functional 
currency of the section 987 QBU; and
    (B) The exchange rate specified in paragraph (c)(2)(i) of this 
section for translating the cost recovery deduction (that is, the 
historic rate for the property to which such deduction is attributable) 
less the exchange rate used to translate COGS under the simplified 
inventory method described in paragraph (c)(2)(iv)(A) of this section 
(that is, the yearly average exchange rate for the taxable year).
    (iii) Adjustment to beginning inventory for non-LIFO inventory. In 
the case of inventory with respect to which a section 987 QBU does not 
use the LIFO inventory method (non-LIFO inventory), the translated COGS 
amount computed under paragraph (c)(2)(iv)(A) of this section is 
increased or decreased (as appropriate) by the product of:
    (A) The ending non-LIFO inventory included on the closing balance 
sheet for the preceding year, expressed in the functional currency of 
the section 987 QBU; and
    (B) The exchange rate described in Sec. Sec.  1.987-4(e)(2)(ii) and 
1.987-1(c)(3)(i)(B) that is used for translating ending inventory on 
the closing balance sheet for the preceding year (which is generally 
the yearly average exchange rate for the preceding year) less the 
exchange rate used to translate COGS under paragraph (c)(2)(iv)(A) of 
this section (that is, the yearly average exchange rate for the taxable 
year). For purposes of this paragraph (c)(3)(iii)(B), in the first 
taxable year in which a current rate election is revoked or otherwise 
ceases to be in effect, the exchange rate that is used for translating 
ending inventory on the closing balance sheet for the preceding year is 
deemed to be equal to the spot rate applicable to the last day of the 
preceding taxable year.
    (iv) Adjustment for year of LIFO liquidation. In the case of 
inventory with respect to which a section 987 QBU uses the LIFO 
inventory method, for each LIFO layer liquidated in whole or in part 
during the taxable year, the translated COGS amount computed under 
paragraph (c)(2)(iv)(A) of this section is increased or decreased (as 
appropriate) by the product of:
    (A) The amount of the LIFO layer liquidated during the taxable 
year, expressed in the functional currency of the section 987 QBU; and
    (B) The exchange rate described in Sec. Sec.  1.987-4(e)(2)(ii) and 
1.987-1(c)(3)(i)(B) or (F) that is used for translating such LIFO layer 
(which is generally the yearly average exchange rate for the year such 
LIFO layer arose) less the exchange rate used to translate COGS under 
paragraph (c)(2)(iv)(A) of this section (that is, the yearly average 
exchange rate for the taxable year).
    (d) [Reserved]
    (e) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, U.S. Corp is a domestic 
corporation that uses the calendar year as its taxable year and has the 
U.S. dollar as its functional currency. Except as otherwise indicated, 
U.S. Corp is the owner of Business A, a section 987 QBU with the euro 
as its functional currency, and elects under paragraph (c)(2)(iv)(B) of 
this section to use the historic inventory method with respect to 
Business A but does not make any other elections under section 987. 
Exchange rates used in these examples are selected for the purpose of 
illustrating the principles of this section. No inference (for example, 
whether a currency is hyperinflationary or not) is intended by their 
use.
    (1) Example 1. Business A accrues [pound]100 of income from the 
provision of services. Under paragraph (b)(2)(i) of this section, the 
[pound]100 is translated into [euro]90 at the spot rate on the date of 
accrual, without the use of a spot rate convention. In determining U.S. 
Corp's taxable income, the [euro]90 of income is translated into 
dollars at the rate provided in paragraph (c)(1) of this section.
    (2) Example 2. Business A sells a historic asset consisting of non-
inventory property for [pound]100. Under paragraph (b)(2)(i) of this 
section, the [pound]100 amount realized is translated into [euro]85 at 
the spot rate on the sale date without the use of a spot rate

[[Page 78175]]

convention. In determining U.S. Corp's taxable income, the [euro]85 is 
translated into dollars at the rate provided in paragraph (c)(1) of 
this section. The euro basis of the property is translated into dollars 
at the rate provided in paragraph (c)(2)(i) of this section (that is, 
the historic rate).
    (3) Example 3--(i) Facts. Business A uses a first-in, first-out 
(FIFO) method of accounting for inventory. Business A sells 1,200 units 
of inventory in year 2 for [euro]3 per unit. Business A's gross sales 
are translated under paragraph (c)(1) of this section at the yearly 
average exchange rate for the year of the sale. The yearly average 
exchange rate is [euro]1 = $1.02 for year 1 and [euro]1 = $1.05 for 
year 2.
    (ii) Analysis--(A) Business A's dollar gross sales will be computed 
as follows:

                                 Table 1 to Paragraph (e)(3)(ii)(A)--Gross Sales
                                                    [Year 2]
----------------------------------------------------------------------------------------------------------------
                                           Number of       Amount in     [euro]/$ yearly average
                 Month                       units          [euro]                rate              Amount in $
----------------------------------------------------------------------------------------------------------------
Jan...................................             100             300  [euro]1 = $1.05.........          315.00
Feb...................................             200             600  [euro]1 = $1.05.........          630.00
March.................................               0               0  [euro]1 = $1.05.........            0.00
April.................................             200             600  [euro]1 = $1.05.........          630.00
May...................................             100             300  [euro]1 = $1.05.........          315.00
June..................................               0               0  [euro]1 = $1.05.........            0.00
July..................................             100             300  [euro]1 = $1.05.........          315.00
Aug...................................             100             300  [euro]1 = $1.05.........          315.00
Sept..................................               0               0  [euro]1 = $1.05.........            0.00
Oct...................................               0               0  [euro]1 = $1.05.........            0.00
Nov...................................             100             300  [euro]1 = $1.05.........          315.00
Dec...................................             300             900  [euro]1 = $1.05.........          945.00
                                       -------------------------------------------------------------------------
                                                 1,200  ..............  ........................       $3,780.00
----------------------------------------------------------------------------------------------------------------

    (B) The purchase price for each inventory unit was [euro]1.50. 
Under Sec.  1.987-1(c)(3)(i) and paragraph (c)(2)(iv)(B) of this 
section, the basis of each item of inventory is translated into dollars 
at the yearly average exchange rate for the year the inventory was 
acquired.

                       Table 2 to Paragraph (e)(3)(ii)(B)--Opening Inventory and Purchases
                                                    [Year 2]
----------------------------------------------------------------------------------------------------------------
                                           Number of       Amount in     [euro]/$ yearly average
                 Month                       units          [euro]                rate              Amount in $
----------------------------------------------------------------------------------------------------------------
Opening inventory (purchased in Dec.               100             150  [euro]1 = $1.02.........          153.00
 year 1).
Purchases in year 2
    Jan...............................             300             450  [euro]1 = $1.05.........          472.50
    Feb...............................               0               0  [euro]1 = $1.05.........               0
    March.............................               0               0  [euro]1 = $1.05.........               0
    April.............................             300             450  [euro]1 = $1.05.........          472.50
    May...............................               0               0  [euro]1 = $1.05.........               0
    June..............................               0               0  [euro]1 = $1.05.........               0
    July..............................             300             450  [euro]1 = $1.05.........          472.50
    Aug...............................               0               0  [euro]1 = $1.05.........               0
    Sept..............................               0               0  [euro]1 = $1.05.........               0
    Oct...............................               0               0  [euro]1 = $1.05.........               0
    Nov...............................             300             450  [euro]1 = $1.05.........          472.50
    Dec...............................               0               0  [euro]1 = $1.05.........               0
                                                 1,200  ..............  ........................        1,890.00
----------------------------------------------------------------------------------------------------------------

    (C) Because Business A uses a FIFO method for inventory, Business A 
is considered to have sold in year 2 the 100 units of opening inventory 
purchased in year 1 ($153.00), the 300 units purchased in January year 
2 ($472.50), the 300 units purchased in April year 2 ($472.50), the 300 
units purchased in July year 2 ($472.50), and 200 of the 300 units 
purchased in November year 2 ($315.00). Accordingly, Business A's 
translated dollar COGS for year 2 is $1,885.50. Business A's opening 
inventory for year 3 is 100 units of inventory with a translated dollar 
basis of $157.50.
    (D) Accordingly, for purposes of section 987, Business A has gross 
income in dollars of $1,894.50 ($3,780.00--$1,885.50) for year 2.
    (4) [Reserved]
    (5) Example 5. The facts are the same as in paragraph (e)(3) of 
this section (Example 3) except that during year 2, Business A incurred 
[euro]100 of depreciation expense with respect to a truck. No portion 
of the depreciation expense is an inventoriable cost. The truck was 
purchased on January 15, year 1. The yearly average exchange rate for 
year 1 was [euro]1 = $1.02. Under paragraph (c)(2)(i) of this section, 
the [euro]100 of depreciation is translated into dollars at the 
historic rate. The historic rate is the yearly average exchange rate 
for year 1. Accordingly, U.S. Corp takes into account depreciation of 
$102 with respect to Business A in year 2.
    (6) Example 6. The facts are the same as in paragraph (e)(5) of 
this section

[[Page 78176]]

(Example 5) except that the [euro]100 of depreciation expense incurred 
during year 2 with respect to the truck is an inventoriable cost. As a 
result, the depreciation expense is capitalized into the 1,200 units of 
inventory purchased by Business A in year 2. Of those 1,200 units, 
1,100 units are sold during the year, and 100 units become ending 
inventory. The portion of depreciation expense capitalized into 
inventory that is sold during year 2 is reflected in Business A's euro 
COGS and is translated at the [euro]1 = $1.02 yearly average exchange 
rate for year 1, the year in which the truck was purchased. The portion 
of the depreciation expense capitalized into the 100 units of ending 
inventory is not taken into account in year 2 but rather, will be taken 
into account in the year the ending inventory is sold, translated at 
the [euro]1 = $1.02 yearly average exchange rate for year 1.
    (7) Example 7. Business A purchased raw land on October 16, year 1, 
for [euro]8,000 and sold the land on November 1, year 2, for 
[euro]10,000. The yearly average exchange rate was [euro]1 = $1.02 for 
year 1 and [euro]1 = $1.05 for year 2. Under paragraph (c)(1) of this 
section, the amount realized is translated into dollars at the yearly 
average exchange rate for year 2 ([euro]10,000 x $1.05 = $10,500). 
Under paragraph (c)(2)(i) of this section, the basis is determined at 
the historic rate for year 1, which is the yearly average exchange rate 
under section Sec.  1.987-1(c)(3)(i) for such year ([euro]8,000 x $1.02 
= $8,160). Accordingly, the amount of gain reported by U.S. Corp on the 
sale of the land is $2,340 ($10,500--$8,160).
    (8) Example 8. The facts are the same as in paragraph (e)(7) of 
this section (Example 7), except that U.S. Corp makes a current rate 
election under Sec.  1.987-1(d)(2). Under paragraph (c)(2) of this 
section, none of the exceptions to paragraph (c)(1) of this section 
apply in a taxable year for which an annual recognition election or a 
current rate election is in effect. As a result, all items of income, 
gain, deduction, and loss with respect to Business A are translated 
into U.S Corp's functional currency at the yearly average exchange rate 
under paragraph (c)(1) of this section. Business A's gain on the sale 
of the land is determined in its functional currency and is equal to 
[euro]2,000 (amount realized of [euro]10,000 less basis of 
[euro]8,000). This gain is translated at the yearly average exchange 
rate for year 2 of [euro]1 = $1.05, and the amount of gain reported by 
U.S. Corp on the sale of the land is $2,100. The result would be the 
same if U.S. Corp made an annual recognition election under Sec.  
1.987-5(b)(2).
0
9. Section 1.987-4 is revised to read as follows:


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

    (a) In general. The net unrecognized section 987 gain or loss of a 
section 987 QBU is determined by the owner annually as provided in 
paragraph (b) of this section in the owner's functional currency. Only 
assets and liabilities reflected on the books and records of the 
section 987 QBU under Sec.  1.987-2(b) are taken into account.
    (b) Calculation of net unrecognized section 987 gain or loss. Net 
unrecognized section 987 gain or loss of a section 987 QBU for a 
taxable year equals the sum of:
    (1) The section 987 QBU's net accumulated unrecognized section 987 
gain or loss for all prior taxable years as determined in paragraph (c) 
of this section; and
    (2) The section 987 QBU's unrecognized section 987 gain or loss for 
the current taxable year as determined in paragraph (d) of this 
section.
    (c) Net accumulated unrecognized section 987 gain or loss for all 
prior taxable years--(1) In general. A section 987 QBU's net 
accumulated unrecognized section 987 gain or loss for all prior taxable 
years is the aggregate of the amounts determined under Sec.  1.987-4(d) 
for all prior taxable years to which this section applies, reduced 
(without duplication) by amounts recognized under Sec.  1.987-5(a), 
amounts treated as deferred section 987 gain or loss, and amounts 
treated as suspended section 987 loss for all prior taxable years to 
which this section applies.
    (2) Additional adjustments for certain taxable years beginning on 
or before December 31, 2024. For any section 987 QBU in existence 
before the transition date, see Sec.  1.987-10(e)(5) and (f)(2) for 
additional adjustments to the section 987 QBU's net accumulated 
unrecognized section 987 gain or loss.
    (d) Calculation of unrecognized section 987 gain or loss for a 
taxable year. The unrecognized section 987 gain or loss of a section 
987 QBU for a taxable year is generally determined under paragraphs 
(d)(1) through (10) of this section. However, for taxable years in 
which a current rate election or an annual recognition election is in 
effect, the unrecognized section 987 gain or loss of a section 987 QBU 
for a taxable year is determined by only applying paragraphs (d)(1) 
through (5) and (10) of this section.
    (1) Step 1: Determine the change in the owner functional currency 
net value of the section 987 QBU for the taxable year--(i) In general. 
The change in the owner functional currency net value of the section 
987 QBU for the taxable year equals--
    (A) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the taxable year; less
    (B) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the preceding taxable year.
    (ii) Year section 987 QBU is terminated. If a section 987 QBU is 
terminated within the meaning of Sec.  1.987-8 during an owner's 
taxable year, the owner functional currency net value of the section 
987 QBU described in paragraph (d)(1)(i)(A) of this section is 
determined on the date the section 987 QBU is terminated.
    (iii) First taxable year of a section 987 QBU. If the owner's 
taxable year is the first taxable year of a section 987 QBU, the owner 
functional currency net value of the section 987 QBU described in 
paragraph (d)(1)(i)(B) of this section is zero.
    (iv) First year in which an election is in effect or ceases to be 
in effect. Except as otherwise provided, the owner functional currency 
net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of 
this section is determined based on the elections that were (or were 
not) in effect on the last day of the preceding taxable year.
    (2) Step 2: Increase the amount determined in step 1 by the amount 
of assets transferred from the section 987 QBU to the owner--(i) In 
general. The amount determined in paragraph (d)(1) of this section is 
increased by the total amount of assets transferred from the section 
987 QBU to the owner during the taxable year translated into the 
functional currency of the owner as provided in paragraph (d)(2)(ii) of 
this section.
    (ii) Assets transferred from the section 987 QBU to the owner 
during the taxable year. The total amount of assets transferred from 
the section 987 QBU to the owner for the taxable year translated into 
the functional currency of the owner equals the sum of:
    (A) The amount of the functional currency of the section 987 QBU 
and the aggregate adjusted basis of all marked assets, after taking 
into account Sec.  1.988-1(a)(10), transferred to the owner during the 
taxable year determined in the

