[Federal Register Volume 63, Number 43 (Thursday, March 5, 1998)]
[Rules and Regulations]
[Pages 10772-10776]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-5470]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8765]
RIN 1545-AL24; 1545-AS68
Change From Dollar Approximate Separate Transactions Method of
Accounting (DASTM) to the Profit and Loss Method of Accounting/Change
From the Profit and Loss Method to DASTM
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final Income Tax Regulations relating
to adjustments required when a qualified business unit (QBU) that used
the profit and loss method of accounting (P&L) in a post-1986 year
begins to use the dollar approximate separate transaction method of
accounting (DASTM) and adjustments required when a QBU that used DASTM
begins using P&L. The regulations provide rules for taxpayers to
construct an opening dollar balance sheet for the QBU and require
income adjustments in certain cases.
DATES: These regulations are effective April 6, 1998.
FOR FURTHER INFORMATION CONTACT: Howard Wiener at (202) 622-3870 (not a
toll-free number) of the office of Chief Counsel (International) within
the Office of Chief Counsel, Internal Revenue Service, 1111
Constitution Avenue, N.W. Washington, DC 20224.
SUPPLEMENTARY INFORMATION:
Background
On January 5, 1993 and July 25, 1994, the IRS published proposed
amendments to Sec. 1.985-7 in the Federal Register at 58 FR 300 (INTL-
0045-92) and Sec. 1.985-1 in the Federal Register at 59 FR 37733 (INTL-
0066-92), respectively. No public hearing was held and few comments
were received. After consideration of these comments, the regulations
are adopted as a Treasury Decision with modifications as described
below.
Explanation of Provisions
I. Proposed Rules for Changing From P&L to DASTM (Sec. 1.985-7)
1. The Proposed Regulations
The proposed regulations under Sec. 1.985-7 set forth transition
rules for QBUs changing from the profit and loss method of accounting
(P&L) to DASTM in tax years after 1987. Section 1.985-6 provides the
translation rules for QBUs using DASTM in 1987. Generally, when a QBU
changes its functional currency, two basic issues arise: (1) How should
the QBU translate its balance sheet accounts into the new functional
currency in a way that preserves any unrecognized currency gain or loss
which accrued in the old functional currency; and (2) whether income
adjustments need to be made to recognize any currency gain or loss
which accrued in the old functional currency that cannot be preserved.
Section 1.985-5 provides rules that generally apply when a QBU
changes its functional currency. Under Sec. 1.985-5 balance sheet
accounts are translated using the spot rate on the last day prior to
the taxable year of change. In addition, Sec. 1.985-5 generally
requires recognition of unrealized exchange gain or loss on instruments
and other accounts that were maintained in the functional currency to
which the QBU is changing.
The proposed regulations issued under Sec. 1.985-7 were issued in
response to taxpayer comments that Sec. 1.985-5 resulted in significant
distortions when a QBU either elected or was required to use DASTM.
Applying the spot rate on the last day prior to the year in which the
QBU begins to use DASTM (the ``taxable year of change'') to translate
fixed assets typically results in a significant loss of basis in dollar
terms and does not take into account certain income and expense
distortions that occur in the period immediately preceding the taxable
year of change.
In response to taxpayers' comments, the proposed regulations
provide for use of the translation rules provided under Sec. 1.985-3.
These rules generally translate fixed assets at the historical exchange
rate and other assets and liabilities at the current exchange rate. To
correct for distortions that would result from applying historic
exchange rates for fixed assets while applying the current year's spot
rate for other balance sheet accounts, the proposed regulations provide
for income adjustments in the case of a controlled foreign corporation
(CFC) and a branch that reflect amounts that would have been included
in income under DASTM.
