[Federal Register Volume 59, Number 141 (Monday, July 25, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17570]
[[Page Unknown]]
[Federal Register: July 25, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8556]
RIN 1545-AP70
Computation and Characterization of Income and Earnings and
Profits Under the Dollar Approximate Separate Transactions Method of
Accounting (DASTM)
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final Income Tax Regulations relating
to the computation and characterization of income or earnings and
profits under the dollar approximate separate transactions method of
accounting (DASTM). These regulations are issued under section 985 of
the Internal Revenue Code of 1986 (Code), which was added to the Code
by the Tax Reform Act of 1986. These regulations provide guidance for
taxpayers with a qualified business unit (QBU) operating in a
hyperinflationary environment, i.e., a QBU that must use the dollar as
its functional currency and determine income or earnings and profits
under DASTM because its functional currency otherwise would be a
hyperinflationary currency.
DATES: These regulations are effective July 25, 1994.
For dates of applicability, see the Effective Dates portion of the
preamble under SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION CONTACT: Jacob Feldman or Teresa B. Hughes of
the Office of Associate Chief Counsel, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC 20224, Attention: CC:CORP:T:R
(INTL-29-91) (202-622-3870, not a toll-free call).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulation
has been reviewed and approved by the Office of Management and Budget
in accordance with the requirements of the Paperwork Reduction Act (44
U.S.C. 3504(h)) under control number 1545-1051. The estimated annual
burden per respondent varies from 45 minutes to 1\3/4\ hours, depending
on individual circumstances, with an estimated average of 1\1/4\ hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer PC:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attention: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Background
On July 17, 1991, proposed amendments to Sec. 1.985-3 were
published in the Federal Register at 56 FR 32525. In addition,
conforming changes were proposed to Secs. 1.904-4, 1.954-2T, 1.985-0,
1.985-1, and 1.985-2. A public hearing was held on September 13, 1991.
A number of comments, which are discussed below, were received on
issues raised by the proposed regulations. After consideration of these
comments, the regulations are adopted as a Treasury decision with the
modifications described below.
Explanation of Provisions
Under Sec. 1.985-1(b)(2)(ii)(A), a QBU that would otherwise have a
hyperinflationary currency as its functional currency must use the
dollar as its functional currency and must compute income or earnings
and profits using DASTM for taxable years beginning after August 24,
1994. Any change in a QBU's method of accounting which results from the
QBU's adoption of DASTM under these final regulations shall be deemed
to have been made with the consent of the Commissioner.
Some commentators objected to the requirement that use of the
dollar and DASTM be made mandatory for a QBU operating in a
hyperinflationary environment. The suggestion that use of the dollar
and DASTM should continue to be elective was not adopted because the
use of a hyperinflationary functional currency and the profit and loss
method of accounting (P&L method) does not clearly reflect income.
Under the P&L method, income or loss is computed in the
hyperinflationary currency and translated into dollars at the
appropriate exchange rate for the accounting period. The P&L method
distorts income and loss of a QBU with substantial depreciable assets.
As the hyperinflationary currency depreciates with respect to the
dollar, sales revenues (as measured in the hyperinflationary currency)
increase; but depreciation and amortization deductions, which are based
on hyperinflationary currency cost bases, remain constant. This results
in an overstatement of income. Another distortion occurs with respect
to income and expense derived from hyperinflationary financial assets
and liabilities. For example, a QBU that borrows in hyperinflationary
currency will incur and deduct a very high level of nominal interest
expense, reflecting the lender's expectation that payment of interest
and repayment of principal will be in devalued currency. However, under
the P&L method, the offsetting exchange gain (relative to the dollar)
on a QBU's hyperinflationary currency liabilities is deferred, causing
the income of net borrowers to be understated.
In light of these distortions, use of a hyperinflationary
functional currency and the P&L method by QBUs operating in a
hyperinflationary environment is not appropriate. The regulations,
therefore, generally require that QBUs operating in a hyperinflationary
environment use the dollar and DASTM for future taxable years. Under
Sec. 1.985-1(b)(2)(ii)(B)(2), however, a taxpayer is not required to
use DASTM to compute the income or loss or earnings and profits of a
foreign corporation that is not a controlled foreign corporation. This
exception is provided because minority shareholders of a foreign
corporation may be unable to obtain the information required to apply
DASTM. However, where the necessary information can be obtained,
Sec. 1.985-1(b)(2)(ii)(B)(2) provides that DASTM may be elected by a
noncontrolled section 902 corporation under the procedural rules of
Sec. 1.985-2(c)(3).