[[Page 78177]]

functional currency of the section 987 QBU and translated into the 
functional currency of the owner at the spot rate applicable to the 
date of transfer; and
    (B) The aggregate adjusted basis of all historic assets, after 
taking into account Sec.  1.988-1(a)(10), transferred to the owner 
during the taxable year determined in the functional currency of the 
section 987 QBU and translated into the functional currency of the 
owner at the historic rate for each such asset.
    (3) Step 3: Decrease the amount determined in steps 1 and 2 by the 
amount of assets transferred from the owner to the section 987 QBU--(i) 
In general. The aggregate amount determined in paragraphs (d)(1) and 
(2) of this section is decreased by the total amount of assets 
transferred from the owner to the section 987 QBU during the taxable 
year determined in the functional currency of the owner as provided in 
paragraph (d)(3)(ii) of this section.
    (ii) Assets transferred from the owner to the section 987 QBU 
during the taxable year. The total amount of assets transferred from 
the owner to the section 987 QBU for the taxable year equals the sum 
of:
    (A) The amount of functional currency of the owner transferred to 
the section 987 QBU during the taxable year; and
    (B) The aggregate adjusted basis of all assets, after taking into 
account Sec.  1.988-1(a)(10), transferred to the section 987 QBU during 
the taxable year determined in the functional currency of the owner 
immediately before the transfer.
    (4) Step 4: Decrease the amount determined in steps 1 through 3 by 
the amount of liabilities transferred from the section 987 QBU to the 
owner--(i) In general. The aggregate amount determined in paragraphs 
(d)(1) through (3) of this section is decreased by the total amount of 
liabilities transferred from the section 987 QBU to the owner during 
the taxable year translated into the functional currency of the owner 
as provided in paragraph (d)(4)(ii) of this section.
    (ii) Liabilities transferred from the section 987 QBU to the owner 
during the taxable year. The total amount of liabilities transferred 
from the section 987 QBU to the owner for the taxable year equals the 
sum of:
    (A) The amount of marked liabilities transferred to the owner 
during the taxable year determined in the functional currency of the 
section 987 QBU and translated into the functional currency of the 
owner at the spot rate applicable to the date of transfer; and
    (B) The amount of historic liabilities, after taking into account 
Sec.  1.988-1(a)(10), transferred to the owner during the taxable year 
determined in the functional currency of the section 987 QBU and 
translated into the functional currency of the owner at the historic 
rate for each such liability.
    (5) Step 5: Increase the amount determined in steps 1 through 4 by 
the amount of liabilities transferred from the owner to the section 987 
QBU. The aggregate amount determined in paragraphs (d)(1) through (4) 
of this section is increased by the total amount of liabilities, after 
taking into account Sec.  1.988-1(a)(10), transferred from the owner to 
the section 987 QBU during the taxable year determined in the 
functional currency of the owner immediately before the transfer.
    (6) Step 6: Decrease or increase the amount determined in steps 1 
through 5 by the section 987 taxable income or loss, respectively, of 
the section 987 QBU for the taxable year. The aggregate amount 
determined in paragraphs (d)(1) through (5) of this section is 
decreased or increased by the section 987 taxable income or loss, 
respectively, computed under Sec.  1.987-3 for the taxable year.
    (7) Step 7: Increase the amount determined in steps 1 through 6 by 
any expenses or losses that are not deductible in computing the section 
987 taxable income or loss of the section 987 QBU for the taxable year. 
The aggregate amount determined under paragraphs (d)(1) through (6) of 
this section is increased by the amount of any expense or loss that 
reduces the basis of assets or increases the amount of liabilities on 
the adjusted balance sheet of the section 987 QBU for the taxable year 
but is not deductible in computing the section 987 QBU's taxable income 
or loss for the taxable year (such as business interest expense that is 
not deductible under section 163(j)). Items of expense or loss 
described in the preceding sentence are translated into the functional 
currency of the owner using the exchange rate that would apply under 
Sec.  1.987-3(c) if they were deductible in computing the section 987 
QBU's taxable income or loss for the taxable year. However, any foreign 
income taxes incurred by the section 987 QBU with respect to which the 
owner claims a credit are translated at the same rate at which such 
taxes were translated under section 986(a).
    (8) Step 8: Decrease the amount determined in steps 1 through 7 by 
the amount of any income or gain that is not included in taxable income 
in computing the section 987 taxable income or loss of the section 987 
QBU for the taxable year. The aggregate amount determined under 
paragraphs (d)(1) through (7) of this section is decreased by the 
amount of any income or gain that increases the basis of assets or 
reduces the amount of liabilities on the adjusted balance sheet of the 
section 987 QBU for the taxable year but is not included in taxable 
income in computing the section 987 QBU's taxable income or loss for 
the taxable year. Items of income or gain described in the preceding 
sentence are translated into the functional currency of the owner using 
the exchange rate that would apply under Sec.  1.987-3(c) if they were 
included in taxable income in computing the section 987 QBU's taxable 
income or loss for the taxable year.
    (9) Step 9: Increase or decrease the amount determined in steps 1 
through 8 by any income or gain, or any deduction or loss, 
respectively, that does not impact the adjusted balance sheet. The 
aggregate amount determined under paragraphs (d)(1) through (8) of this 
section is increased by any items of income or gain taken into account 
in step 6 that do not increase the basis of assets or reduce the amount 
of liabilities on the adjusted balance sheet of the section 987 QBU for 
the taxable year, and decreased by any items of deduction or loss taken 
into account in step 6 that do not reduce the basis of assets or 
increase the amount of liabilities on the adjusted balance sheet of the 
section 987 QBU for the taxable year. Items of income, gain, deduction, 
or loss described in the preceding sentence are translated into the 
functional currency of the owner using the exchange rate that applied 
under Sec.  1.987-3(c) in computing the section 987 QBU's taxable 
income or loss for the taxable year.
    (10) Step 10: Decrease or increase the amount determined in steps 1 
through 9 by any increase or decrease, respectively, to the adjusted 
balance sheet that is not previously taken into account under steps 2 
through 9--(i) In general. Except as provided in paragraph (d)(10)(iii) 
of this section, the aggregate amount determined under paragraphs 
(d)(1) through (9) of this section is--
    (A) Decreased by the residual increase to the adjusted balance 
sheet (as defined in paragraph (d)(10)(ii) of this section), translated 
into the owner's functional currency at the yearly average exchange 
rate for the taxable year; or
    (B) Increased by the residual decrease to the adjusted balance 
sheet (as defined in paragraph (d)(10)(ii) of this section), translated 
into the owner's functional currency at the yearly average exchange 
rate for the taxable year.

[[Page 78178]]

    (ii) Determining the residual increase or decrease to the adjusted 
balance sheet. The residual increase to the adjusted balance sheet is 
the positive amount, if any, that would be determined under paragraphs 
(d)(1) through (9) of this section in the functional currency of the 
section 987 QBU if such amounts were determined in the functional 
currency of the section 987 QBU. The residual decrease to the adjusted 
balance sheet is the negative amount, if any, that would be determined 
under paragraphs (d)(1) through (9) of this section in the functional 
currency of the section 987 QBU if such amounts were determined in the 
functional currency of the section 987 QBU.
    (iii) Modifications for taxable years to which a current rate 
election or an annual recognition election applies. For any taxable 
year to which a current rate election or an annual recognition election 
applies, paragraphs (d)(10)(i) and (ii) of this section are applied by 
replacing ``paragraphs (d)(1) through (9)'' with ``paragraphs (d)(1) 
through (5).''
    (e) Determination of the owner functional currency net value of a 
section 987 QBU--(1) In general. The owner functional currency net 
value of a section 987 QBU on the last day of a taxable year is equal 
to the aggregate amount of functional currency and the adjusted basis 
of each other asset on the section 987 QBU's adjusted balance sheet on 
that day, less the aggregate amount of each liability on the section 
987 QBU's adjusted balance sheet on that day, in each case translated 
into the owner's functional currency as provided in paragraph (e)(2) of 
this section.
    (2) Translation of adjusted balance sheet items into the owner's 
functional currency. The amount of the section 987 QBU's functional 
currency, the basis of an asset, or the amount of a liability is 
translated as follows:
    (i) Marked item. A marked item is translated into the owner's 
functional currency at the spot rate applicable to the last day of the 
relevant taxable year.
    (ii) Historic item. A historic item is translated into the owner's 
functional currency at the historic rate.
    (f) Combinations and separations--(1) Combinations. The net 
accumulated unrecognized section 987 gain or loss of a combined QBU for 
a taxable year is equal to the sum of the combining QBUs' net 
accumulated unrecognized section 987 gain or loss. See paragraph 
(f)(3)(i) of this section (Example 1) for an illustration of this rule.
    (2) Separations. The net accumulated unrecognized section 987 gain 
or loss of a separated QBU for a taxable year is equal to the 
separating QBU's net accumulated unrecognized section 987 gain or loss 
multiplied by the separation fraction. For purposes of determining the 
owner functional currency net value of the separated QBUs on the last 
day of the taxable year preceding the taxable year of separation under 
paragraphs (d)(1)(i)(B) and (e) of this section, the balance sheets of 
the separated QBUs on that day will be deemed to reflect the assets and 
liabilities reflected on the balance sheet of the separating QBU on 
that day, apportioned between the separated QBUs in a reasonable manner 
that takes into account the assets and liabilities reflected on the 
balance sheets of the separated QBUs immediately after the separation. 
See paragraph (f)(3)(ii) of this section (Example 2) for an 
illustration of this rule.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (f)(1) and (2) of this section. For purposes of these 
examples, assume that no section 987 elections are in effect.
    (i) Example 1. Combination of two section 987 QBUs that have the 
same owner--(A) Facts. DC1, a domestic corporation, owns Entity A, a 
DE. Entity A conducts a manufacturing business that constitutes a 
section 987 QBU (Manufacturing QBU) that has the euro as its functional 
currency. Manufacturing QBU has a net accumulated unrecognized section 
987 loss of $100. DC1 also owns Entity B, a DE. Entity B conducts a 
sales business that constitutes a section 987 QBU (Sales QBU) that has 
the euro as its functional currency. Sales QBU has a net accumulated 
unrecognized section 987 gain of $110. During the taxable year, Entity 
A merges into Entity B under local law pursuant to which Entity A 
ceases to exist, Entity B survives, and Entity B acquires all the 
assets and liabilities of Entity A. As a result, the books and records 
of Manufacturing QBU and Sales QBU are combined into a new single set 
of books and records. The combined entity has the euro as its 
functional currency.
    (B) Analysis. Pursuant to Sec.  1.987-2(c)(9)(i), Manufacturing QBU 
and Sales QBU are combining QBUs, and their combination does not give 
rise to a transfer that is taken into account in determining the amount 
of a remittance (as defined in Sec.  1.987-5(c)). For purposes of 
computing net unrecognized section 987 gain or loss under this section 
for the year of the combination, the combination is deemed to have 
occurred on the last day of the owner's prior taxable year, such that 
the owner functional currency net value of the combined section 987 QBU 
at the end of that taxable year described under paragraph (d)(1)(i)(B) 
of this section takes into account items reflected on the balance 
sheets of both Manufacturing QBU and Sales QBU at that time. 
Additionally, any transactions between Manufacturing QBU and Sales QBU 
occurring during the year of the merger will not result in transfers to 
or from a section 987 QBU. Pursuant to paragraph (f)(1) of this 
section, the combined QBU will have a net accumulated unrecognized 
section 987 gain of $10 (the $100 loss from Manufacturing QBU plus the 
$110 gain from Sales QBU).
    (ii) Example 2. Separation of two section 987 QBUs that have the 
same owner--(A) Facts. DC1, a domestic corporation, owns Entity A, a 
DE. Entity A conducts a business in the Netherlands that constitutes a 
section 987 QBU (Dutch QBU) that has the euro as its functional 
currency. The business of Dutch QBU consists of manufacturing and 
selling bicycles and scooters and is recorded on a single set of books 
and records. On the last day of year 1, the adjusted basis of the gross 
assets of Dutch QBU is [euro]1,000. In year 2, the net accumulated 
unrecognized section 987 loss of Dutch QBU from all prior taxable years 
is $200. During year 2, Entity A separates the bicycle and scooter 
business such that each business begins to have its own books and 
records and to meet the definition of a section 987 QBU under Sec.  
1.987-1(b)(3) (hereafter, ``bicycle QBU'' and ``scooter QBU''). There 
are no transfers between DC1 and Dutch QBU before the separation. After 
the separation, the aggregate adjusted basis of bicycle QBU's assets is 
[euro]600 and the aggregate adjusted basis of scooter QBU's assets is 
[euro]400. Each section 987 QBU continues to have the euro as its 
functional currency.
    (B) Analysis. Pursuant to Sec.  1.987-2(c)(9)(iii), bicycle QBU and 
scooter QBU are separated QBUs, and the separation of Dutch QBU, a 
separating QBU, does not give rise to a transfer taken into account in 
determining the amount of a remittance. For purposes of computing net 
unrecognized section 987 gain or loss under this section for year 2, 
the separation will be deemed to have occurred on the last day of the 
owner's prior taxable year, year 1. Pursuant to paragraph (f)(2) of 
this section and Sec.  1.987-1(h), bicycle QBU will have a separation 
fraction of [euro]600/[euro]1,000 and net accumulated unrecognized 
section 987 loss of $120 ([euro]600/[euro]1,000 x $200), and scooter 
QBU will have a separation fraction of [euro]400/[euro]1,000 and net 
accumulated unrecognized section 987 loss of $80 ([euro]400/[euro]1,000 
x $200).
    (g) Examples. The following examples illustrate the provisions of 
this section.