In the case of a CFC, the proposed regulations provide for a
shareholder level income adjustment to the extent subpart F income
realized during the period after 1986 until the taxable year of change
differs from subpart F income that would have been realized if the CFC
had used DASTM throughout this period. In the case of a branch, the
regulations provide that any difference between the branch's local
currency
[[Page 10773]]
equity translated into dollars at the spot exchange rate on the last
day prior to the taxable year of change and the taxpayer's dollar basis
pool on that day is included in income over three taxable years
beginning with the taxable year of change. For purposes of translating
the balance sheet of noncontrolled section 902 corporations, the
proposed regulations apply historic exchange rates for fixed assets. In
such case, no shareholder level income adjustments are required.
Recognizing the administrative burden of making income adjustments
for all post-1986 tax years in the case of a CFC, the preamble to the
proposed regulations requested comments regarding three alternative
transition rules as follows: (1) Requiring shareholder level
adjustments for the three-year base period used to determine the
hyperinflationary status of the local currency (in which case the
general rule of Sec. 1.985-5 would be applied in preparing the balance
sheet for the first year of the base period); (2) treating a portion of
retained earnings as subpart F income based on an average historical
rate of subpart F income to total earnings and profits, and (3) using
the spot rate on the last day prior to the taxable year of change to
translate balance sheet items with special rules to allow historical
exchange rates to translate fixed assets to the extent of unrealized
exchange loss on paid-in capital.
2. Reasons for Change
The IRS is concerned that the approach of the proposed regulations
could create a significant administrative burden for shareholders of
CFCs. The administrative burden results from the requirement that
shareholders recompute subpart F income for all of the CFC's post 1986
taxable years. If the functional currency of a CFC becomes
hyperinflationary in a year that is significantly distant from the
CFC's first post-1986 taxable year, records supporting the required
recomputation may be unavailable.
Further, the required recomputation under the proposed regulations
is generally inconsistent with the policy of sections 986 and 987 that
the income of branches with a functional currency different than that
of the taxpayer and the earnings and profits of foreign corporations be
computed under a profit and loss method, except in the case of
hyperinflation. See S. Rep. No. 99-313, 99th Cong., 2d Sess., 454
(1986). The recomputation under the proposed regulation would put the
CFC on DASTM for non-hyperinflationary years. Accordingly, the rules in
the proposed regulations have been modified as described below.
II. Final Regulations for Changing From P&L to DASTM (Sec. 1.985-7)
1. General Rule
The approach employed in the final regulations has the general
effect of treating a QBU as if it had applied Sec. 1.985-5 on the last
day of the last taxable year prior to the base period for determining
whether a currency is hyperinflationary (transition date) and had
applied DASTM during the taxable years beginning after the transition
date until the taxable year of change (look-back period). This approach
addresses the problems of applying Sec. 1.985-5 in the taxable year of
change for purposes of translating fixed assets by applying the
historical exchange rate to the extent fixed assets were acquired
during the look-back period. Assets acquired prior to the look-back
period are translated by applying the spot rate on the transition date.
This approach also corrects distortions in income and expense
(generally interest income and expense) that occur during the look-back
period.
The final regulations respond to taxpayers' comments and provide an
appropriate rule for translating the adjusted basis of fixed assets
into dollars by applying an exchange rate in effect prior to the
hyperinflationary period. Moreover, this method more accurately
reflects Congressional intent for QBUs to apply the profit and loss
method except in the case of hyperinflation. In addition, this approach
decreases the administrative burden of changing to DASTM.
2. Foreign Corporations
In the case of a foreign corporation which is either required or
elects to use DASTM, four basic corporate level adjustments are
required as follows. (1) The balance sheet is translated by treating
the corporation as if it had changed its functional currency to the
dollar for the first post-transition date taxable year and had applied
the rules of Sec. 1.985-5(c) on the transition date. Assets acquired
and liabilities incurred in the functional currency during the look-
back period are translated by applying the rules of Sec. 1.985-3. (2)
The unrealized gain or loss on dollar denominated section 988
transactions as determined on the transition date are treated as if
recognized on that date (and actual gain or loss recognized on dollar
denominated section 988 transactions during the look-back period is
reversed). (3) The dollar value of the pre-1987 E&P of the corporation
as stated on the transition date in the functional currency is
translated into U.S. dollars at the spot rate in effect on the
transition date. (4) The dollar value of the post-1986 E&P is computed
by translating the post-1986 E&P as stated on the transition date in
the functional currency at the spot rate on such date and adding to it
the E&P for the years during the look-back period as computed under
DASTM.