Section 1.985-1(b)(2)(ii)(B)(1) clarifies the rule for determining
the functional currency of a QBU branch of a foreign corporation when
the foreign corporation has a non-dollar functional currency that is
not hyperinflationary. If the QBU branch otherwise would have a
hyperinflationary currency as its functional currency, the branch's
functional currency is the functional currency of the foreign
corporation.
The definition of hyperinflationary currency, now found in
Sec. 1.985-1(b)(2)(ii)(D), has been revised to clarify that the
cumulative inflation rate during the thirty-six month base period is
based on compounded inflation rates for the base period, and not on the
sum of annual inflation rates. This change conforms the definition of
hyperinflationary currency more closely to that applicable under United
States generally accepted accounting principles (GAAP).
Section 1.985-3(a) provides that, for all purposes of subtitle A,
DASTM must be used to compute gross income, income or loss, or earnings
and profits (or deficits in earnings and profits). This provision is
intended to clarify that DASTM gain or loss is part of gross income for
purposes of the de minimis and full inclusion rules of section
954(b)(3) (A) and (B), and that DASTM gain or loss must be taken into
account in applying the related party interest rules of section
954(b)(5), among other computations.
Section 1.985-3(a) further provides that, for open taxable years
beginning after December 31, 1986, but before the effective date of
these regulations, the taxpayer has the option to elect DASTM for any
open taxable year (and all subsequent taxable years). Taxpayers
previously using the P&L method that wish to elect DASTM for prior open
years may do so by amending their tax returns for the applicable years
and complying with the applicable election procedures of Sec. 1.985-2,
including the conformity requirements of Sec. 1.985-2(d)(3), if
applicable. Taxpayers that have elected DASTM and applied the rules
under prior Sec. 1.985-3 may elect to apply the rules under this
revised Sec. 1.985-3 by amending their tax returns for the applicable
years. In either case, the Commissioner is deemed to consent.
If a taxpayer elects for prior years to change the functional
currency of a QBU operating in a hyperinflationary environment to the
dollar, it must make the adjustments described in Sec. 1.985-5 (or
Sec. 1.985-5T, if applicable) if the year of change begins after 1987,
or the adjustments described in Sec. 1.985-6 (or Sec. 1.985-6T, if
applicable) if the year of change begins in 1987. The adjustments
described in Sec. 1.985-5 (or Sec. 1.985-5T, if applicable) must be
included in income in the taxable year prior to the year of change
unless that prior taxable year is closed. In that case, the adjustments
must be included in income in the year of change.
Certain countries with hyperinflation require taxpayers to make
adjustments to the balance sheet under a system of monetary correction
with respect to fixed assets and capital, with corresponding
adjustments to the profit and loss statement. Under U.S. GAAP, these
adjustments are reversed. Section 1.985-3(b)(2) and Sec. 1.985-
3(d)(2)(ii) have been clarified to require reversal of monetary
correction adjustments required by local accounting principles.
Taxpayers suggested that they should be permitted to translate
certain financial assets and liabilities at the period-end exchange
rate, rather than at the average exchange rate for the last translation
period in order to conform the rules under Sec. 1.985-3 to GAAP. To
make it clear that the period-end exchange rate may be used,
Sec. 1.985-3(c)(6) has been amended to indicate that a spot exchange
rate on the last day of the taxable period is a reasonable method,
provided that it is consistently and used and conforms to the
taxpayer's method of financial accounting.
Taxpayers requested guidance with respect to transactions described
in section 988(c)(1) (B) and (C) denominated in a currency other than a
QBU's hyperinflationary currency or the dollar (third currency
transaction). In order to parallel the financial accounting rules for
the administrative ease of taxpayers and the Service, Sec. 1.985-
3(c)(9) provides that taxpayers may use any reasonable method of
accounting for third currency transactions so long as such method is
consistent with their method of financial accounting.
Several commentators requested that the regulations provide a
simpler method of allocating and apportioning DASTM gain or loss for
small taxpayers. This suggestion has been adopted. Section 1.985-
3(e)(2) provides that a taxpayer with a QBU having an adjusted basis in
assets of $10 million or less (taking into account assets of related
QBUs resident in the same country) may elect to allocate DASTM gain or
loss ratably to all items of the QBU's gross income (determined prior
to adjustment for DASTM gain or loss). Thus, for purposes of the
foreign tax credit, DASTM gain or loss is allocated on the basis of the
relative amounts of gross income in each separate category described in
section 904(d). Similarly, for purposes of section 952, DASTM gain or
loss is allocated to subpart F income in a separate category based on
the ratio of gross subpart F income in the separate category to total
gross income in that category. Commentators also requested a simpler
method for taxpayers with one or two section 904(d) separate categories
(or a de minimis amount in a second category). This suggestion was not
adopted because the allocation rules in Sec. 1.985-3(e)(3) more
accurately reflect the income of large taxpayers.