[[Page 78179]]

For purposes of the examples, U.S. Corp is a domestic corporation that 
uses the calendar year as its taxable year and has the dollar as its 
functional currency. Except as otherwise indicated, no section 987 
elections are in effect. Exchange rate assumptions used in these 
examples are selected for the purpose of illustrating the principles of 
this section, and no inference is intended by their use. Additionally, 
the examples are not intended to demonstrate when activities constitute 
a trade or business within the meaning of Sec. Sec.  1.989(a)-
1(b)(2)(ii)(A) and 1.989(a)-1(c) and therefore whether a section 987 
QBU is considered to exist.
    (1) Example 1--(i) Facts. On July 1, year 1, U.S. Corp establishes 
Japan Branch, a section 987 QBU that has the yen as its functional 
currency, and U.S. Corp transfers to Japan Branch [yen]100,000 with a 
basis of $1,000 and raw land with a basis of $500. On the same day, 
Japan Branch borrows [yen]10,000 from a bank. In year 1, Japan Branch 
earns [yen]12,000 for providing services and incurs [yen]2,000 of 
related expenses. Japan Branch thus earns [yen]10,000 of net income in 
year 1. The spot rate on July 1, year 1, is $1 = [yen]100; the spot 
rate on December 31, year 1, is $1 = [yen]120; and the average rate for 
the period of July 1, year 1, to December 31, year 1, is $1 = [yen]110. 
Thus, the [yen]12,000 of services revenue when translated under Sec.  
1.987-3(c)(1) at the yearly average exchange rate equals $109.09 
([yen]12,000 x ($1/[yen]110)) = $109.09). The [yen]2,000 of expenses 
translated at the same yearly average exchange rate equals $18.18 
([yen]2,000 x ($1/[yen]110) = $18.18). Thus, Japan Branch's net income 
translated into dollars equals $90.91 ($109.09--$18.18 = $90.91).
    (ii) Analysis. Under paragraph (a) of this section, U.S. Corp must 
compute the net unrecognized section 987 gain or loss of Japan Branch 
for year 1. Because this is Japan Branch's first taxable year, the net 
unrecognized section 987 gain or loss (as defined under paragraph (b) 
of this section) is the branch's unrecognized section 987 gain or loss 
for year 1 as determined in paragraph (d) of this section. The 
calculations under paragraph (d) of this section are made as follows:
    (A) Step 1. Under paragraph (d)(1) of this section (Step 1), U.S. 
Corp must determine the change in the owner functional currency net 
value (OFCNV) of Japan Branch for year 1 in dollars. The change in the 
OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch 
determined in dollars on the last day of year 1, less the OFCNV of 
Japan Branch determined in dollars on the last day of the preceding 
taxable year.
    (1) The OFCNV of Japan Branch on December 31, year 1 is determined 
under paragraph (e) of this section as the sum of the basis of each 
asset on Japan Branch's adjusted balance sheet on December 31, year 1, 
less the sum of each liability on Japan Branch's adjusted balance sheet 
on that date, translated into dollars as provided in paragraph (e)(2) 
of this section.
    (2) For this purpose, Japan Branch will show the following assets 
and liabilities on its adjusted balance sheet for December 31, year 1: 
cash of [yen]120,000; raw land with a basis of [yen]55,000 ($500 
translated under Sec.  1.987-2(d)(2) at the historic rate of $1 = 
[yen]110); and liabilities of [yen]10,000.
    (3) Under paragraph (e)(2) of this section, U.S. Corp will 
translate these items as follows. The [yen]120,000 is a marked asset 
and the [yen]10,000 liability is a marked liability. These items are 
translated into dollars on December 31, year 1, using the spot rate on 
December 31, year 1, of $1 = [yen]120. The raw land is a historic asset 
and is translated into dollars under paragraph (e)(2)(ii) of this 
section at the historic rate, which under Sec.  1.987-1(c)(3)(i)(A) is 
the yearly average exchange rate of $1 = [yen]110 applicable to the 
year the land was transferred to the QBU.
    (4) The OFCNV of Japan Branch on December 31, year 1, in dollars is 
$1,416.67, determined below. The OFCNV of Japan Branch on December 31, 
year 1, is shown below in dollars (together with the corresponding 
amounts in yen).

                           Table 1 to Paragraph (g)(1)(ii)(A)(4)--OFCNV--End of Year 1
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets
    Yen.......................................         120,000  $1 = [yen]120 (spot rate-12/31/         1,000.00
                                                                 year 1).
                                                                $1 = [yen]110 (historic rate-
                                                                 yearly average rate-year 1).
    Land......................................          55,000  ................................          500.00
                                               -----------------------------------------------------------------
    Total assets..............................         175,000  ................................        1,500.00
Liabilities
    Bank loan.................................          10,000  $1 = [yen]120 (spot rate-12/31/            83.33
                                                                 year 1).
                                               -----------------------------------------------------------------
Total liabilities.............................          10,000  ................................           83.33
Year 1 ending net value.......................         165,000  ................................        1,416.67
----------------------------------------------------------------------------------------------------------------

    (5) Under paragraph (d)(1) of this section, the change in OFCNV of 
Japan Branch for year 1 is equal to the OFCNV of the branch determined 
in dollars on December 31, year 1, (which is $1,416.67) less the OFCNV 
of the branch determined in dollars on the last day of the preceding 
taxable year. Because this is the first taxable year of Japan Branch, 
the OFCNV of Japan Branch determined in dollars on the last day of the 
preceding taxable year is zero under paragraph (d)(1)(iii) of this 
section. Accordingly, the change in OFCNV of Japan Branch for year 1 is 
$1,416.67.
    (B) Step 2 (no adjustment). No adjustment is made under paragraph 
(d)(2) of this section (Step 2) because no assets were transferred by 
Japan Branch to U.S. Corp during the taxable year.
    (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan 
Branch [yen]100,000 with a basis of $1,000.00 and raw land with a basis 
of $500.00 (equal to [yen]55,000, translated under Sec.  1.987-2(d)(2) 
at the historic rate of $1 = [yen]110). The total amount of assets 
transferred from U.S. Corp to Japan Branch in dollars is $1,500, and 
the total amount of the transfer in yen is [yen]155,000. Therefore, 
under paragraph (d)(3) of this section (Step 3), the amount determined 
in previous steps is reduced by $1,500.00, from $1,416.67 to negative 
$83.33.
    (D) Steps 4 and 5 (no adjustment). No adjustment is made under 
paragraphs (d)(4) and (5) of this section (Steps 4 and 5) because no 
liabilities were transferred by U.S. Corp to Japan Branch or by Japan 
Branch to U.S. Corp during the taxable year.
    (E) Step 6. Under paragraph (d)(6) of this section (Step 6), the 
amount determined in previous steps is

[[Page 78180]]

decreased by the section 987 taxable income of Japan Branch of $90.91, 
from negative $83.33 to negative $174.24.
    (F) Steps 7 through 9 (no adjustment). No adjustment is made under 
paragraphs (d)(7) through (9) of this section (Steps 7 through 9) 
because all of Japan Branch's items of income or deduction for the 
taxable year impact the adjusted balance sheet and are taken into 
account in computing taxable income.
    (G) Step 10 (no adjustment)--(1) Calculation of residual increase 
or decrease to the adjusted balance sheet. Under paragraph (d)(10)(ii) 
of this section, the residual increase (or decrease) to the adjusted 
balance sheet is the positive (or negative) amount, if any, that would 
be determined under paragraphs (d)(1) through (9) of this section 
(Steps 1 through 9) in the functional currency of the section 987 QBU 
if such amounts were determined in the functional currency of the 
section 987 QBU. In year 1, the relevant steps that must be applied in 
the functional currency of Japan Branch (the yen) are paragraphs 
(d)(1), (3), and (6) of this section (Steps 1, 3, and 6). For purposes 
of applying paragraph (d)(1) of this section (Step 1) in yen, the 
change in the net value of Japan Branch is [yen]165,000. See paragraph 
(g)(1)(ii)(A)(4) of this section. For purposes of applying paragraph 
(d)(3) of this section (Step 3) in yen, the amount of assets 
transferred from U.S. Corp to Japan Branch is [yen]155,000. See 
paragraph (g)(1)(ii)(C) of this section. For purposes of applying 
paragraph (d)(6) of this section (Step 6) in yen, Japan Branch earned 
[yen]10,000 of net income in year 1. The application of these steps 
results in no residual increase or decrease to the adjusted balance 
sheet, as shown below:

 Table 2 to Paragraph (g)(1)(ii)(G)(1)--Application of Relevant Steps in
                                   Yen
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Change in net value in yen (Step 1)..................       [yen]165,000
Subtract amount determined in yen under Step 3            ([yen]155,000)
 (transfers from owner to section 987 QBU)...........
Subtract amount determined in yen under Step 6             ([yen]10,000)
 (section 987 taxable income or loss)................
                                                      ------------------
    Residual increase or decrease to the adjusted                 [yen]0
     balance sheet...................................
------------------------------------------------------------------------

    (2) No residual increase or decrease to the adjusted balance sheet. 
As explained in paragraph (g)(1)(ii)(G)(1) of this section, there is no 
residual increase or decrease to the adjusted balance sheet of Japan 
Branch in year 1. Therefore, no adjustment is made under paragraph 
(d)(10) of this section (Step 10). Accordingly, the unrecognized 
section 987 loss of Japan Branch for year 1 is $174.24.
    (2) Example 2--(i) Facts. The facts are the same as in paragraph 
(g)(1) of this section (Example 1), except that U.S. Corp makes a 
current rate election under Sec.  1.987-1(d)(2) for year 1.
    (ii) Analysis. Because a current rate election is in effect for 
year 1, the unrecognized section 987 gain or loss for year 1 is 
determined by applying only paragraphs (d)(1) through (5) and (10) of 
this section (Steps 1 through 5 and Step 10). The calculations under 
paragraph (d) of this section are made as follows:
    (A) Step 1. The change in the OFCNV of Japan Branch for year 1 is 
equal to the OFCNV of Japan Branch determined in dollars on the last 
day of year 1, less the OFCNV of Japan Branch determined in dollars on 
the last day of the preceding taxable year.
    (1) For this purpose, Japan Branch will show the same assets and 
liabilities on its adjusted balance sheet for December 31, year 1 as 
are described in paragraph (g)(1)(ii)(A)(2) of this section (Example 
1), but the land is treated as a marked asset as a result of the 
current rate election. The adjusted balance sheet reflects cash of 
[yen]120,000, raw land with a basis of [yen]50,000 ($500 translated 
under Sec.  1.987-2(d)(1) at the July 1, year 1 spot rate of $1 = 
[yen]100), and liabilities of [yen]10,000.
    (2) Because of the current rate election, all of Japan Branch's 
assets and liabilities are treated as marked items. Therefore, under 
paragraph (e)(2) of this section, these items are translated into 
dollars on December 31, year 1, using the spot rate on December 31, 
year 1, of $1 = [yen]120.
    (3) The OFCNV of Japan Branch on December 31, year 1, and the 
change in OFCNV of Japan Branch for year 1, is $1,333.33, determined 
below. The OFCNV (and change in OFCNV) of Japan Branch is shown below 
(together with the corresponding amounts in yen).

                    Table 3 to Paragraph (g)(2)(ii)(A)(3)--OFCNV and Change in OFCNV--Year 1
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets
    Yen.......................................         120,000  $1 = [yen]120 (spot rate-12/31/         1,000.00
                                                                 year 1).
    Land......................................          50,000  $1 = [yen]120 (spot rate-12/31/           416.67
                                                                 year 1).
                                               -----------------------------------------------------------------
        Total assets..........................         170,000  ................................        1,416.67
Liabilities
    Bank loan.................................          10,000  $1 = [yen]120 (spot rate-12/31/            83.33
                                                                 year 1).
                                               -----------------------------------------------------------------
        Total liabilities.....................          10,000  ................................           83.33
Year 1 ending net value.......................         160,000  ................................        1,333.33
Net value on the last day of the preceding                   0  ................................               0
 taxable year.
                                               -----------------------------------------------------------------
    Change in net value.......................         160,000  ................................        1,333.33
----------------------------------------------------------------------------------------------------------------

    (B) Step 2 (no adjustment). No adjustment is made under paragraph 
(d)(2) of this section (Step 2) because no assets were transferred by 
Japan Branch to U.S. Corp during the taxable year.