In the case of a CFC, there are three shareholder level adjustments
as follows: (1) The U.S. shareholders must take into income exchange
gain or loss on the deemed recognition of the section 988 transactions
as determined at the corporate level to the extent such gain or loss is
subpart F income. (2) The U.S. shareholders must recognize foreign
currency gain or loss as computed under section 986(c) as if all
previously taxed earnings and profits were distributed on the
transition date (however, any actual 986(c) gain or loss recognized
during the look-back period is reversed). (3) The subpart F income of
the CFC is recomputed during the look-back period under DASTM and
compared to the subpart F income as computed under the P&L method. The
difference (positive or negative) is taken into account in the taxable
year of change and spread over four years. Similar rules apply to
United States persons who have made an election under section 1295 to
treat a passive foreign investment company as a qualified electing
fund. In the case of other foreign corporations, no shareholder level
income adjustments are necessary.
4. Branches
In accord with the general approach articulated above, the
regulations treat a branch changing to DASTM as applying the principles
of Sec. 1.985-5 on the transition date. Thus, the balance sheet is
translated by treating the branch as if it had changed its functional
currency to the dollar for the first post-transition date taxable year
and had applied the rules of Sec. 1.985-5(c) on the transition date.
Unrealized gain or loss on dollar denominated section 988 transactions
as stated on the transition date are treated as if recognized on that
date (and any actual gain or loss realized with respect to section 988
transactions during the look-back period is reversed). Further, the
regulations require that the taxpayer recognize gain or loss
attributable to the branch's equity pool (as stated on the transition
date) under the principles of section 987, computed as if the branch
terminated on the transition date. Such gain or loss is reduced by any
section 987 gain and increased by any section 987 loss that was
recognized by the
[[Page 10774]]
taxpayer with respect to remittances during the look-back period.
Finally, branch income shall be determined under Sec. 1.985-3 for each
look-back year and compared to the amount that was taken into account
for each year. The sum of the difference (positive or negative) is
taken into account in the taxable year of change and spread over four
years.
III. Rules for Changing from DASTM to P&L (Sec. 1.985-1)
Under the proposed regulation, a QBU that has been required or had
elected to use DASTM must change functional currency to the currency of
its economic environment in a year in which the currency is no longer
hyperinflationary pursuant to the three-year test under Sec. 1.985-
1(b). These rules provide that when a taxpayer changes from DASTM to
the P&L method of accounting, Sec. 1.985-5 shall apply for purposes of
translating a QBU's balance sheet and for making certain income
adjustments. Because these rules generally do not create distortions
and are administrable, the final regulations adopt these regulations as
proposed.
IV. Other Changes
Various conforming changes have been made to Secs. 1.985-1 and
1.985-5 to account for the addition of Sec. 1.985-7. In addition, the
definition of hyperinflation has been liberalized to provide that for
purposes of determining whether a currency is hyperinflationary for
income tax purposes, United States generally accepted accounting
principles will be accepted provided that the determination is based on
criteria that is substantially similar to the general rules provided in
the regulations, the method of determination is applied consistently
from year to year, and the same method is applied to all related
persons.
Special Analysis
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Accordingly, a regulatory flexibility analysis is not required.
Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Small
Business Administration for comment on its impact on small business.
Drafting Information
The principal author of these regulations is Howard A. Wiener of
the Office of the Associate Chief Counsel (International). Other
personnel from the IRS and Treasury Department also participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.985-1 is amended by:
1. Revising paragraph (b)(2)(ii)(C).
2. Adding a sentence to the end of paragraph (b)(2)(ii)(D).
3. Adding paragraph (b)(2)(ii)(E).
The additions and revision reads as follows:
Sec. 1.985-1 Functional currency.