The prior final regulations under Sec. 1.985-3 provided for the
allocation of DASTM gains and losses to section 904(d) separate
categories based on foreign source gross income in each category. There
was no attempt to identify DASTM gain or loss with specific assets or
liabilities. However, in the proposed regulations under Sec. 1.985-3,
DASTM gain or loss was identified with specific assets and was directly
allocated to specific section 904(d) separate categories based on the
income those assets would generate. With respect to liabilities, the
proposed regulations provided that DASTM gain or loss should be
allocated to the section 904(d) separate categories in the same manner
as the allocation and apportionment of interest expense. The proposed
regulations applied this method of allocation to all liabilities.
Some comments suggested that DASTM gain or loss on certain non-
interest-bearing liabilities, particularly short-term non-interest-
bearing trade payables, should be directly allocated to the same
section 904(d) separate category as the income produced by the
purchased good or service to which the payable relates. The suggested
rationale for this approach is that in a hyperinflationary environment
the purchase price for deferred payment of goods or services reflects a
premium for inflation expected to occur prior to payment. This
overstated purchase price is reflected in cost of goods sold,
distorting the taxpayer's income in the pertinent section 904(d)
separate category. Therefore, in order to compensate for this
distortion, commentators recommended adjusting cost of goods sold by
the DASTM gain on the trade payable.
In response to this suggestion, Sec. 1.985-3(e) now provides
different rules for allocating and apportioning DASTM gain or loss with
respect to interest-bearing liabilities (under Sec. 1.985-3(e)(3)(vii))
and non-interest-bearing liabilities (under Sec. 1.985-3(e)(3)(viii)).
Section 1.985-3(e)(3)(vii)(A) now provides that the amount of DASTM
gain on interest-bearing liabilities reduces interest expense generated
by such liabilities; any DASTM gain in excess of interest expense is
sourced or otherwise classified in the same manner that interest
expense is allocated and apportioned. Any DASTM loss on interest-
bearing liabilities is allocated and apportioned in the same manner
that interest expense is allocated and apportioned under Sec. 1.861-9T
(without regard to the exceptions to fungibility in Sec. 1.861-10T).
Section 1.985-3(e)(3)(vii)(B) provides rules with respect to the
allocation of DASTM gain or loss on debt that gives rise to related
person interest expense under section 954(b)(5). Section 954(b)(5)
requires that related person interest expense must first be allocated
to foreign personal holding company income that is passive income to
the extent thereof and therefore to the section 904(d)(1)(A) separate
category for passive income for purposes of the foreign tax credit
limitation. To prevent distortion, any DASTM gain or loss arising from
such related person debt must also be allocated for purposes of
sections 904 and 952 in the same manner that the related person
interest expense of that debt is required to be allocated under the
rules of section 954(b)(5).
One commentator suggested that, in applying the modified gross
income method under Sec. 1.861-9T(j) to allocate and apportion the
interest expense of a controlled foreign corporation, the gross income
in each section 904(d) separate category should first be adjusted by
the amount of DASTM gain or loss allocated to assets under Sec. 1.985-
3(e)(3)(v). Section 1.985-3(e)(3)(vii)(C) of the final regulations
adopts this suggestion and requires that, before applying the modified
gross income method under Sec. 1.861-9T(j), an adjustment to gross
income must be made for DASTM gain or loss attributed to assets under
Sec. 1.985-3(e)(3)(v) and DASTM gain or loss on short-term, non-
interest-bearing trade payables under Sec. 1.985-3(e)(3)(viii)(A).
In accordance with comments described above, Sec. 1.985-
3(e)(3)(viii)(A) provides that DASTM gain or loss on short-term, non-
interest-bearing trade payables is allocated to the same category or
type of gross income as the cost or expense to which the trade payable
relates. For this purpose, a short-term, non-interest-bearing trade
payable is a non-interest-bearing liability with a term of 183 days or
less that is incurred to purchase property or services to be used by
the obligor in an active trade or business. Under Sec. 1.985-
3(e)(3)(viii)(B), a similar rule has been provided for excise tax
payables.
Under Sec. 1.985-3(e)(3)(viii)(C)(1), DASTM gain or loss on other
non-interest-bearing liabilities is allocated under Sec. 1.985-
3(e)(3)(ix) (i.e., on a gross income basis). However, under Sec. 1.985-
3(e)(3)(viii)(C)(2), the taxpayer may demonstrate to the satisfaction
of the district director, or the district director may determine, that
application of the gross income allocation method would result in a
substantial distortion of income. In that case, DASTM gain or loss on
such liabilities may be attributed to the same section 904(d) separate
category or subpart F category as the transaction to which the
liability relates.