[[Page 78181]]

    (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan 
Branch [yen]100,000 with a basis of $1,000.00 and raw land with a basis 
of $500.00 (equal to [yen]50,000, translated under Sec.  1.987-2(d)(1) 
at the spot rate on July 31, year 1 of $1 = [yen]100). The total amount 
of assets transferred in dollars is $1,500.00, and the amount of assets 
transferred in yen is [yen]150,000. Therefore, under paragraph (d)(3) 
of this section (Step 3), the amount determined in previous steps is 
reduced by $1,500, from $1,333.33 to negative $166.67.
    (D) Steps 4 and 5 (no adjustment). No adjustment is made under 
paragraphs (d)(4) and (5) of this section (Steps 4 and 5) because no 
liabilities were transferred by U.S. Corp to Japan Branch or by Japan 
Branch to U.S. Corp during the taxable year.
    (E) Steps 6 through 9 do not apply. Under paragraph (d) of this 
section, paragraphs (d)(6) through (9) of this section (Steps 6 through 
9) do not apply because a current rate election is in effect.
    (F) Step 10--(1) Application of relevant steps in Japan Branch's 
functional currency. Under paragraph (d)(10)(iii) of this section, 
because a current rate election is in effect, the residual increase or 
decrease to the adjusted balance sheet is determined by applying 
paragraphs (d)(1) through (5) of this section (Steps 1 through 5) in 
the functional currency of the section 987 QBU. The relevant steps that 
must be applied under paragraph (d)(10) of this section in the 
functional currency of Japan Branch are paragraphs (d)(1) and (3) of 
this section (Steps 1 and 3). See paragraphs (g)(2)(ii)(A) and (C) of 
this section for amounts determined in yen. The residual increase to 
the adjusted balance sheet is determined as follows:

 Table 4 to Paragraph (g)(2)(ii)(F)(1)--Application of Relevant Steps in
                                   Yen
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Step 1: Change in net value..........................       [yen]160,000
Step 3: Subtract amount of transfers from owner to        ([yen]150,000)
 section 987 QBU.....................................
                                                      ------------------
    Residual increase or decrease to the adjusted            [yen]10,000
     balance sheet...................................
------------------------------------------------------------------------

    (2) Residual increase or decrease to the adjusted balance sheet. As 
explained in paragraph (g)(2)(ii)(F)(1) of this section, the residual 
increase to Japan Branch's adjusted balance sheet in year 1 is 
[yen]10,000. This amount, translated at the yearly average exchange 
rate of $1 = [yen]110, equals $90.91. Therefore, the amount determined 
in previous steps is reduced by $90.91, from negative $166.67 to 
negative $257.58. Accordingly, the unrecognized section 987 loss of 
Japan Branch for year 1 is $257.58.
    (3) Example 3--(i) Facts--(A) Background. The facts in year 1 are 
the same as in paragraph (g)(2) of this section (Example 2). In year 9, 
a current rate election remains in effect, U.S. Corp has net 
unrecognized section 987 loss of $1,000 with respect to Japan Branch, 
and Japan Branch does not make a remittance. On December 31, year 9, 
the adjusted balance sheet of Japan Branch shows the following assets 
and liabilities: cash of [yen]120,000; raw land with a basis of 
[yen]50,000; and liabilities of [yen]10,000. Effective for year 10, 
U.S. Corp revokes the current rate election.
    (B) Operations in year 10. In year 10, Japan Branch earns 
[yen]12,000 for providing services and incurs [yen]2,000 of related 
expenses. Japan Branch thus earns [yen]10,000 of net income in year 10. 
On December 31, year 10, the adjusted balance sheet of Japan Branch 
shows the following assets and liabilities: cash of [yen]130,000; raw 
land with a basis of [yen]50,000; and liabilities of [yen]10,000. 
Assume that the spot rate on December 31, year 9, is $1 = [yen]120; the 
spot rate on December 31, year 10, is $1 = [yen]130; and the yearly 
average exchange rate for year 10 is $1 = [yen]125. Thus, the 
[yen]12,000 of services revenue when properly translated under Sec.  
1.987-3(c)(1) at the yearly average exchange rate equals $96.00 
([yen]12,000 x ($1/[yen]125)) = $96.00). The [yen]2,000 of expenses 
translated at the same yearly average exchange rate equals $16.00 
([yen]2,000 x ($1/[yen]125) = $16.00). Thus, Japan Branch's net income 
translated into dollars equals $80. There are no transfers of assets or 
liabilities between U.S. Corp and Japan Branch in year 10.
    (ii) Analysis--(A) Determination of OFCNV for year 9. Under 
paragraph (d)(1)(iv) of this section, the OFCNV of a section 987 QBU on 
the last day of the preceding taxable year is determined based on the 
elections that were (or were not) in effect on the last day of that 
taxable year. In year 9, a current rate election was in effect. 
Therefore, in determining the OFCNV of Japan Branch for year 9, all 
assets and liabilities of Japan Branch (including the land) are treated 
as marked items. The OFCNV of Japan Branch for year 9, is $1,333.33, 
determined under paragraph (e) of this section as follows (together 
with the corresponding amounts in yen):

                            Table 5 to Paragraph (g)(3)(ii)(A)--OFCNV--End of Year 9
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets
    Yen.......................................         120,000  $1 = [yen]120 (spot rate-12/31/         1,000.00
                                                                 year 9).
    Land......................................          50,000  $1 = [yen]120 (spot rate-12/31/           416.67
                                                                 year 9).
                                               -----------------------------------------------------------------
        Total assets..........................         170,000  ................................        1,416.67
Liabilities
    Bank loan.................................          10,000  $1 = [yen]120 (spot rate-12/31/            83.33
                                                                 year 9).
                                               -----------------------------------------------------------------
        Total liabilities.....................          10,000  ................................           83.33
Year 9 ending net value.......................         160,000  ................................        1,333.33
----------------------------------------------------------------------------------------------------------------

    (B) Determination of OFCNV for year 10. In year 10, a current rate 
election is not in effect. Therefore, in determining the OFCNV of Japan 
Branch for year 10, the land owned by Japan Branch is treated as a 
historic item. Under Sec.  1.987-1(c)(3)(i)(F), the historic rate 
applicable to historic items that were properly reflected on the books 
and

[[Page 78182]]

records of Japan Branch on the last day of the last taxable year in 
which a current rate election was in effect (December 31, year 9) 
generally is equal to the spot rate applicable to that day. Therefore, 
the historic rate applicable to the land is the spot rate on December 
31, year 9. The OFCNV of Japan Branch for year 10 is $1,339.74, 
determined under paragraph (e) of this section as follows (together 
with the corresponding amounts in yen):

                            Table 6 to Paragraph (g)(3)(ii)(B)--OFCNV--End of Year 10
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets
    Yen.......................................         130,000  $1 = [yen]130 (spot rate-12/31/         1,000.00
                                                                 year 10).
    Land......................................          50,000  $1 = [yen]120 (historic rate-             416.67
                                                                 spot rate-12/31/year 9).
                                               -----------------------------------------------------------------
        Total assets..........................         180,000  ................................        1,416.67
Liabilities
    Bank loan.................................          10,000  $1 = [yen]130 (spot rate-12/31/            76.92
                                                                 year 10).
                                               -----------------------------------------------------------------
        Total liabilities.....................          10,000  ................................           76.92
Year 10 ending net value......................         170,000  ................................        1,339.74
----------------------------------------------------------------------------------------------------------------

    (C) Determination of unrecognized section 987 gain or loss for year 
10. The unrecognized section 987 gain or loss of Japan Branch for year 
10 is determined under paragraph (d) of this section as follows:
    (1) Step 1. The change in the OFCNV of Japan Branch for year 10 is 
equal to the OFCNV of Japan Branch determined in dollars on the last 
day of year 10, less the OFCNV of Japan Branch determined in dollars on 
the last day of year 9. Therefore, the change in OFCNV is equal to 
$6.41 ($1,339.74 - $1,333.33).
    (2) Steps 2 through 5 (no adjustment). No adjustment is made under 
paragraphs (d)(2) through (5) of this section (Steps 2 through 5) 
because no assets or liabilities were transferred by U.S. Corp to Japan 
Branch or by Japan Branch to U.S. Corp during the taxable year.
    (3) Step 6. Under paragraph (d)(6) of this section (Step 6), the 
amount determined in previous steps is decreased by the section 987 
taxable income of Japan Branch of $80.00, from $6.41 to negative 
$73.59.
    (4) Steps 7 through 10 (no adjustment). No adjustment is made under 
paragraphs (d)(7) through (10) of this section (Steps 7 through 10) 
because all of Japan Branch's items of income or deduction for the 
taxable year impact the adjusted balance sheet and are taken into 
account in computing taxable income. In addition, Japan Branch does not 
have a residual increase or decrease to the adjusted balance sheet 
(because the change in net value of [yen]10,000 is equal to the amount 
of Japan Branch's net income in year 10). Accordingly, the unrecognized 
section 987 loss of Japan Branch for year 10 is negative $73.59.
    (D) Determination of net unrecognized section 987 gain or loss. In 
year 10, Japan Branch has net accumulated section 987 loss of $1,000. 
Because U.S. Corp revoked the current rate election for year 10, the 
net accumulated section 987 loss of $1,000 becomes suspended section 
987 loss under Sec.  1.987-11(d)(2) and Japan Branch's net accumulated 
section 987 loss is reduced to zero. Therefore, in year 10, Japan 
Branch's net unrecognized section 987 loss is equal to $73.59, its 
unrecognized section 987 loss for year 10.
0
10. Section 1.987-5 is revised to read as follows:


Sec.  1.987-5  Recognition of section 987 gain or loss.

    (a) Recognition of section 987 gain or loss by the owner of a 
section 987 QBU. The taxable income of an owner of a section 987 QBU 
includes the owner's section 987 gain or loss recognized with respect 
to the section 987 QBU for the taxable year. Except as otherwise 
provided in Sec.  1.987-7A(c)(4)(ii), 1.987-11(c), 1.987-12(b) or (e), 
or 1.987-13(h) or (k), for any taxable year the owner's section 987 
gain or loss recognized with respect to a section 987 QBU is equal to:
    (1) The owner's net unrecognized section 987 gain or loss with 
respect to the section 987 QBU determined under Sec.  1.987-4 on the 
last day of such taxable year (or, if earlier, on the day the section 
987 QBU is terminated under Sec.  1.987-8); multiplied by
    (2) The owner's remittance proportion for the taxable year, as 
determined under paragraph (b) of this section.
    (b) Remittance proportion--(1) In general. Except as provided in 
paragraph (b)(2) of this section, the owner's remittance proportion 
with respect to a section 987 QBU for a taxable year is equal to:
    (i) The amount of the remittance, as determined under paragraph (c) 
of this section, to the owner from the section 987 QBU for such taxable 
year; divided by
    (ii) The sum of:
    (A) The aggregate adjusted basis of the gross assets of the section 
987 QBU as of the end of the taxable year that are reflected on its 
year-end balance sheet translated into the owner's functional currency 
as provided in Sec.  1.987-4(e)(2); and
    (B) The amount of the remittance, as determined under paragraph (c) 
of this section.
    (2) Annual recognition election. A taxpayer may elect to recognize 
its net unrecognized section 987 gain or loss with respect to the 
section 987 QBU on an annual basis (annual recognition election). For 
any taxable year in which the annual recognition election is in effect, 
the owner's remittance proportion with respect to a section 987 QBU is 
one. See paragraph (g) of this section for an example illustrating this 
rule. Additionally, for any taxable year of an original deferral QBU 
owner in which an annual recognition election is in effect, the 
remittance proportion with respect to any successor deferral QBU is 
one.
    (c) Remittance--(1) Definition. A remittance is determined in the 
owner's functional currency and equals the excess, if any, of:
    (i) The aggregate of all amounts transferred from the section 987 
QBU to the owner during the taxable year, as determined in paragraph 
(d) of this section; over
    (ii) The aggregate of all amounts transferred from the owner to the 
section 987 QBU during the taxable year, as determined in paragraph (e) 
of this section.
    (2) Day when a remittance is determined. An owner's remittance from 
a section 987 QBU is determined on the last day of the owner's taxable 
year (or, if earlier, on the day the section 987 QBU is terminated 
under Sec.  1.987-8).

[[Page 78183]]

    (3) Termination. A termination of a section 987 QBU as determined 
under Sec.  1.987-8 is treated as a remittance of all the gross assets 
of the section 987 QBU to the owner on the date of such termination. 
See Sec.  1.987-8(e). Accordingly, the remittance proportion in the 
case of a termination is one.
    (d) Aggregate of all amounts transferred from the section 987 QBU 
to the owner for the taxable year. For purposes of paragraph (c)(1)(i) 
of this section, the aggregate of all amounts transferred from the 
section 987 QBU to the owner for the taxable year is the aggregate 
amount of functional currency and the aggregate adjusted basis of the 
other assets transferred, as determined in the owner's functional 
currency under Sec.  1.987-4(d)(2). Solely for this purpose, the amount 
of liabilities transferred from the owner to the section 987 QBU, as 
determined in the owner's functional currency under Sec.  1.987-
4(d)(5), is treated as a transfer of assets from the section 987 QBU to 
the owner with an adjusted basis equal to the amount of such 
liabilities.
    (e) Aggregate of all amounts transferred from the owner to the 
section 987 QBU for the taxable year. For purposes of paragraph 
(c)(1)(ii) of this section, the aggregate of all amounts transferred 
from the owner to the section 987 QBU for the taxable year is the 
aggregate amount of functional currency and the aggregate adjusted 
basis of the assets transferred, as determined in the owner's 
functional currency under Sec.  1.987-4(d)(3). Solely for this purpose, 
the amount of liabilities transferred from the section 987 QBU to the 
owner determined under Sec.  1.987-4(d)(4) is treated as a transfer of 
assets from the owner to the section 987 QBU with an adjusted basis 
equal to the amount of such liabilities.
    (f) Determination of owner's adjusted basis in transferred assets 
and amount of transferred liabilities--(1) In general. The owner's 
adjusted basis in an asset or the amount of a liability received in a 
transfer from a section 987 QBU (whether or not such transfer is made 
in connection with a remittance) is determined in the owner's 
functional currency under the rules prescribed in paragraphs (f)(2) and 
(3) of this section.
    (2) Marked items. The basis of a marked asset or amount of a marked 
liability is the amount determined by translating the section 987 QBU's 
functional currency basis of the asset or amount of the liability, 
after taking into account Sec.  1.988-1(a)(10), into the owner's 
functional currency at the spot rate applicable to the date of 
transfer.
    (3) Historic items. The basis of a historic asset or amount of a 
historic liability is the amount determined by translating the section 
987 QBU's functional currency basis of the asset or amount of the 
liability, after taking into account Sec.  1.988-1(a)(10), into the 
owner's functional currency at the historic rate for the asset or 
liability.
    (g) Example. The following example illustrates the calculation of 
section 987 gain or loss under this section. For purposes of this 
example, except as otherwise indicated, assume that no section 987 
elections are in effect.
    (1) Facts--(i) U.S. Corp, a domestic corporation with the dollar as 
its functional currency, operates in the United Kingdom through 
Business A, a section 987 QBU with the pound as its functional 
currency. During year 2, the following transfers took place between 
U.S. Corp and Business A. On January 5, year 2, U.S. Corp transferred 
to Business A $300, which Business A used during the year to purchase 
services. On March 5, year 2, Business A transferred a machine to U.S. 
Corp. The pound adjusted basis of the machine when properly translated 
into dollars as described under Sec.  1.987-4(d)(2)(ii)(B) and 
paragraph (d) of this section is $500. On November 1, year 2, Business 
A transferred pounds to U.S. Corp. The dollar amount of the pounds when 
properly translated as described under Sec.  1.987-4(d)(2)(ii)(A) and 
paragraph (d) of this section is $2,300. On December 7, year 2, U.S 
Corp transferred a truck to Business A with an adjusted basis of 
$2,000.
    (ii) At the end of year 2, Business A holds assets, properly 
translated into the owner's functional currency pursuant to Sec.  
1.987-4(e)(2), consisting of a computer with a pound adjusted basis 
equivalent to $500, a truck with a pound adjusted basis equivalent to 
$2,000, and pounds equivalent to $2,850. In addition, Business A has a 
pound liability entered into in year 1 with Bank A. All such assets and 
liabilities are reflected on the books and records of Business A. 
Assume that the net unrecognized section 987 gain for Business A as 
determined under Sec.  1.987-4 as of the last day of year 2 is $80.
    (2) Analysis. U.S. Corp's section 987 gain with respect to Business 
A is determined as follows:
    (i) Computation of amount of remittance. Under paragraphs (c)(1) 
and (2) of this section, U.S. Corp must determine the amount of the 
remittance for year 2 in the owner's functional currency (dollars) on 
the last day of year 2. The amount of the remittance for year 2 is 
$500, determined as follows:

                     Table 1 to Paragraph (g)(2)(i)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
            Transfers from Business A to U.S. Corp in dollars
------------------------------------------------------------------------
Machine.................................................            $500
Pounds..................................................           2,300
                                                         ---------------
    Aggregate transfers from Business A to U.S. Corp....          $2,800
------------------------------------------------------------------------
            Transfers from U.S. Corp to Business A in dollars
------------------------------------------------------------------------
U.S. dollars............................................            $300
Truck...................................................           2,000
                                                         ---------------
    Aggregate transfers from U.S. Corp to Business A....          $2,300
------------------------------------------------------------------------
                   Computation of amount of remittance
------------------------------------------------------------------------
Aggregate transfers from Business A to U.S. Corp........          $2,800
Less: aggregate transfers from U.S. Corp to Business A..         (2,300)
                                                         ---------------
    Total remittance....................................            $500
------------------------------------------------------------------------

    (ii) Computation of section 987 QBU gross assets plus remittance. 
Under paragraph (b)(1)(ii) of this section, Business A must determine 
the aggregate basis of its gross assets that are reflected on its year-
end balance sheet translated into the owner's functional currency and 
must increase this amount by the amount of the remittance.