* * * * *
(b) * * *
(2) * * *
(ii) * * *
(C) Change in functional currency. If a QBU is required to change
its functional currency to the dollar under paragraph (b)(2)(ii)(A) of
this section, or chooses or is required to change its functional
currency to the dollar for any open taxable year (and all subsequent
taxable years) under Sec. 1.985-3(a)(2)(ii), the change is considered
to be made with the consent of the Commissioner for purposes of
Sec. 1.985-4. A QBU changing functional currency must make adjustments
described in Sec. 1.985-7 if the year of change (as defined in
Sec. 1.481-1(a)(1)) begins after 1987, or the adjustments described in
Sec. 1.985-6 if the year of change begins in 1987. No adjustments under
section 481 are required solely because of a change in functional
currency described in this paragraph (b)(2)(ii)(C).
(D) * * * In making the determination whether a currency is
hyperinflationary, the determination for purposes of United States
generally accepted accounting principles may be used for income tax
purposes provided the determination is based on criteria that is
substantially similar to the rules previously set forth in this
paragraph (b)(2)(ii)(D), the method of determination is applied
consistently from year to year, and the same method is applied to all
related persons as defined in Sec. 1.985-3(e)(2)(vi).
(E) Change in functional currency when currency ceases to be
hyperinflationary--(1) In general. A QBU that has been required to use
the dollar as its functional currency under paragraph (b)(2) of this
section, or has elected to use the dollar as its functional currency
under paragraph (b)(2)(ii)(B)(2) of this section or Sec. 1.985-2, must
change its functional currency as of the first day of the first taxable
year that follows three consecutive taxable years in which the currency
of its economic environment, determined under paragraph (c)(2) of this
section, is not a hyperinflationary currency. The functional currency
of the QBU for such year shall be determined in accordance with
paragraph (c) of this section. For purposes of Sec. 1.985-4, the change
is considered to be made with the consent of the Commissioner. See
Sec. 1.985-5 for adjustments that are required upon a change in
functional currency.
(2) Effective Date. This paragraph (b)(2)(ii)(E) of this section
applies to taxable years beginning after April 6, 1998.
Par. 3. Section 1.985-5(a) is amended by adding the following
sentence to the end of the paragraph:
Sec. 1.985-5 Adjustments required upon change in functional currency.
(a) * * * However, a QBU that changes to the dollar pursuant to
Sec. 1.985-1(b)(2) after 1987 shall apply Sec. 1.985-7.
* * * * *
Par. 4. Section 1.985-7 is added as follows:
Sec. 1.985-7 Adjustments required in connection with a change to
DASTM.
(a) In general. If a QBU begins to use the dollar approximate
separate transactions method of accounting set forth in Sec. 1.985-3
(DASTM) in a taxable year beginning after April 6, 1998, adjustments
shall be made as provided by this section. For the rules with respect
to foreign corporations, see paragraph (b) of this section. For the
rules with respect to adjustments to the income of United States
shareholders of controlled foreign corporations, see paragraph (c) of
this section. For the rules with respect to adjustments relating to QBU
branches, see paragraph (d) of this section. For the effective date of
this section, see paragraph (e). For purposes of applying this section,
the look-back period shall be the period
[[Page 10775]]
beginning with the first taxable year after the transition date and
ending on the last day prior to the taxable year of change. The term
transition date means the later of the last day of the last taxable
year ending before the base period as defined in Sec. 1.985-
1(b)(2)(ii)(D) or the last day of the taxable year in which the QBU
last applied DASTM. The taxable year of change shall mean the taxable
year of change as defined in Sec. 1.481-1(a)(1). The application of
this paragraph may be illustrated by the following examples:
Example 1. A calendar year QBU that has not previously used
DASTM operates in a country in which the functional currency of the
country is hyperinflationary as defined under Sec. 1.985-
1(b)(2)(ii)(D) for the QBU's 1999 tax year. The look-back period is
the period from January 1, 1996 through December 31, 1998, the
transition date is December 31, 1995, and the taxable year of change
is the taxable year beginning January 1, 1999.