The temporary regulations under Sec. 1.954-2T have been amended in
this Treasury Decision and will be finalized as part of a separate
regulation.
An accompanying proposed regulation provides rules that would
require a taxpayer to change from DASTM to the P&L method when the
currency which otherwise would be its functional currency ceases to be
hyperinflationary.
Effective Date
These regulations are effective for taxable years beginning after
August 24, 1994. However, a taxpayer may elect to apply Sec. 1.985-3 to
any open taxable year beginning after December 31, 1986 (whether or not
DASTM has been previously elected for some or all of those years). In
order to make this election, the taxpayer must apply Sec. 1.985-3 to
that year and all subsequent years. In addition, each person that is
related (within the meaning of Sec. 1.985-3(e)(2)(vi)) to the taxpayer
on the last day of any taxable year for which the election is effective
and that would have been eligible to elect DASTM must also apply
Sec. 1.985-3 to that year and all subsequent years.
Special Analyses
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)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue 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 authors of these regulations are Jacob Feldman and
Teresa B. Hughes of the Office of Associate Chief Counsel
(International) within the Office of Chief Counsel, IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are 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. In Sec. 1.904-4, paragraph (j) is revised to read as
follows:
Sec. 1.904-4 Separate application of section 904 with respect to
certain categories of income.
* * * * *
(j) Special rule for DASTM gain or loss. Any DASTM gain or loss
computed under Sec. 1.985-3(d) must be allocated among the categories
of income under the rules of Sec. 1.985-3 (e)(2)(iv) or (e)(3). The
rules of Sec. 1.985-3(e) apply before the rules of section
904(d)(2)(A)(iii)(III) (the exception from passive income for high-
taxed income).
* * * * *
Par. 3. In Sec. 1.954-2T, paragraph (g)(2)(i) is revised to read as
follows:
Sec. 1.954-2T Foreign personal holding company income; taxable years
beginning after December 31, 1986 (temporary).
* * * * *
(g) * * *
(2) * * * (i) Qualified business units using the dollar approximate
separate transactions method. Any DASTM gain or loss computed under
Sec. 1.985-3(d) must be allocated under the rules of Sec. 1.985-3
(e)(2)(iv) or (e)(3).
* * * * *
Par. 4. Section 1.985-0 is amended by revising the table of
contents entry for Sec. 1.985-3 to read as follows:
Sec. 1.985-0 Outline of regulation.
* * * * *
Sec. 1.985-3 United States dollar approximate separate transactions
method.
(a) Scope and effective date.
(b) Statement of method.
(c) Translation into United States dollars.
(d) Computation of DASTM gain or loss.
(e) Effect of DASTM gain or loss on gross income, taxable
income, or earnings and profits.
* * * * *
Par. 5. Section 1.985-1 is amended as follows:
1. Revise the fifth, seventh, and eighth sentences of paragraph
(a)(1).
2. Revise paragraph (b).
3. Revise paragraph (c)(6).
4. Add a new sentence to the end of paragraph (d)(1)(ii) and remove
the concluding text at the end of paragraph (d)(1).
5. The revisions and additions read as follows:
Sec. 1.985-1 Functional currency.
(a) * * * (1) * * * Section 1.985-3 sets forth the dollar
approximate separate transactions method that certain QBUs must use to
compute their income or loss or earnings and profits. * * * Section
1.985-5 provides adjustments that are required to be made upon a change
in functional currency. Finally, Sec. 1.985-6 provides transition rules
for a QBU that uses the dollar approximate separate transactions method
for its first taxable year beginning after December 31, 1986.
* * * * *
(b) Dollar functional currency--(1) In general. The dollar shall be
the functional currency of a taxpayer or QBU described in paragraph
(b)(1) (i) through (v) of this section regardless of the currency used
in keeping its books and records (as defined in Sec. 1.989(a)-1(d)).
The dollar shall be the functional currency of--
(i) A taxpayer that is not a QBU (e.g., an individual);
(ii) A QBU that conducts its activities primarily in dollars. A QBU
conducts its activities primarily in dollars if the currency of the
economic environment in which the QBU conducts its activities is
primarily the dollar. The facts and circumstances test set forth in
paragraph (c)(2) of this section shall apply in making this
determination;
(iii) Except as otherwise provided by ruling or administrative
pronouncement, a QBU that has the United States, or any possession or
territory of the United States where the dollar is the standard
currency, as its residence (as defined in section 988(a)(3)(B));
(iv) A QBU that does not keep books and records in the currency of
any economic environment in which a significant part of its activities
is conducted. Whether a QBU keeps such books and records is determined
in accordance with paragraph (c)(3) of this section; or
(v) A QBU that produces income or loss that is, or is treated as,
effectively connected with the conduct of a trade or business within
the United States.