                     Table 2 to Paragraph (g)(2)(ii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Computer................................................            $500
Pounds..................................................           2,850
Truck...................................................           2,000
                                                         ---------------
  Aggregate gross assets................................          $5,350
Remittance..............................................            $500
Aggregate basis of Business A's gross assets at end of            $5,850
 year 2, increased by amount of remittance..............
------------------------------------------------------------------------

    (iii) Computation of remittance proportion. Under paragraph (b) of 
this section, Business A must compute the remittance proportion by 
dividing the $500 remittance amount by the $5,850 sum of the aggregate 
basis of Business A's gross assets and the amount of the remittance. 
The resulting remittance proportion is 0.085.
    (iv) Computation of section 987 gain or loss. The amount of U.S. 
Corp's section 987 gain or loss that is recognized with respect to 
Business A is determined under paragraph (a) of this section by 
multiplying the 0.085 remittance proportion by the $80 of net 
unrecognized section 987 gain. U.S. Corp's resulting recognized section 
987 gain for year 2 is $6.80.

[[Page 78184]]

    (3) Annual recognition election. If an annual recognition election 
under paragraph (b)(2) of this section were in effect for year 2, U.S. 
Corp's remittance proportion would be one. Accordingly, U.S. Corp would 
recognize all $80 of the net unrecognized section 987 gain with respect 
to Business A.
0
11. Section 1.987-6, as proposed to be amended by 81 FR 88882 (December 
8, 2016), is further amended by:
0
a. Revising paragraph (a).
0
b. Adding paragraph (b) introductory text.
0
c. Revising paragraphs (b)(1) through (3), and (c).
    The revisions and addition read as follows:


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

    (a) Ordinary income or loss. Section 987 gain or loss is ordinary 
income or loss for Federal income tax purposes.
    (b) Character and source of section 987 gain or loss. With respect 
to each section 987 QBU, the character and source of section 987 gain 
or loss is determined under this paragraph (b) for all purposes of the 
Internal Revenue Code, including sections 904(d), 907, and 954. 
References to an owner in this paragraph (b) include a partner of a 
partnership (other than a section 987 aggregate partnership) or 
shareholder of an S corporation that has section 987 gain or loss 
attributable to a section 987 QBU owned by the partnership or S 
corporation.
    (1) Timing of character and source determination. The character and 
source of section 987 gain or loss is determined based on the initial 
assignment pursuant to paragraph (b)(2)(i) of this section and may be 
reassigned in the year in which the section 987 gain or loss is 
recognized pursuant to paragraph (b)(2)(ii) of this section. The 
initial assignment is made in the earliest of the taxable years 
described in paragraphs (b)(1)(i) through (iv) of this section.
    (i) The taxable year in which the net unrecognized section 987 gain 
or loss is recognized.
    (ii) The taxable year in which the net unrecognized section 987 
loss becomes suspended section 987 loss.
    (iii) The taxable year in which the net unrecognized section 987 
gain or loss becomes deferred section 987 gain or loss.
    (iv) In the case of pretransition gain or loss that is recognized 
ratably over the transition period pursuant to the election under Sec.  
1.987-10(e)(5)(ii), the taxable year that includes the transition date.
    (2) Method for determining the character and source of section 987 
gain or loss--(i) Initial assignment--(A) In general. In a taxable year 
of the initial assignment, determined under paragraph (b)(1) of this 
section, the owner assigns gross section 987 gain or loss to the 
statutory and residual groupings in the same proportions as the 
proportions in which the tax book value of the assets of the section 
987 QBU are assigned to the groupings under the asset method in 
Sec. Sec.  1.861-9(g) and 1.861-9T(g), as modified by this paragraph 
(b)(2)(i). For purposes of applying the asset method, the owner takes 
into account only the assets that are attributed to the section 987 QBU 
under Sec.  1.987-2(b).
    (B) Special rules for applying the asset method to assign section 
987 gain or loss. For purposes of assigning gross section 987 gain or 
loss to the statutory and residual groupings under paragraph 
(b)(2)(i)(A) of this section, the proportions in which the tax book 
value of the assets of the section 987 QBU are assigned to the 
groupings described in paragraph (b)(2)(i)(A) of this section are 
determined without regard to section 987 gain or loss. Further, the 
section 987 gain or loss is assigned after any reattribution of gross 
income required under Sec.  1.904-4(f)(2)(vi) or 1.951A-
2(c)(7)(ii)(B)(2) (or the principles thereof, as applicable), but 
before the allocation and apportionment of expenses or the application 
of provisions that are based on a net income computation, such as the 
high-tax exception to passive category income in Sec.  1.904-4(c), the 
high-tax exception to foreign base company income in Sec.  1.954-1(d), 
and the high-tax exclusion from tested income in Sec.  1.951A-2(c)(7).
    (C) Section 987 gain or loss that is assigned to subpart F income 
groups treated as attributable to section 988 transactions. Section 987 
gain or loss assigned under paragraphs (b)(2)(i)(A) and (B) of this 
section to a grouping described in Sec.  1.960-1(d)(2)(ii)(B)(2)(i) 
through (v) (subpart F income groups) is treated as foreign currency 
gain or foreign currency loss attributable to section 988 transactions 
not directly related to the business needs of the controlled foreign 
corporation and is taken into account for purposes of determining the 
excess of foreign currency gains over foreign currency losses 
characterized as foreign personal holding company income under section 
954(c)(1)(D).
    (D) Section 987 gain or loss assigned to tentative tested income 
rather than tested income--(1) In general. In the case of a controlled 
foreign corporation, the initial assignment of section 987 gain or loss 
under paragraphs (b)(2)(i)(A) and (B) of this section is made as though 
the election described in Sec.  1.951A-2(c)(7)(viii) is in effect for 
the taxable year. As a result, section 987 gain or loss that would have 
initially been characterized as tested income in a section 904 category 
if no election under Sec.  1.951A-2(c)(7) was in effect is initially 
characterized as tentative tested income in the section 904 category (a 
tentative tested income group).
    (2) For purposes of the GILTI high-tax exclusion, section 987 gain 
or loss is not attributable to any tested unit. In the case of a 
controlled foreign corporation, the initial assignment of section 987 
gain or loss is made as though the section 987 gain or loss was not 
attributable to any tested unit for purposes of applying Sec.  1.951A-
2(c)(7) (GILTI high-tax exclusion). See paragraph (b)(2)(iii) of this 
section (applying the GILTI high-tax exclusion by treating all section 
987 gain or loss in the same tentative tested income group as composing 
a single tentative tested income item).
    (E) Initial assignment applies for purposes of the loss-to-the-
extent-of-gain rule. See Sec.  1.987-11(e) and (f) (grouping of section 
987 gain and loss and applying the loss-to-the-extent-of-gain rule on 
basis of the initial assignment of section 987 gain and loss under this 
paragraph (b)(2)(i)).
    (ii) Reassignment of section 987 gain or loss. In the taxable year 
in which section 987 gain or loss is recognized (determined by taking 
into account Sec. Sec.  1.987-5, 1.987-11(e), 1.987-12(c), and 1.987-
13(b) through (d), if applicable), the section 987 gain or loss is 
sourced and characterized based on the initial determination in 
paragraph (b)(2)(i)(B) of this section, but with appropriate changes to 
account for the application of provisions that are based on a net 
income computation such as the high-tax exception to passive category 
income in Sec.  1.904-4(c), the high-tax exception to foreign base 
company income in Sec.  1.954-1(d), and the high-tax exclusion to 
tested income in Sec.  1.951A-2(c)(7). Thus, for example, if an 
election under Sec.  1.951A-2(c)(7)(viii) (GILTI high-tax exclusion) is 
in effect for the taxable year, section 987 gain or loss initially 
assigned to a tentative tested income group will be reassigned to a 
tested income group (as defined in Sec.  1.960-1(d)(2)(ii)(C)) or to 
the residual income group (as defined in Sec.  1.960-1(d)(2)(ii)(D)). 
If no election is made under Sec.  1.951A-2(c)(7)(viii) for a taxable 
year, all of the section 987 gain or loss that is recognized in the 
taxable year that was initially assigned to tentative tested income 
under paragraph (b)(2)(i) of this section, is reassigned to

[[Page 78185]]

the appropriate tested income group (as defined in Sec.  1.960-
1(d)(2)(ii)(C)).
    (iii) Special rule for the application of the GILTI high-tax 
exclusion to section 987 gain or loss. Section 987 gain in a tentative 
tested income group that is recognized by a controlled foreign 
corporation in a taxable year comprises a single tentative gross tested 
income item (as if it were allocable to its own tested unit) within the 
meaning of Sec.  1.951A-2(c)(7)(ii), and section 987 loss in a 
tentative tested income group that is recognized by a controlled 
foreign corporation in the taxable year is allocated and apportioned to 
the corresponding tentative gross tested income item for purposes of 
calculating the tentative tested income item within the meaning of 
Sec.  1.951A-2(c)(7)(iii). Thus, for purposes of applying the high-tax 
exclusion in Sec.  1.951A-2(c)(7), all of the section 987 gain and loss 
in a tentative tested income group that is recognized by the controlled 
foreign corporation in a taxable year is a single tentative tested 
income item.
    (3) Allocation and apportionment of foreign income tax to section 
987 items under section 861. For purposes of applying the definition of 
a corresponding U.S. item in Sec.  1.861-20(b), an item of foreign 
gross income and an item of section 987 gain or loss are treated as 
arising from the same transaction or other realization event only if 
the requirements in both paragraphs (b)(3)(i) and (ii) of this section 
are satisfied.
    (i) The foreign gross income is an item of foreign currency gain or 
loss. The owner of the section 987 QBU, original deferral QBU owner, or 
original suspended loss QBU owner includes the foreign gross income 
under the laws of the foreign country in which it is a tax resident 
because under that foreign law it is required to recognize foreign 
currency gain or loss with respect to its interest in the section 987 
QBU or with respect to a successor deferral QBU or successor suspended 
loss QBU.
    (ii) The same event or events give rise to both the foreign gross 
income and the section 987 gain or loss. The remittance under Sec.  
1.987-5(c) that gave rise to the item of section 987 gain or loss 
comprises one or more of the events that gave rise to the item of 
foreign gross income described in paragraph (b)(3)(i) of this section.
* * * * *
    (c) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, assume that no section 987 
elections are in effect.
    (1) Example 1. CFC is a controlled foreign corporation with the 
Swiss franc (Sf) as its functional currency. CFC is the owner of 
Business A, a section 987 QBU that has the euro as its functional 
currency. For year 1, CFC does not have an election described in Sec.  
1.951A-2(c)(7)(viii) in effect, and CFC recognizes section 987 gain of 
Sf10,000 under Sec.  1.987-5. Business A has average total assets of 
Sf1,000,000 in year 1, which generate income (other than section 987 
gain) as follows: Sf750,000 of assets that produce gross income in the 
statutory grouping for general category tested income under sections 
904(d)(1)(A) and 951A; and Sf250,000 of assets that produce foreign 
source passive gross income in one of the groupings described in Sec.  
1.960-1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups). Under 
paragraphs (b)(2)(i)(A), (B), and (D) of this section, Sf7,500 
(Sf750,000/Sf1,000,000 x Sf10,000) of the section 987 gain is initially 
assigned to the statutory grouping of foreign source general category 
tentative tested income. Because an election under Sec.  1.951A-
2(c)(7)(viii) is not in effect for the taxable year in which the 
section 987 gain is recognized, the section 987 gain is reassigned 
under paragraph (b)(2)(ii) of this section to foreign source general 
category tested income. The remaining Sf2,500 (Sf250,000/Sf1,000,000 x 
Sf10,000) is characterized under paragraphs (b)(2)(i)(A) and (B) of 
this section by reference to assets that give rise to foreign source 
passive gross income in one of the groupings described in Sec.  1.960-
1(d)(2)(ii)(B)(2)(i) through (v) (subpart F income groups) and is 
therefore treated under paragraph (b)(2)(i)(C) of this section as 
foreign source foreign currency gain taken into account for purpose of 
determining foreign personal holding company income under section 
954(c)(1)(D). All of the section 987 gain is treated as ordinary 
income.
    (2) Example 2. The facts are the same as in paragraph (c)(1) of 
this section (Example 1) except that: CFC recognizes section 987 loss 
of Sf40,000, Sf10,000 of which is characterized under paragraphs 
(b)(2)(i)(A) and (B) of this section by reference to assets that give 
rise to foreign source passive gross income in one of the groupings 
described in Sec.  1.960-1(d)(2)(ii)(B)(2)(i) through (v) (subpart F 
income groups); and CFC otherwise has Sf12,000 of net foreign currency 
gain determined under Sec.  1.954-2(g) that is taken into account in 
determining the excess of foreign currency gain over foreign currency 
losses characterized as foreign personal holding company income under 
section 954(c)(1)(D). Under paragraph (b)(2)(i)(C) of this section, the 
Sf10,000 section 987 loss characterized by reference to assets that 
give rise to foreign source passive gross income in one of the 
groupings described in Sec.  1.960-1(d)(2)(ii)(B)(2)(i) through (v) 
(subpart F income groups) is treated as foreign currency loss taken 
into account under section 954(c)(1)(D) for purposes of computing 
foreign personal holding company income. Accordingly, CFC will 
aggregate the Sf10,000 section 987 loss with the Sf12,000 net foreign 
currency gain and will have Sf2,000 of net foreign currency gain 
characterized as passive foreign personal holding company income under 
section 954(c)(1)(D).