Example 2. A QBU that has not previously used DASTM with a
taxable year ending June 30, operates in a country in which the
functional currency of the country is hyperinflationary for the
QBU's tax year beginning July 1, 1999 as defined under Sec. 1.985-
1(b)(2)(ii)(D) (where the base period is the thirty-six calendar
months immediately preceding the first day of the current calendar
year 1999). The look-back period is the period from July 1, 1995
through June 30, 1999, the transition date is June 30, 1995, and the
taxable year of change is the taxable year beginning July 1, 1999.
(b) Adjustments to foreign corporations--(1) In general. In the
case of a foreign corporation, the corporation shall make the
adjustments set forth in paragraphs (b)(2) through (4) of this section.
The adjustments shall be made on the first day of the taxable year of
change.
(2) Treatment of certain section 988 transactions--(i) Exchange
gain or loss from section 988 transactions unrealized as of the
transition date. A foreign corporation shall adjust earnings and
profits by the amount of any unrealized exchange gain or loss that was
attributable to a section 988 transaction (as defined in sections
988(c)(1)(A), (B), and (C)) that was denominated in terms of (or
determined by reference to) the dollar and was held by the corporation
on the transition date. Such gain or loss shall be computed as if
recognized on the transition date and shall be reduced by any gain and
increased by any loss recognized by the corporation with respect to
such transaction during the look-back period. The amount of such gain
or loss shall be determined without regard to the limitations of
section 988(b) (i.e., whether any gain or loss would be realized on the
transaction as a whole). The character and source of such gain or loss
shall be determined under section 988. Proper adjustments shall be made
to account for gain or loss taken into account by reason of this
paragraph (b)(2). See Sec. 1.985-5(f) Example 1, footnote 1.
(ii) Treatment of a section 988 transaction entered into and
terminated during the look-back period. A foreign corporation shall
reduce earnings and profits by the amount of any gain, and increase
earnings and profits by the amount of any loss, that was recognized
with respect to any dollar denominated section 988 transactions entered
into and terminated during the look-back period.
(3) Opening balance sheet. The opening balance sheet of a foreign
corporation for the taxable year of change shall be determined as if
the corporation had changed its functional currency to the dollar by
applying Sec. 1.985-5(c) on the transition date and had translated its
assets and liabilities under Sec. 1.985-3 during the look-back period.
(4) Earnings and profits adjustments--(i) Pre-1987 accumulated
profits. The foreign income taxes and accumulated profits or deficits
in accumulated profits of a foreign corporation that are attributable
to taxable years beginning before January 1, 1987, as stated on the
transition date, and that were maintained for purposes of section 902
in the old functional currency, shall be translated into dollars at the
spot rate in effect on the transition date. The applicable accumulated
profits shall be reduced on a last-in, first-out basis by the aggregate
dollar amount (translated from functional currency in accordance with
the rules of section 989(b)) attributable to earnings and profits that
were distributed (or treated as distributed) during the look-back
period to the extent such amounts distributed exceed the earnings and
profits calculated under (b)(4)(ii) or (b)(4)(iii), as applicable. See
Sec. 1.902-1(b)(2)(ii). Once translated into dollars, these pre-1987
taxes and accumulated profits or deficits in accumulated profits shall
(absent a change in functional currency) remain in dollars for all
federal income tax purposes.
(ii) Post-1986 undistributed earnings of a CFC. In the case of a
controlled foreign corporation (within the meaning of section 957 or
section 953(c)(1)(B))(CFC) or a foreign corporation subject to the
rules of Sec. 1.904-6(a)(2), the corporation's post-1986 undistributed
earnings in each separate category as defined in Sec. 1.904-5(a)(1) as
of the first day of the taxable year of change (and prior to adjustment
under paragraph (c)(1) of this section) shall equal the sum of--
(A) The corporation's post-1986 undistributed earnings and profits
(or deficit in earnings and profits) in each separate category as
defined in Sec. 1.904-5(a)(1) as stated on the transition date
translated into dollars at the spot rate in effect on the transition
date; and
(B) The sum of the earnings and profits (or deficit in earnings and
profits) in each separate category determined under Sec. 1.985-3 for
each post-transition date taxable year prior to the taxable year of
change.