(2) QBUs operating in a hyperinflationary environment--(i) Taxable
years beginning on or before August 24, 1994. For taxable years
beginning on or before August 24, 1994, see Sec. 1.985-2 with respect
to a QBU that elects to use, or is otherwise required to use, the
dollar as its functional currency.
(ii) Taxable years beginning after August 24, 1994.--(A) In
general. For taxable years beginning after August 24, 1994, except as
otherwise provided in paragraph (b)(2)(ii)(B) of this section, any QBU
that otherwise would be required to use a hyperinflationary currency as
its functional currency must use the dollar as its functional currency
and compute income or loss or earnings and profits under the rules of
Sec. 1.985-3.
(B) Exceptions--(1) Certain QBU branches. The functional currency
of a QBU that otherwise would be required to use a hyperinflationary
currency as its functional currency and that is a branch of a foreign
corporation having a non-dollar functional currency that is not
hyperinflationary shall be the functional currency of the foreign
corporation. Such QBU's income or loss or earnings and profits shall be
determined under Sec. 1.985-3 by substituting the functional currency
of the foreign corporation for the dollar.
(2) Corporation that is not a controlled foreign corporation. A
foreign corporation (or its QBU branch) operating in a
hyperinflationary environment is not required to use the dollar as its
functional currency pursuant to paragraph (b)(2)(ii)(A) of this section
if that foreign corporation is not a controlled foreign corporation as
defined in section 957 or 953(c)(1)(B). However, a noncontrolled
section 902 corporation, as defined in section 904(d)(2)(E), may elect
to use the dollar (or, if appropriate, the currency specified in
paragraph (b)(2)(ii)(B)(1) of this section) as its (or its QBU
branch's) functional currency under the procedures set forth in
Sec. 1.985-2(c)(3).
(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 the
adjustments described in Sec. 1.985-5 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. The adjustments
described in Sec. 1.985-5 must be included in income in the taxable
year prior to the year of change unless that prior taxable year is
closed. In that case, the adjustments must be included in income in the
year of change. No adjustments under section 481 are required solely
because of a change in functional currency described in this paragraph
(b)(2)(ii)(C).
(D) Hyperinflationary currency. For purposes of sections 985
through 989, the term hyperinflationary currency means the currency of
a country in which there is cumulative inflation during the base period
of at least 100 percent as determined by reference to the consumer
price index of the country listed in the monthly issues of the
``International Financial Statistics'' or a successor publication of
the International Monetary Fund. If a country's currency is not listed
in the monthly issues of ``International Financial Statistics,'' a QBU
may use any other reasonable method consistently applied for
determining the country's consumer price index. Base period means, with
respect to any taxable year, the thirty-six calendar months immediately
preceding the first day of the current calendar year. For this purpose,
the cumulative inflation rate for the base period is based on
compounded inflation rates. Thus, if for 1991, 1992, and 1993, a
country's annual inflation rates are 29 percent, 25 percent, and 30
percent, respectively, the cumulative inflation rate for the three-year
base period is 110 percent [((1.29 x 1.25 x 1.3)-1.0 x
1.10)x100=110%] and the currency of the country for the QBU's 1994 year
is considered hyperinflationary.
(c) * * *
(6) Effect of changed circumstances. Regardless of any change in
circumstances, a QBU may change its functional currency determined
under this paragraph (c) only if the QBU complies with Sec. 1.985-4 or
the Commissioner's consent is considered to have been granted under
Sec. 1.985-2(d)(4) or Sec. 1.985-3(a)(2)(ii).
(d) * * *
(1) * * *
(ii) * * * For purposes of this paragraph (d)(1), if a QBU of a
foreign corporation has the dollar as its functional currency under
paragraph (b)(2) of this section, the QBU's activities shall be
considered dollar activities of the corporation.
* * * * *
Par. 6. Section 1.985-2 is amended by revising paragraphs (a) and
(b)(2) to read as follows:
Sec. 1.985-2 Election to use the United States dollar as the
functional currency of a QBU.
(a) Background and scope--(1) In general. This section permits an
eligible QBU to elect to use the dollar as its functional currency for
taxable years beginning on or before August 24, 1994. An election to
use a dollar functional currency is not permitted for a QBU other than
an eligible QBU. Paragraph (b) of this section defines an eligible QBU.
Paragraph (c) of this section describes the time and manner for making
the dollar election and paragraph (d) of this section describes the
effect of making the election. For the definition of a QBU, see section
989(a). See Sec. 1.985-1(b)(2)(ii) for rules requiring a QBU to use the
dollar as its functional currency in taxable years beginning after
August 24, 1994.