Sec.  1.987-7   [Redesignated as Sec.  1.987-7B]

0
12. Section 1.987-7 is redesignated as Sec.  1.987-7B.
0
13. Section 1.987-7A is added to read as follows:


Sec.  1.987-7A   Partnerships and S corporations that own section 987 
QBUs.

    (a) Scope and special rule--(1) In general. This section provides 
rules applicable to partnerships (other than section 987 aggregate 
partnerships) and S corporations that own section 987 QBUs and their 
partners and shareholders. Paragraph (b) of this section provides the 
general rule that partnerships are treated as owners of section 987 
QBUs. Paragraph (c) of this section provides special rules that apply 
to section 987 QBUs owned by partnerships and their partners. Paragraph 
(d) of this section provides rules for adjusting the partner's basis in 
its partnership interest for its section 987 gain or loss allocated 
from the partnership. Paragraph (e) of this section is reserved for 
rules regarding the treatment of section 987 gain or loss when a 
partner transfers or otherwise reduces its interest in a partnership. 
Paragraph (f) of this section is reserved for special rules regarding 
the source and character of section 987 gain and loss of a partner with 
respect to a section 987 QBU owned by a partnership that would apply in 
addition to Sec.  1.987-6. Paragraph (g) of this section provides that 
S corporations are treated in the same manner as partnerships for 
purposes of the section 987 regulations. Paragraph (h) of this section 
provides examples.
    (2) References to partnerships are to non-section 987 aggregate 
partnerships. For purposes of the section 987 regulations, references 
to ``partnerships'' are treated as references to partnerships that are 
not section 987 aggregate partnerships, except where the context 
otherwise requires.

[[Page 78186]]

    (b) Partnerships treated as owners of section 987 QBUs. Except as 
otherwise provided, the section 987 regulations apply to a partnership 
that is the owner of a section 987 QBU in the same manner as they apply 
to other owners of section 987 QBUs. See paragraph (c) of this section 
and Sec.  1.987-1(b)(1)(ii) (de minimis rule), providing special rules 
for partnerships that are owners of a section 987 QBU. Thus, for 
example, if a partnership owns an eligible QBU with a functional 
currency that is different from the functional currency of the 
partnership, the eligible QBU is a section 987 QBU, the partnership is 
its owner, and the unrecognized section 987 gain or loss of the section 
987 QBU for a taxable year is determined under Sec.  1.987-4(d) by 
reference to the functional currency of the partnership and the section 
987 QBU.
    (c) Section 987 QBUs owned by partnerships--(1) Annual allocation 
of a partnership's unrecognized section 987 gain or loss to its 
partners--(i) In general. This paragraph (c)(1) applies to each taxable 
year of a partnership and with respect to each section 987 QBU of the 
partnership. A partnership determines its unrecognized section 987 gain 
or loss for a taxable year under Sec.  1.987-4(d) with respect to each 
section 987 QBU. The partnership allocates to each partner the 
partner's share of the unrecognized section 987 gain or loss for a 
taxable year with respect to each section 987 QBU. The partnership 
determines each partner's share of unrecognized section 987 gain or 
loss for a taxable year under paragraph (c)(1)(ii) of this section. 
Each partner translates its share of unrecognized section 987 gain or 
loss for a taxable year into the partner's functional currency, if 
necessary, at the yearly average exchange rate for the partnership's 
taxable year.
    (ii) Determination of partner's share of unrecognized section 987 
gain or loss. A partnership determines a partner's share of any 
unrecognized section 987 gain or loss for the taxable year with respect 
to a section 987 QBU based on the partner's distributive share of 
profits or losses with respect to the section 987 QBU for the taxable 
year, as determined by the partnership agreement. The principles of 
section 706(d) apply to this determination.
    (iii) Partner-level attribute. Net unrecognized section 987 gain or 
loss, deferred section 987 gain or loss, and suspended section 987 loss 
of a partner that are attributable to a partnership are attributes of 
the partner (not the partnership). As a result, the section 987 gain or 
loss cannot be used by the partnership or any other partner, including 
any person that acquires the partner's partnership interest (other than 
in a transaction described in section 381(a)).
    (2) Net unrecognized section 987 gain or loss with respect to a 
section 987 QBU is determined at the partner level. A partner 
determines its net unrecognized section 987 gain or loss with respect 
to a section 987 QBU owned by a partnership under Sec.  1.987-4(b) and 
(c) at the partner level by taking into account the partner's share of 
unrecognized section 987 gain or loss with respect to the section 987 
QBU owned by a partnership.
    (3) Recognition (or suspension) of net unrecognized section 987 
gain or loss upon remittance. With respect to a section 987 QBU owned 
by a partnership, a person that is a partner on the last day of the 
partnership's taxable year determines the amount of its net 
unrecognized section 987 gain or loss that is recognized under Sec.  
1.987-5(a) by reference to its net unrecognized section 987 gain or 
loss with respect to the section 987 QBU (after taking into account the 
adjustments under paragraphs (c)(1) and (4) of this section) and the 
partnership's remittance proportion, as determined under Sec.  1.987-
5(a)(2).
    (4) Deferred section 987 gain or loss and suspended section 987 
loss--(i) Loss to the extent of gain rule applied at the partner level. 
The amount of suspended section 987 loss recognized and taken into 
account by a partner under Sec.  1.987-11(e) (loss to the extent of 
gain rule) is determined by reference to section 987 gain recognized by 
the partner, without regard to whether the section 987 gain is 
attributable to a section 987 QBU owned by a partnership.
    (ii) Partner- and partnership-level application of Sec. Sec.  
1.987-11 through 1.987-13--(A) Partner owns an interest in the 
partnership. During the time in which a partner or its controlled group 
owns an interest in a partnership from which it was allocated 
unrecognized section 987 gain or loss, Sec. Sec.  1.987-11 through 
1.987-13 are applied by treating the partnership as the owner, original 
deferral QBU owner, or original suspended loss QBU owner, as 
appropriate, and treating the partner's net unrecognized section 987 
gain or loss as deferred section 987 gain or loss or suspended section 
987 loss, as appropriate.
    (B) Termination of partner's interest in the partnership. If the 
partner ceases to own an interest in a partnership from which it was 
allocated unrecognized section 987 gain or loss, then each successor 
deferral QBU or successor suspended loss QBU of the partnership is 
retested under Sec.  1.987-12(b) or 1.987-13(c) and treated as if the 
partner had transferred the eligible QBU to its actual owner 
immediately after the partner ceased to own an interest in the 
partnership. Accordingly, if the owner of the eligible QBU is not a 
member of the partner's controlled group, the partner may recognize its 
deferred section 987 gain or loss or suspended section 987 loss to the 
extent provided in Sec.  1.987-12(b) or 1.987-13(c).
    (5) Section 987 elections--(i) Elections made by the partnership. 
Except as provided in paragraph (c)(6)(ii) of this section, section 987 
elections are made by the partnership and apply to the partnership and 
section 987 gain or loss attributable to the partnership. See section 
703(b); see also Sec.  1.987-1(g) (additional rules regarding section 
987 elections).
    (ii) Elections made by partner--(A) Annual recognition election in 
certain cases. If a person ceases to be a partner in a partnership and 
becomes an original deferral QBU owner or original suspended loss QBU 
owner, that person (and not the partnership) may make the annual 
recognition election under Sec.  1.987-5(b)(2) with respect to its 
deferred section 987 gain or loss or suspended section 987 loss that 
was originally attributable to a section 987 QBU of the partnership.
    (B) Election to recognize pretransition section 987 gain or loss 
ratably. The election to recognize pretransition section 987 gain or 
loss ratably over the transition period under Sec.  1.987-10(e)(5)(ii) 
is made by a partner, and not the partnership.
    (d) Basis adjustments--(1) In general. When, and to the extent 
that, a partner recognizes section 987 gain or loss, defers section 987 
gain or loss, or suspends section 987 loss attributable to the 
partnership, the partner's adjusted basis in the partnership is 
adjusted under the principles of section 705 as if the item of income 
or loss was part of the partner's distributive share of partnership 
items.
    (2) Tiered-partnership structures. If a partner (upper-tier 
partner) that adjusts its basis in a partnership under paragraph (d)(1) 
of this section owns the partnership indirectly through one or more 
other partnerships, the partner adjusts its basis in the partnership in 
which it owns a direct interest, and that partnership adjusts its basis 
in the partnership in which it owns a direct interest, with similar 
rules applying to each successive partnership through which the upper-
tier partner owns its interest in the lower-tier partnership to which 
the section 987 gain or loss was

[[Page 78187]]

attributable. The adjustment with respect to an interest in a lower-
tier partnership constitutes a basis adjustment solely with respect to 
the partner that adjusts its basis in the upper-tier partnership under 
paragraph (d)(1) of this section.
    (e) through (f) [Reserved]
    (g) S corporations treated as partnerships. For purposes of the 
section 987 regulations, S corporations are treated in the same manner 
as partnerships and shareholders of S corporations are treated in the 
same manner as partners of partnerships. Thus, for example, if an S 
corporation is the owner of a section 987 QBU, the unrecognized section 
987 gain or loss of the section 987 QBU would be allocated annually to 
its shareholders.
    (h) Examples. The following examples illustrate the principles of 
this section. For purposes of these examples, DC1 and DC2 are domestic 
corporations, FC1 and FC2 are controlled foreign corporations that use 
the euro as their functional currency, DE1 and DE2 are disregarded 
entities, Business A is an eligible QBU that has the euro as its 
functional currency, and Business B is an eligible QBU that has the 
pound as its functional currency. Each person is a calendar year 
taxpayer. Except as otherwise indicated, no section 987 elections are 
in effect during any of the periods described in the examples. Exchange 
rates used in these examples are selected for the purpose of 
illustrating the principles of this section and no inference is 
intended by their use.
    (1) Example 1--(i) Facts. DC1 wholly owns FC1 and DC2 wholly owns 
FC2. FC1 and FC2 are not related within the meaning of section 267(b) 
or 707(b). FC1 and FC2 each own a 50 percent interest in P, a foreign 
partnership. P owns 100 percent of DE1, which owns Business A. P also 
owns 100 percent of DE2, which owns Business B. The partnership 
agreement provides that FC1 and FC2 will each be allocated 50 percent 
of the profits and losses from both Business A and Business B. P's 
functional currency is the euro.
    (ii) Analysis. Because P's two partners, FC1 and FC2, are not 
related within the meaning of section 267(b) or 707(b), P is not 
treated as a section 987 aggregate partnership under Sec.  1.987-1(h). 
As a result, pursuant to Sec.  1.987-1(b)(5), P is the owner of 
Business A and Business B because it has direct ownership of Business A 
and Business B, each of which is an eligible QBU. Because Business A is 
an eligible QBU with the same functional currency as its owner, P, 
Business A is not a section 987 QBU Sec.  1.987-1(b)(3)(i). However, 
Business B is an eligible QBU with a functional currency that is 
different from the functional currency of its owner, P. As a result, 
Business B is a section 987 QBU under Sec.  1.987-1(b)(3)(i), and P is 
its owner under Sec.  1.987-1(b)(5) and paragraph (b) of this section.
    (2) Example 2--(i) Facts. The facts are the same as in paragraph 
(h)(1) of this section (Example 1). In year 1, P has unrecognized 
section 987 gain (determined under Sec.  1.987-4(d)) with respect to 
Business B of [euro]100. In year 2, P has unrecognized section 987 loss 
with respect to Business B of [euro]60. In year 3, P has unrecognized 
section 987 loss with respect to Business B of [euro]120. In year 3, 
Business B transfers [euro]50 to P on December 31. Following the 
transfer, its gross assets are [euro]450. There are no other transfers 
between Business B and P in year 3.
    (ii) Analysis--(A) Partner's net unrecognized section 987 gain or 
loss. Pursuant to paragraph (c)(1) of this section, in each of years 1, 
2, and 3, P allocates to FC1 and FC2 their respective shares of the 
unrecognized section 987 gain or loss for the P taxable year with 
respect to its section 987 QBU, Business B. FC1 and FC2's share of the 
unrecognized section 987 gain or loss in each taxable year is based on 
their distributive share of the profits or losses with respect to 
Business B. Accordingly, in year 1, P allocates unrecognized section 
987 gain of [euro]50 to each of FC1 and FC2; in year 2, P allocates 
unrecognized section 987 loss of [euro]30 to each of FC1 and FC2; and 
in year 3, P allocates unrecognized section 987 loss of [euro]60 to 
each of FC1 and FC2. As a result, in year 3, before taking into account 
any amount recognized under Sec.  1.987-5, FC1 and FC2 each have net 
unrecognized section 987 loss with respect to Business B of [euro]40 
([euro]50-[euro]30-[euro]60) under Sec.  1.987-4(b) and paragraphs 
(c)(1) and (2) of this section.
    (B) Recognition of section 987 loss. Because Business A distributed 
[euro]50 to P in year 3, P's remittance proportion is 10 percent 
([euro]50 over the sum of [euro]450 and [euro]50) under Sec.  1.987-
5(b). As a result, each partner, FC1 and FC2, recognizes 10 percent of 
its net unrecognized section 987 loss with respect to Business B under 
Sec.  1.987-5(a) and paragraph (c)(3) of this section. Accordingly, FC1 
and FC2 each recognize [euro]4 ([euro]40 x 10 percent) section 987 loss 
in year 3 and have net accumulated unrecognized section 987 loss of 
[euro]36 ([euro]40-[euro]4) in year 4. FC1's adjusted basis in its 
partnership interest is reduced by [euro]4 and FC2's adjusted basis in 
its partnership interest is reduced by [euro]4 under the principles of 
section 705, under paragraph (d)(1) of this section.
    (3) Example 3--(i) The facts are the same as in paragraph (h)(2) of 
this section (Example 2), except that in years 1 through 3, FC1 has a 
current rate election in effect and FC2 has an annual recognition 
election in effect.
    (ii) Analysis. The analysis is the same as in paragraph (h)(2) of 
this section (Example 2). Because P does not have a current rate 
election in effect, FC1 can recognize the section 987 loss of [euro]4 
in year 3 without limitation under Sec.  1.987-11(e) pursuant to 
paragraph (c)(5)(i) of this section. Similarly, because P does not have 
an annual recognition election in effect, while FC2 is a partner in P, 
FC2 does not recognize its section 987 gain or loss with respect to 
Business B on an annual basis pursuant to paragraphs (c)(5)(i) and 
(c)(5)(ii)(A) of this section.
    (4) Example 4--(i) Facts. The facts are the same as in paragraph 
(h)(2) of this section (Example 2), except that FC2 has the Japanese 
yen as its functional currency during all relevant time periods. The 
yearly average exchange rate is [euro]1 = [yen]150 in year 1; [euro]1 = 
[yen]175 in year 2; and [euro]1 = [yen]125 in year 3.
    (ii) Analysis. Each year, FC2 converts its share of P's 
unrecognized section 987 gain or loss into yen at the yearly average 
exchange rate pursuant to paragraph (c)(1)(i) of this section. As a 
result, in year 1, FC2's share of the unrecognized section 987 gain 
with respect to Business B is [yen]7,500 ([euro]50 section 987 gain 
converted to yen at the yearly average exchange rate of [euro]1 = 
[yen]150); in year 2, FC2's share of the unrecognized section 987 loss 
with respect to Business B is [yen]5,250 ([euro]30 section 987 loss 
converted to yen at the yearly average exchange rate of [euro]1 = 
[yen]175); and in year 3, FC2's share of the unrecognized section 987 
loss with respect to Business B is [yen]7,500 ([euro]60 section 987 
loss converted to yen at the yearly average exchange rate of [euro]1 = 
[yen]125). In year 3, FC2's net unrecognized section 987 loss with 
respect to Business B is [yen]5,250 ([yen]7,500-[yen]5,250-[yen]7,500). 
As explained in paragraph (h)(2)(i)(B) of this section (Example 2), P's 
remittance proportion with respect to Business B is 10 percent. 
Therefore, FC2 recognizes section 987 loss of [yen]525 under Sec.  
1.987-5(a) and paragraph (c)(3) of this section. FC2's net accumulated 
unrecognized section 987 loss with respect to Business B in year 4 is 
[yen]4,725 ([yen]5250-[yen]525). FC2's adjusted basis in its 
partnership interest is reduced by [yen]525 under the principles of 
section 705, under paragraph (d)(1) of this section.