Such amount shall be reduced by the aggregate dollar amount
(translated from functional currency in accordance with the rules of
section 989(b)) attributable to earnings and profits that were
distributed (or treated as distributed) during the look-back period out
of post-1986 earnings and profits in such separate category. For
purposes of applying this paragraph (b)(4)(ii)(B), the opening balance
sheet for calculating earnings and profits under Sec. 1.985-3 for the
first post-transition year shall be translated into dollars pursuant to
Sec. 1.985-5(c).
(iii) Post-1986 undistributed earnings of other foreign
corporations. In the case of a foreign corporation that is not a CFC or
subject to the rules of Sec. 1.904-6(a)(2), the corporation's post-1986
undistributed earnings shall equal the sum of--
(A) The corporation's post-1986 undistributed earnings (or deficit)
on the transition date translated into dollars at the spot rate in
effect on the transition date; and
(B) The sum of the earnings and profits (or deficit in earnings and
profits) determined under Sec. 1.985-3 for each post-transition date
taxable year (or such later year determined under section 902(c)(3)(A))
prior to the taxable year of change.
Such amount shall be reduced by the aggregate dollar amount
(translated from functional currency in accordance with the rules of
section 989(b)) that was distributed (or treated as distributed) during
the look-back period out of post-1986 earnings and profits. For
purposes of applying this paragraph (b)(4)(iii)(B), the opening balance
sheet for calculating earnings and profits under Sec. 1.985-3 for the
first post-transition year shall be translated into dollars pursuant to
Sec. 1.985-5(c).
(c) United States shareholders of controlled foreign corporations--
(1) In general. A United States shareholder (within the meaning of
section 951(b) or section 953(c)(1)(B)) of a CFC that
[[Page 10776]]
changes to DASTM shall make the adjustments set forth in paragraphs (c)
(2) through (5) of this section on the first day of the taxable year of
change. Adjustments under this section shall be taken into account by
the shareholder (or such shareholder s successor in interest) ratably
over four taxable years beginning with the taxable year of change.
Similar rules shall apply in determining adjustments to income of
United States persons who have made an election under section 1295 to
treat a passive foreign investment company as a qualified electing
fund.
(2) Treatment under subpart F of income recognized on section 988
transactions. The character of amounts taken into account under
paragraph (b)(2) of this section for purposes of sections 951 through
964, shall be determined on the transition date and to the extent
characterized as subpart F income shall be taken into account in
accordance with the rules of paragraph (c)(1) of this section. Such
amounts shall retain their character for all federal income tax
purposes (including sections 902, 959, 960, 961, 1248, and 6038).
(3) Recognition of foreign currency gain or loss on previously
taxed earnings and profits on the transition date. Gain or loss is
recognized under section 986(c) as if all previously taxed earnings and
profits as determined on the transition date, if any, were distributed
on such date. Such gain or loss shall be reduced by any foreign
currency gain and increased by any foreign currency loss that was
recognized under section 986(c) with respect to distributions of
previously taxed earnings and profits during the look-back period. Such
amount shall be characterized in accordance with section 986(c) and
taken into account in accordance with the rules of paragraph (c)(1) of
this section.
(4) Subpart F income adjustment. Subpart F income in a separate
category shall be determined under Sec. 1.985-3 for each look-back
year. For this purpose, the opening DASTM balance sheet shall be
determined under Sec. 1.985-5. The sum of the difference (positive or
negative) between the amount computed pursuant to Sec. 1.985-3 and
amount that was included in income for each year shall be taken into
account in the taxable year of change pursuant to paragraph (c)(1) of
this section. Such amounts shall retain their character for all federal
income tax purposes (including sections 902, 959, 960, 961, 1248, and
6038). For rules applicable if an adjustment under this section results
in a loss for the taxable year in a separate category, see section
904(f) and the regulations thereunder. The amount of previously taxed
earnings and profits as determined under section 959(c)(2) shall be
adjusted (positively or negatively) by the amount taken into account
under this paragraph (c)(4) as of the first day of the taxable year of
change.