(2) Exception. Pursuant to Sec. 1.985-1(b)(2)(ii)(B)(2), the rules
of paragraph (c)(3) of this section shall apply with respect to the
procedure required to be followed by a noncontrolled section 902
corporation as defined in section 904(d)(2)(E) to elect the dollar as
its (or its QBU branch's) functional currency and the application of
Sec. 1.985-3.
(b) * * *
(2) Hyperinflationary currency. See Sec. 1.985-1(b)(2)(ii)(D) for
the definition of hyperinflationary currency.
* * * * *
Par. 7. Section 1.985-3 is revised to read as follows:
Sec. 1.985-3 United States dollar approximate separate transactions
method.
(a) Scope and effective date--(1) Scope. This section describes the
United States dollar (dollar) approximate separate transactions method
of accounting (DASTM). For all purposes of subtitle A, this method of
accounting must be used to compute the gross income, taxable income or
loss, or earnings and profits (or deficit in earnings and profits) of a
QBU (as defined in section 989(a)) that has the dollar as its
functional currency pursuant to Sec. 1.985-1(b)(2).
(2) Effective date--(i) In general. This section is effective for
taxable years beginning after August 24, 1994.
(ii) DASTM prior-year election. A taxpayer may elect to apply this
section to any open taxable year beginning after December 31, 1986
(whether or not DASTM has been previously elected for some or all of
those years). In order to make this election, the taxpayer must apply
Sec. 1.985-3 to that year and all subsequent years. In addition, each
person that is related (within the meaning of Sec. 1.985-3(e)(2)(vi))
to the taxpayer on the last day of any taxable year for which the
election is effective and that would have been eligible to elect DASTM
must also apply these rules to that year and all subsequent years. A
taxpayer that has not previously elected to apply DASTM to its prior
taxable years may make the DASTM election for the pertinent years by
filing amended returns and complying with the applicable election
procedures of Sec. 1.985-2. Form 8819 shall be attached to the return
for the first year for which the election is to be effective. A
taxpayer that has elected DASTM for prior taxable years and applied the
rules under Sec. 1.985-3 (as contained in the April 1, 1994 edition of
26 CFR part 1 (1.908 to 1.1000)) may amend its returns to apply the
rules of this Sec. 1.985-3. In either case, the DASTM election for
prior taxable years shall be deemed to be made with the consent of the
Commissioner.
(b) Statement of method. Under DASTM, income or loss or earnings
and profits (or a deficit in earnings and profits) of a QBU for its
taxable year shall be determined in dollars by--
(1) Preparing an income or loss statement from the QBU's books and
records (within the meaning of Sec. 1.989(a)-1(d)) as recorded in the
QBU's hyperinflationary currency (as defined in Sec. 1.985-
1(b)(2)(ii)(D));
(2) Making the adjustments necessary to conform such statement to
United States generally accepted accounting principles and tax
accounting principles (including reversing monetary correction
adjustments required by local accounting principles);
(3) Translating the amounts of hyperinflationary currency as shown
on such adjusted statement into dollars in accordance with paragraph
(c) of this section; and
(4) Adjusting the resulting dollar income or loss or earnings and
profits (or deficit in earnings and profits) and, where necessary,
particular items of gross income, deductible expense or other amounts,
in accordance with paragraph (e) of this section to reflect the amount
of DASTM gain or loss as determined under paragraph (d) of this
section.
(c) Translation into United States dollars--(1) In general. Except
as otherwise provided in this paragraph (c), the amounts shown on the
income or loss statement, as adjusted under paragraph (b)(2) of this
section, shall be translated into dollars at the exchange rate (as
defined in paragraph (c)(6) of this section) for the translation period
(as defined in paragraph (c)(7) of this section) to which they relate.
However, if the QBU previously changed its functional currency to the
dollar, and the rules of Sec. 1.985-5 (or, if applicable, Sec. 1.985-
5T, as contained in the April 1, 1993 edition of 26 CFR part 1 (1.908
to 1.1000)) applied in translating its balance sheet amounts into
dollars, then the spot exchange rate applied under those rules shall be
used to translate any amount that would otherwise be translated at a
rate determined by reference to a translation period prior to the
change in functional currency. For example, depreciation with respect
to an asset acquired while the QBU had a nondollar functional currency
shall be translated into dollars at the spot rate on the last day of
the taxable year before the year of change to a dollar functional
currency, rather than at the rate for the period in which the asset was
acquired.
(2) Cost of goods sold. The dollar value of cost of goods sold
shall equal the sum of the dollar values of beginning inventory and
purchases less the dollar value of closing inventory as these amounts
are determined under paragraph (c)(3) of this section.