[[Page 78188]]

Sec.  1.987-7B   [Amended]

0
14. In newly redesignated Sec.  1.987-7B amend paragraph (a) by 
removing the language ``Sec.  1.987-1(b)(4)(ii)'' and adding the 
language ``Sec.  1.987-1(b)(5)(ii)'' in its place.
0
15. Section 1.987-7C is added to read as follows:


Sec.  1.987-7C   Transitioning between partnership and section 987 
aggregate partnership treatment.

    (a) In general. This section provides rules for when a partnership 
becomes or ceases to be a section 987 aggregate partnership. Paragraph 
(b) of this section provides transition rules regarding partnerships 
that cease to be section 987 aggregate partnerships but continue to be 
partnerships. Paragraph (c) of this section provides transition rules 
regarding partnerships that were not section 987 aggregate partnerships 
but become section 987 aggregate partnerships. See Sec.  1.987-1(h) for 
the definition of a section 987 aggregate partnership.
    (b) Partnership ceases to be a section 987 aggregate partnership--
(1) In general. Solely for purposes of section 987, when a partnership 
ceases to be a section 987 aggregate partnership but continues to be a 
partnership, each eligible QBU (pre-termination QBU) of a partner owned 
indirectly through the section 987 aggregate partnership is deemed to 
terminate and transfer all its assets and liabilities to the 
partnership (the deemed termination) and the partnership is then 
treated as forming each of its eligible QBUs (each, a post-termination 
QBU) and transferring to each post-termination QBU the assets and 
liabilities of the post-termination QBU (including those assets and 
liabilities that were assets and liabilities of a pre-termination QBU).
    (2) Section 987 gain or loss with respect to pre-termination QBU. 
Notwithstanding the deemed termination described in paragraph (b)(1) of 
this section, if, immediately before the deemed termination, a partner 
had any net unrecognized section 987 gain or loss or suspended section 
987 loss with respect to a pre-termination QBU that was a section 987 
QBU, and after the deemed termination, the assets and liabilities of 
the pre-termination QBU are assets and liabilities of a post-
termination QBU, then either paragraph (b)(2)(i) or (ii) of this 
section applies.
    (i) Post-termination QBU is a section 987 QBU. If the post-
termination QBU is a section 987 QBU, then--
    (A) Section 1.987-12 (deferral of section 987 gain and loss) does 
not apply to the deemed termination; and
    (B) The partner's net unrecognized section 987 gain or loss or 
suspended section 987 loss with respect to the pre-termination QBU is 
not recognized and instead becomes net unrecognized section 987 gain or 
loss or suspended section 987 loss with respect to the post-termination 
QBU that is treated as having been allocated to the partner by the 
partnership.
    (ii) Post-termination QBU is not a section 987 QBU. If paragraph 
(b)(2)(i) of this section does not apply, then Sec.  1.987-13 (rules 
relating to suspended section 987 loss upon termination) is applied to 
the transactions described in paragraph (b)(1) of this section as if 
the partner had transferred the assets and liabilities of the pre-
termination QBU to the partnership. Thus, if the partner had suspended 
section 987 loss with respect to the pre-termination QBU, Sec.  1.987-
13(b) may apply to the deemed transfer and the post-termination QBU may 
be a successor suspended loss QBU. See Sec. Sec.  1.987-5, 1.987-8, 
1.987-11, and 1.987-13 for rules regarding when section 987 gain or 
loss is recognized on terminations.
    (3) Successor deferral QBUs and successor suspended loss QBUs. If a 
section 987 aggregate partnership ceases to be a section 987 aggregate 
partnership (the transition)--
    (i) If any pre-termination QBU was a successor deferral QBU before 
the transition, the successor deferral QBU is treated as transferring 
its assets and liabilities to the post-termination QBU that holds the 
assets and liabilities after the transition for purposes of Sec. Sec.  
1.987-12 and 1.987-13. See Sec.  1.987-12(c)(2).
    (ii) If any pre-termination QBU was a successor suspended loss QBU 
before the transition, the successor suspended loss QBU is treated as 
transferring its assets and liabilities to the post-termination QBU 
that hold the assets and liabilities after the transition for purposes 
of Sec.  1.987-13. See Sec.  1.987-13(c).
    (4) Timing. If a partnership ceases to be a section 987 aggregate 
partnership within the meaning of Sec.  1.987-1(h), the partnership 
continues to be treated as a section 987 aggregate partnership until 
this paragraph (b) is applied. This paragraph (b) is applied 
immediately after the transaction (or series of transactions) or event 
(or series of events) that causes the partnership to cease to be a 
section 987 aggregate partnership (the transition). Thus, for example, 
if person acquires an interest in a section 987 aggregate partnership 
from a partner, and the person is not related to the other partners 
within the meaning of section 267(b) or 707(b), first the section 987 
regulations (such as Sec.  1.987-2(c)(5)) are applied to the transition 
as if the partnership continued to be a section 987 aggregate 
partnership; then this paragraph (b) applies to the partnership and its 
partners (including the acquiring partner) and the partnership ceases 
to be a section 987 aggregate partnership.
    (c) Partnership becomes a section 987 aggregate partnership--(1) In 
general. Solely for purposes of section 987, when a partnership that 
was not a section 987 aggregate partnership becomes a section 987 
aggregate partnership, each eligible QBU (pre-termination QBU) of the 
partnership is deemed to terminate and transfer all of its assets and 
liabilities to the partnership (the deemed termination) and the 
partnership is treated as forming each eligible QBU (post-termination 
QBU) that is indirectly owned by a partner (the partner-owner) and 
transferring to each post-termination QBU the partner-owner's share of 
the assets and liabilities of the partnership's eligible QBU .
    (2) Section 987 gain or loss with respect to pre-termination QBU. 
Notwithstanding the deemed termination described in paragraph (c)(1) of 
this section, if a partner-owner had any net unrecognized section 987 
gain or loss or suspended section 987 loss with respect to a pre-
termination QBU that was a section 987 QBU, then either paragraph 
(c)(2)(i) or (ii) of this section applies.
    (i) Post-termination QBU is a section 987 QBU. If, after the deemed 
termination, the partner-owner's indirectly owned post-termination QBU 
that relates to its share of the assets and liabilities of the pre-
termination QBU is a section 987 QBU of the partner-owner, then--
    (A) Section 1.987-12 does not apply to the deemed termination of 
the pre-termination QBU; and
    (B) The partner-owner's net unrecognized section 987 gain or loss 
or suspended section 987 loss with respect to the pre-termination QBU 
is not recognized and instead becomes net unrecognized section 987 gain 
or loss or suspended section 987 loss with respect to the post-
termination QBU.
    (ii) Post-termination QBU is not a section 987 QBU. If paragraph 
(c)(2)(i) of this section does not apply, then paragraphs (c)(2)(ii)(A) 
and (B) of this section are applied sequentially.
    (A) First, paragraph (c)(2)(i) of this section is applied as if the 
post-termination QBU was a section 987 QBU (the deemed section 987 QBU) 
after the deemed termination.
    (B) Second, the section 987 regulations are applied as if the 
deemed

[[Page 78189]]

section 987 QBU had transferred its assets and liabilities to the post-
termination QBU. Thus, if the partner-owner had suspended section 987 
loss with respect to the pre-termination QBU, Sec.  1.987-13(b) may 
apply to the deemed transfer and the post-termination QBU may be a 
successor suspended loss QBU. See Sec. Sec.  1.987-5, 1.987-8, 1.987-
11, and 1.987-13 for rules regarding when section 987 gain or loss is 
recognized on terminations.
    (3) Successor deferral QBUs and successor suspended loss QBUs. If a 
partnership that was not a section 987 aggregate partnership becomes a 
section 987 aggregate partnership (the transition)--
    (i) If the partnership owned any successor deferral QBUs before the 
transition, each successor deferral QBU is treated as transferring its 
assets and liabilities to the indirectly owned QBUs that hold the 
assets and liabilities after the transition for purposes of Sec. Sec.  
1.987-12 and 1.987-13. See Sec.  1.987-12(c)(2).
    (ii) If the partnership owned any successor suspended loss QBUs 
before the transition, each successor suspended loss QBU is treated as 
transferring its assets and liabilities to the indirectly owned QBUs 
that hold the assets and liabilities after the transition for purposes 
of Sec.  1.987-13. See Sec.  1.987-13(c).
    (iii) If the partnership was an original deferral QBU owner with 
respect to a successor deferral QBU before the transition, each partner 
that has deferred section 987 gain or loss with respect to the 
successor deferral QBU becomes an original deferral QBU owner with 
respect to the successor deferral QBU for purposes of Sec.  1.987-12.
    (iv) If the partnership was an original suspended loss QBU owner 
with respect to a successor suspended loss QBU before the transition, 
each partner that has suspended section 987 loss with respect to the 
successor suspended loss QBU becomes an original suspended loss QBU 
owner with respect to the successor suspended loss QBU.
    (4) Timing. If a partnership that was not a section 987 aggregate 
partnership becomes a section 987 aggregate partnership within the 
meaning of Sec.  1.987-1(h), the partnership is not treated as a 
section 987 aggregate partnership until this paragraph (c) is applied. 
This paragraph (c) is applied immediately after the transaction (or 
series of transactions) or event (or series of events) that causes the 
partnership to become a section 987 aggregate partnership (the 
transition). Thus, for example, if a person acquires an interest in a 
partnership that is not a section 987 aggregate partnership from a 
partner, and as a result of the acquisition, all of the partners are 
related within the meaning of section 267(b) or 707(b), first the 
section 987 regulations (such as Sec.  1.987-7A(e)) are applied to the 
transition as if the partnership was not a section 987 aggregate 
partnership; then this paragraph (c) applies to the partnership and its 
partners (including the acquiring partner) and the partnership becomes 
a section 987 aggregate partnership.
0
16. Section 1.987-8 is amended by:
0
a. Adding a fourth sentence after the third sentence in paragraph (a);
0
b. Revising paragraph (b) introductory text;
0
c. In paragraph (b)(2) in the second sentence removing the language 
``shall be'' and adding the language ``is'' in its place and revising 
the last sentence;
0
d. In paragraph (b)(3) in the first sentence removing the language 
``(as defined in section 957)'';
0
e. Adding paragraphs (b)(5) and (6);
0
f. Revising paragraph (c);
0
g. In paragraph (d) removing the text ``For further guidance, see Sec.  
1.987-8T(d)'';
    h. Revising the second and third sentences in paragraph (e);
0
i. Designating Examples 1 through 7 of paragraph (f) as paragraphs 
(f)(1) through (7).
0
j. In newly designated paragraph (f)(1):
0
i. Removing the language ``2021'' wherever it appears and adding the 
language ``year 1'' in its place; and
0
ii. Removing the language ``2022'' wherever it appears and adding the 
language ``year 2'' in its place;
0
k. Adding the language ``the'' before ``Business A section 987 QBU'' in 
the last sentence of newly designated paragraph (f)(1)(ii);
0
l. Revising newly designated paragraph (f)(3);
0
m. In newly designated paragraph (f)(4)(i), removing the language 
``transfers'' and adding the language ``distributes'' in its place;
0
n. Removing and reserving newly designated paragraph (f)(5);
0
o. In newly designated paragraph (f)(6):
0
i. Removing the language ``2021'' wherever it appears and adding the 
language ``year 1'' in its place; and
0
ii. Removing the language ``2026'' wherever it appears and adding the 
language ``year 6'' in its place;
0
p. In newly designated paragraph (f)(6)(ii)(A), removing the language 
``Sec.  1.987-1(b)(4)(i)'' and adding the language ``Sec.  1.987-
1(b)(5)'' in its place.
    The revisions and additions read as follows:


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

    (a) * * * Paragraph (d) of this section is reserved. * * *.
    (b) In general. Except as provided in paragraph (c) of this 
section, a section 987 QBU terminates if the conditions described in 
any one of paragraphs (b)(1) through (6) of this section are satisfied.
* * * * *
    (2) * * * See paragraphs (f)(2), (5), and (6) of this section 
(Examples 2, 5, and 6).
* * * * *
    (5) Section 987 QBU ceases to be an eligible QBU with a functional 
currency different from its owner. The section 987 QBU ceases to be an 
eligible QBU that has a functional currency different from its owner. 
See also Sec.  1.985-5(d)(2) (section 987 QBU changes its functional 
currency to that of its owner) and (e)(4)(iii) (owner changes its 
functional currency to that of its section 987 QBU).
    (6) Change in form of ownership. The owner of the section 987 QBU 
changes its form of ownership of the section 987 QBU from direct 
ownership to indirect ownership, or from indirect ownership to direct 
ownership.
    (c) Transactions described in section 381(a)--(1) Liquidations. 
Notwithstanding paragraph (b) of this section, a termination does not 
occur when the owner (distributor) of a section 987 QBU ceases to exist 
in a liquidation described in section 332 pursuant to which it 
transfers the section 987 QBU to another corporation (distributee), 
except in the following cases:
    (i) The distributor is a domestic corporation and the distributee 
is a foreign corporation.
    (ii) The distributor is a foreign corporation and the distributee 
is a domestic corporation.
    (iii) The distributor and the distributee are both foreign 
corporations and the functional currency of the distributee is the same 
as the functional currency of the distributor's section 987 QBU.
    (2) Reorganizations. Notwithstanding paragraph (b) of this section, 
a termination does not occur when the owner (transferor) of the section 
987 QBU ceases to exist in a reorganization described in section 
381(a)(2) pursuant to which it transfers the section 987 QBU to another 
corporation (acquiring corporation), except in the following cases:
    (i) The transferor is a domestic corporation and the acquiring 
corporation is a foreign corporation.