(5) Foreign tax credit. A United States shareholder of a CFC shall
compute an amount of foreign taxes deemed paid under section 960 with
respect to any positive adjustments determined under paragraph (c) of
this section. The amount of foreign tax deemed paid shall be computed
with reference to the full amount of the adjustment and to the post-
1986 undistributed earnings determined under paragraph (b)(4) (i) and
(ii) of this section and the post-1986 foreign income taxes of the CFC
on the first day of the taxable year of change (i.e., without taking
into account earnings and taxes for the taxable year of change.) For
purposes of section 960, the associated taxes in each separate category
shall be allocated pro rata among, and deemed paid in, the
shareholder's taxable years in which the income is taken into account.
(No adjustment to foreign taxes deemed paid in prior years is required
solely by reason of a negative adjustment to income under paragraph
(c)(1) of this section.)
(d) QBU branches--(1) In general. In the case of a QBU branch, the
taxpayer shall make the adjustments set forth in paragraphs (d)(2)
through (d)(4) of this section. Adjustments under this section shall be
taken into account by the taxpayer ratably over four taxable years
beginning with the taxable year of change.
(2) Treatment of certain section 988 transactions--(i) Exchange
gain or loss from section 988 transactions unrealized as of the
transition date. A QBU branch shall adjust income by the amount of any
unrealized exchange gain or loss that was attributable to a section 988
transaction (as defined in sections 988(c)(1) (A), (B), and (C)) that
was denominated in terms of (or determined by reference to) the dollar
and was held by the QBU branch on the transition date. Such gain or
loss shall be computed as if recognized on the transition date and
shall be reduced by any gain and increased by any loss recognized by
the QBU branch with respect to such transaction during the look-back
period. The amount of such gain or loss shall be determined without
regard to the limitations of section 988(b) (i.e., whether any gain or
loss would be realized on the transaction as a whole). The character
and source of such gain or loss shall be determined under section 988.
Proper adjustments shall be made to account for gain or loss taken into
account by reason of this paragraph (d)(2). See Sec. 1.985-5(f) Example
1, footnote 1.
(ii) Treatment of a section 988 transaction entered into and
terminated during the look-back period. A QBU branch shall reduce
income by the amount of any gain, and increase income by the amount of
any loss, that was recognized with respect to any dollar denominated
section 988 transactions entered into and terminated during the look-
back period.
(3) Deemed termination income adjustment. The taxpayer shall
realize gain or loss attributable to the QBU branch's equity pool (as
stated on the transition date) under the principles of section 987,
computed as if the branch terminated on the transition date. Such
amount shall be reduced by section 987 gain and increased by section
987 loss that was recognized by such taxpayer with respect to
remittances during the look-back period.
(4) Branch income adjustment. Branch income in a separate category
shall be determined under Sec. 1.985-3 for each look-back year. For
this purpose, the opening DASTM balance sheet shall be determined under
Sec. 1.985-5. The sum of the difference (positive or negative) between
the amount computed pursuant to Sec. 1.985-3 and amount taken into
account for each year shall be taken into account in the taxable year
of change pursuant to paragraph (d)(1) of this section. Such amounts
shall retain their character for all federal income tax purposes.
(5) Opening balance sheet. The opening balance sheet of a QBU
branch for the taxable year of change shall be determined as if the
branch had changed its functional currency to the dollar by applying
Sec. 1.985-5(c) on the transition date and had translated its assets
and liabilities under Sec. 1.985-3 during the look-back period.
(e) Effective date. This section is effective for taxable years
beginning after April 6, 1998. However, a taxpayer may choose to apply
this section to all open taxable years beginning after December 31,
1986, provided each person, and each QBU branch of a person, that is
related (within the meaning of Sec. 1.985-2(d)(3)) to the taxpayer also
applies this section.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
Approved: February 11, 1998
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 98-5470 Filed 3-4-98; 8:45 am]
BILLING CODE 4830-01-U