(3) Beginning inventory, purchases, and closing inventory--(i)
Beginning inventory. Amounts representing beginning inventory shall be
translated so as to obtain the same amount of dollars which represented
such items in the closing inventory balance for the preceding taxable
year.
(ii) Purchases. Amounts representing items purchased or otherwise
first included in inventory during the taxable year shall be translated
at the exchange rate for the translation period in which the cost of
such items was incurred.
(iii) Closing inventory--(A) In general. Amounts representing items
included in the closing inventory balance shall be translated at the
exchange rate for the translation period in which the cost of such
items was incurred. However, if amounts representing items included in
the closing inventory balance are either valued at market or written
down to market value, they shall be translated at the exchange rate
existing on the last day of the taxable year. For purposes of
determining lower of cost or market, items of inventory included in the
closing inventory balance shall be translated into dollars at the
exchange rate for the translation period in which the cost of such
items was incurred and compared with market as determined in the QBU's
hyperinflationary currency translated into dollars at the exchange rate
existing on the last day of the taxable year.
(B) Determination of translation period. The method used to
determine the translation period of amounts representing items of
closing inventory for purposes of paragraph (c)(3)(iii)(A) of this
section may be based upon reasonable approximations and averages,
including rates of turnover, provided that the method is used
consistently from year to year.
(4) Depreciation, depletion, and amortization. Amounts representing
allowances for depreciation, depletion, or amortization shall be
translated at the exchange rate for the translation period in which the
cost of the underlying asset was incurred, except as provided in
paragraph (c)(1) of this section.
(5) Prepaid expenses or income. Amounts representing expense or
income paid or received in a prior taxable year shall be translated at
the exchange rate for the translation period during which they were
paid or received.
(6) Exchange rate. The exchange rate for a translation period may
be determined under any reasonable method, provided that the method is
consistently applied to all translation periods and conforms to the
taxpayer's method of financial accounting. Reasonable methods include
the average of beginning and ending exchange rates for the translation
period and the spot rate on the last day of the translation period.
Once chosen, a method for determining an exchange rate can be changed
only with the consent of the district director.
(7) Translation period--(i) In general. Except as provided in
paragraphs (c)(3)(iii)(B) and (c)(7)(ii) of this section, a translation
period shall be each month within a QBU's taxable year.
(ii) Exception. A taxpayer may divide its taxable year into
translation periods of equal length (with not more than one short
period annually) that are less than one month. Once such a translation
period is established, it may not be changed without the consent of the
district director.
(8) Dollar transactions--(i) In general. Except as provided in
paragraph (c)(8)(ii) of this section, no DASTM gain or loss is realized
with respect to dollar transactions since the dollar is the functional
currency of the QBU. Thus, the amount of any payment or receipt of
dollars shall be reflected in the income or loss statement by the
amount of such dollars. Also, the income or loss attributable to any
transaction in which the amount that a QBU is entitled to receive (or
is required to pay) by reason of such transaction is denominated in
terms of the dollar, or is determined by reference to the value of the
dollar, must be computed transaction by transaction. For example, if a
foreign corporation lends 20 LC when 20 LC=$20 and is entitled to
receive the LC equivalent of $20 at maturity plus a market rate of
interest in dollars (or its LC equivalent), the loan is a dollar
transaction. Similarly, this paragraph applies to any transaction that
is determined to be a dollar transaction under section 988.
(ii) Non-dollar functional currency. If pursuant to Sec. 1.985-
1(b)(2)(ii)(B)(1), a QBU is required to use a functional currency other
than the dollar, then that currency shall be substituted for the dollar
in applying paragraph (c)(8)(i) of this section.
(9) Third currency transactions--A taxpayer may use any reasonable
method of accounting for transactions described in section 988(c)(1)
(B) and (C) that are denominated in, or determined by reference to, a
currency other than the QBU's hyperinflationary currency or the dollar
(third currency transactions) so long as such method is consistent with
its method of financial accounting.
(10) Examples. The provisions of this paragraph (c) are illustrated
by the following examples:
Example 1. S is an accrual basis QBU that is required to use the
dollar as its functional currency for its first taxable year
beginning in 1994. S's hyperinflationary currency is the ``h.''
During 1994, S accrues 100 dollars attributable to dollar-
denominated sales. Because this is a dollar transaction under
paragraph (c)(8) of this section, S's income or loss for 1994 shall
reflect the 100 dollars (not the hyperinflationary value of such
dollars when accrued).
Example 2. (i) S is an accrual basis QBU that is required to use
the dollar as its functional currency for its first taxable year
beginning in 1994. S's hyperinflationary currency is the ``h.''