[[Page 78190]]

    (ii) The transferor is a foreign corporation and the acquiring 
corporation is a domestic corporation.
    (iii) The transferor is a controlled foreign corporation 
immediately before the transfer, the acquiring corporation is a foreign 
corporation that is not a controlled foreign corporation immediately 
after the transfer, and the acquiring corporation was related to the 
transferor within the meaning of section 267(b) immediately before the 
transfer.
    (iv) The transferor and the acquiring corporation are foreign 
corporations and the functional currency of the acquiring corporation 
is the same as the functional currency of the transferor's section 987 
QBU.
* * * * *
    (e) * * * Thus, except as otherwise provided in the section 987 
regulations, a termination generally results in the recognition of any 
net unrecognized section 987 gain or loss of the section 987 QBU 
(unless it is treated as deferred section 987 gain or loss or suspended 
section 987 loss). See Sec. Sec.  1.987-5(c)(3) (generally recognizing 
section 987 gain or loss on a termination) and 1.987-11 through 1.987-
13 (suspending section 987 gain or loss and deferring section 987 loss 
in certain instances).
    (f) * * *
    (3) Example 3. Cessation of controlled foreign corporation status--
(i) Facts. Foreign parent (FP) is a foreign corporation that owns all 
the stock of U.S. Corp, a domestic corporation. U.S. Corp owns all of 
the stock of FC, a controlled foreign corporation as defined in section 
957. FC is the owner of Business A. U.S. Corp liquidates into FP. FC no 
longer constitutes a controlled foreign corporation after the 
liquidation.
    (ii) Analysis. Because FC ceases to qualify as a controlled foreign 
corporation as a result of a transaction after which persons that were 
related to FC within the meaning of section 267(b) immediately before 
the transaction collectively own sufficient interests in FC such that 
FC would continue to be considered a controlled foreign corporation if 
such persons were United States shareholders within the meaning of 
section 951(b), the Business A section 987 QBU terminates pursuant to 
paragraph (b)(3) of this section.
* * * * *
0
17. Section 1.987-9 is revised to read as follows:


Sec.  1.987-9   Recordkeeping requirements.

    (a) In general. An owner (or the authorized person on behalf of an 
owner) must keep a copy of each section 987 election made by or on 
behalf of an owner (if not required to be made on a form published by 
the Commissioner) and reasonable records sufficient to establish a 
section 987 QBU's taxable income or loss and section 987 gain or loss.
    (b) Supplemental information. A person's obligation to maintain 
records under section 6001 and paragraph (a) of this section is not 
satisfied unless the following information is maintained in those 
records with respect to each section 987 QBU, successor deferral QBU, 
and successor suspended loss QBU for each taxable year:
    (1) The amount of the items of income, gain, deduction, or loss 
attributed to the section 987 QBU in the functional currency of the 
section 987 QBU and its owner.
    (2) The adjusted balance sheet of the section 987 QBU in the 
functional currency of the section 987 QBU and its owner.
    (3) The exchange rates used to translate items of income, gain, 
deduction, or loss of the section 987 QBU into the owner's functional 
currency and, if a spot rate convention is used, the manner in which 
the convention is determined.
    (4) The exchange rates used to translate the assets and liabilities 
of the section 987 QBU into the owner's functional currency and, if a 
spot rate convention is used, the manner in which the convention is 
determined.
    (5) The amount of assets and liabilities transferred by the owner 
to the section 987 QBU determined in the functional currency of the 
owner.
    (6) The amount of assets and liabilities transferred by the section 
987 QBU to the owner determined in the functional currency of the 
owner.
    (7) The amount of the unrecognized section 987 gain or loss for the 
taxable year.
    (8) The amount of the net accumulated unrecognized section 987 gain 
or loss at the close of the taxable year.
    (9) The amount of a remittance and the remittance proportion for 
the taxable year.
    (10) The computations required under Sec. Sec.  1.861-9(g) and 
1.861-9T(g) for purposes of sourcing and characterizing section 987 
gain or loss, deferred section 987 gain or loss, or suspended section 
987 loss under Sec.  1.987-6.
    (11) The cumulative suspended section 987 loss in each recognition 
grouping.
    (12) The outstanding deferred section 987 gain or loss in each 
recognition grouping.
    (13) The transition information required to be determined under 
Sec.  1.987-10(k).
    (c) Retention of records. The records required by this section, or 
records that support the information required on a form published by 
the Commissioner regarding section 987, must be maintained and kept 
available for inspection by the Internal Revenue Service for so long as 
the contents thereof may become relevant in the administration of the 
Internal Revenue Code.
    (d) Information on a dedicated section 987 form. Information 
necessary to determine section 987 gain or loss and section 987 taxable 
income or loss must be reported on a form prescribed for that purpose 
in accordance with the instructions accompanying that form. A taxpayer 
satisfies its obligation described in paragraphs (a) and (b) of this 
section to the extent that the taxpayer provides the specific 
information required on Form 8858 (or its successor) or other form 
prescribed for this purpose (including the information required by the 
instructions accompanying those forms).
0
18. Section 1.987-10 is revised to read as follows:


Sec.  1.987-10   Transition rules.

    (a) Overview--(1) In general. This section provides transition 
rules for the first taxable year in which the section 987 regulations 
apply. This paragraph (a) provides an overview of this section. 
Paragraph (b) of this section describes the scope of this section's 
application. Paragraph (c) of this section provides rules for 
determining the transition date. Paragraph (d) of this section provides 
rules relating to the application of the section 987 regulations after 
the transition date. Paragraph (e) of this section provides rules 
relating to the determination and recognition of pretransition gain or 
loss. Paragraph (f) of this section provides special rules for section 
987 QBUs to which the fresh start transition method was applied. 
Paragraph (g) of this section provides transition rules relating to 
partnerships. Paragraph (h) of this section provides rules relating to 
the source and character of pretransition gain or loss. Paragraph (i) 
of this section is reserved. Paragraph (j) of this section provides 
adjustments to avoid double counting or omissions. Paragraph (k) of 
this section provides reporting requirements that apply in the taxable 
year beginning on the transition date. Paragraph (l) of this section 
provides examples illustrating the rules of this section.
    (2) Terms defined under prior Sec.  1.987-12. For purposes of this 
section, the

[[Page 78191]]

terms deferral QBU, deferral QBU owner, successor QBU, outbound loss 
QBU, outbound section 987 loss, and qualified successor have the 
meaning provided in prior Sec.  1.987-12.
    (b) Scope--(1) Owner of a section 987 QBU. Except as provided in 
paragraph (f) of this section, any person that is an owner of a section 
987 QBU on the applicable transition date must apply the rules of this 
section with respect to the section 987 QBU.
    (2) Deferral QBU owner and owner of outbound loss QBU. Except as 
provided in paragraph (f) of this section, a deferral QBU owner or the 
owner of an outbound loss QBU must apply the rules of this section with 
respect to the deferral QBU or outbound loss QBU if the deferral event 
or outbound loss event occurred before the applicable transition date.
    (c) Transition date--(1) In general. Except as provided in 
paragraph (c)(2) of this section, the transition date for a section 987 
QBU, deferral QBU, or outbound loss QBU is the first day of the first 
taxable year described in Sec.  1.987-14(a)(1), (b), or (c) to which 
this section applies.
    (2) Terminating QBU. With respect to a terminating QBU, the 
transition date is the termination date, and this section is applied 
immediately before the termination. Until the transition date described 
in paragraph (c)(1) of this section, the owner of the terminating QBU 
must apply the section 987 regulations with respect to the terminating 
QBU, and any section 987 gain or loss attributable thereto, without 
regard to any section 987 elections.
    (d) Application of the section 987 regulations after the transition 
date--(1) Owner functional currency net value on the last day of the 
preceding taxable year. Except as provided in paragraph (f) of this 
section, for purposes of applying Sec.  1.987-4 in the taxable year 
beginning on the transition date, the owner functional currency net 
value of a section 987 QBU on the last day of the preceding taxable 
year under Sec.  1.987-4(d)(1)(B) is determined by translating the 
assets and liabilities that are attributable to the section 987 QBU on 
the day before the transition date into the owner's functional currency 
at the spot rate applicable to the day before the transition date.
    (2) Determination of historic rate and adjustments required under 
the simplified inventory method. If a current rate election is not in 
effect for the taxable year beginning on the transition date, the 
historic rate for historic items that are attributable to a section 987 
QBU on the day before the transition date (other than non-LIFO 
inventory subject to the simplified inventory method under Sec.  1.987-
3(c)(2)(iv)(A)) is the spot rate applicable to the day before the 
transition date. The exchange rates used to apply Sec.  1.987-3(c)(3) 
(adjustments required under the simplified inventory method) are 
determined as though a current rate election was in effect for the 
previous taxable year and was revoked for the taxable year beginning on 
the transition date.
    (e) Pretransition gain or loss--(1) In general. Except as provided 
in paragraph (f) of this section, pretransition gain or loss is 
determined and recognized under this paragraph (e).
    (2) Amount of pretransition gain or loss for an owner that applied 
an eligible pretransition method--(i) Owner of a section 987 QBU. If an 
owner of a section 987 QBU applied an eligible pretransition method 
with respect to the section 987 QBU, the amount of pretransition gain 
or loss with respect to the section 987 QBU is equal to the sum of the 
deemed termination amount described in paragraph (e)(2)(i)(A) of this 
section and the owner functional currency net value adjustment 
described in paragraph (e)(2)(i)(B) of this section. See paragraphs 
(l)(1) through (3) of this section (Examples 1 through 3) for an 
illustration of this rule.
    (A) Deemed termination amount. The deemed termination amount is the 
amount of section 987 gain or loss that would have been recognized by 
the owner under the eligible pretransition method if the section 987 
QBU terminated and transferred all of its assets and liabilities to the 
owner on the day before the transition date and prior Sec.  1.987-12 
did not apply.
    (B) Owner functional currency net value adjustment. The owner 
functional currency net value adjustment may be either positive or 
negative and is equal to the amount described in paragraph 
(e)(2)(i)(B)(1) of this section reduced by the amount described in 
paragraph (e)(2)(i)(B)(2) of this section.
    (1) The basis of the assets, reduced by the amount of liabilities, 
that are attributable to the section 987 QBU on the day before the 
transition date, translated into the owner's functional currency at the 
spot rate applicable to the day before the transition date.
    (2) The basis of the assets, reduced by the amount of liabilities, 
that are attributable to the section 987 QBU on the day before the 
transition date, translated into the owner's functional currency at the 
pretransition translation rate on the day before the transition date.
    (C) Pretransition translation rate. The pretransition translation 
rate is the rate that would be used under the eligible pretransition 
method to determine the basis of an asset or the amount of a liability 
in the hands of the owner of a section 987 QBU if the section 987 QBU 
transferred all of its assets and liabilities to the owner.
    (ii) Deferral QBU owner. If a deferral QBU owner applied an 
eligible pretransition method with respect to the deferral QBU, the 
amount of pretransition gain or loss with respect to the deferral QBU 
is equal to the deferred section 987 gain or loss (determined under 
prior Sec.  1.987-12) that was not recognized before the transition 
date with respect to the deferral QBU.
    (iii) Owner of an outbound loss QBU. If the owner of an outbound 
loss QBU applied an eligible pretransition method with respect to the 
outbound loss QBU, the pretransition loss with respect to the outbound 
loss QBU is equal to the outbound section 987 loss that was not added 
to the basis of stock or recognized under prior Sec.  1.987-12 before 
the transition date with respect to the outbound loss QBU.
    (3) Amount of pretransition gain or loss for an owner that did not 
apply an eligible pretransition method--(i) In general. If the owner of 
a section 987 QBU did not apply an eligible pretransition method with 
respect to a section 987 QBU, the amount of pretransition gain or loss 
with respect to the section 987 QBU is determined under paragraph 
(e)(3)(ii) of this section. See paragraph (l)(4) of this section 
(Example 4) for an illustration of this rule.
    (ii) Computation of pretransition gain or loss. With respect to a 
section 987 QBU described in paragraph (e)(3)(i) of this section, 
pretransition gain or loss is equal to the amount described in 
paragraph (e)(3)(ii)(A) of this section reduced by the amount described 
in paragraph (e)(3)(ii)(B) of this section.
    (A) The sum of the owner's annual unrecognized section 987 gain or 
loss determined under paragraph (e)(3)(iii) of this section with 
respect to the section 987 QBU for all taxable years ending before the 
transition date in which it was the owner of the section 987 QBU.
    (B) The total net amount of section 987 gain or loss recognized by 
the owner with respect to the section 987 QBU in all taxable years 
ending before the transition date.
    (iii) Annual unrecognized section 987 gain or loss. An owner of a 
section 987 QBU described in paragraph (e)(3)(i) of this section 
determines annual unrecognized section 987 gain or loss with respect to 
a section 987 QBU under the rules of Sec.  1.987-4(d), applied as 
though a cur