During 1994, S's sales amounted to 240,000,000h, its currently
deductible expenses were 26,000,000h, and its total inventory
purchases amounted to 100,000,000h. During January and February of
1994, S purchased depreciable assets for 80,000,000h and was allowed
depreciation of 4,000,000h. At the end of 1994, S's closing
inventory was 23,000,000h. No election to use a translation period
other than the month is made, S had no transactions described in
paragraph (c)(8) or (c)(9) of this section, and S's closing
inventory was computed on the first-in, first-out inventory method.
S's adjusted income or loss statement for 1994 is translated into
dollars as follows:
----------------------------------------------------------------------------------------------------------------
Hyperinflationary Exchange United States
currency rate dollars
----------------------------------------------------------------------------------------------------------------
Sales
(Jan.-Feb.)..................................................... 10,000,000h \1\20:1 $500,000
(Mar.-Apr.)..................................................... 20,000,000 21:1 952,381
(May.-June.).................................................... 50,000,000 22:1 2,272,727
(July).......................................................... 50,000,000 23:1 2,173,913
(August)........................................................ 20,000,000 26:1 769,231
(Sept.)......................................................... 20,000,000 28:1 714,286
(Oct.).......................................................... 20,000,000 29:1 689,655
(Nov.).......................................................... 20,000,000 30:1 666,667
(Dec.).......................................................... 30,000,000 31:1 967,742
------------------- ----------------
Total..................................................... 240,000,000h .......... 9,706,602
Cost of Goods Sold
Opening Inventory Purchases: 0 .......... 0
(Jan.-Feb.)................................................. 15,000,000h 20:1 750,000
(Mar.-Apr.)................................................. 10,000,000 21:1 476,190
(May-June).................................................. 30,000,000 22:1 1,363,636
(July)...................................................... 20,000,000 23:1 869,565
(August).................................................... 10,000,000 26:1 384,615
(Sept.)..................................................... 5,000,000 28:1 178,571
(Oct.)...................................................... 5,000,000 29:1 172,414
(Nov.)...................................................... 2,500,000 30:1 83,333
(Dec.)...................................................... 2,500,000 31:1 80,645
Less Closing Inventory.......................................... (23,000,000) (\2\) (822,655)
------------------- ----------------
77,000,000h .......... 3,536,314
----------------------------------------------------------------------------------------------------------------
\1\Where multiple months are indicated, the exchange rate applies for all months.
\2\See paragraph (ii) of this Example.
(ii) Since S uses the first-in, first-out inventory method, the
closing inventory is assumed to consist of purchases made during the
most recent translation period as follows:
----------------------------------------------------------------------------------------------------------------
Hyperinflationary United States
currency Exchange rate dollars
----------------------------------------------------------------------------------------------------------------
December..................................................... 2,500,000h 31:1 $80,645
November..................................................... 2,500,000 30:1 83,333
October...................................................... 5,000,000 29:1 172,414
September.................................................... 5,000,000 28:1 178,571
August....................................................... 8,000,000 26:1 307,692
------------------- ---------------
Total.................................................. 23,000,000h .............. 822,655
=================== ===============
Non-Capitalized Expenses
(Jan.-Feb.).................................................. 4,000,000h 20:1 200,000
(Mar.-Apr.).................................................. 2,500,000 21:1 119,048
(May-June)................................................... 2,500,000 22:1 113,636
(July)....................................................... 2,000,000 23:1 86,957
(August)..................................................... 3,000,000 26:1 115,385
(Sept.)...................................................... 3,000,000 28:1 107,143
(Oct.)....................................................... 2,000,000 29:1 68,966
(Nov.)....................................................... 3,000,000 30:1 100,000
(Dec.)....................................................... 4,000,000 31:1 129,032
------------------- ---------------
Total.................................................. 26,000,000h .............. 1,040,167
Depreciation................................................. 4,000,000h 20:1 200,000
Total Cost & Expenses.................................. 107,000,000h .............. 4,776,481
------------------- ---------------
Operating Profit............................................. 133,000,000h .............. 4,930,121
=================== ===============
----------------------------------------------------------------------------------------------------------------
(d) Computation of DASTM gain or loss--(1) Rule. DASTM gain or loss
of a QBU equals--
(i) The net worth of the QBU (as determined under paragraph (d)(2)
of this section) at the end of the taxable year minus the net worth of
the QBU at the end of the preceding taxable year; plus
(ii) The dollar amount of the items described in paragraph (d)(3)
of this section and minus the dollar amount of the items described in
paragraph (d)(4) of this section; minus
(iii) The amount of dollar income or earnings and profits (or plus
the amount of any dollar loss or deficit in earnings and profits) as
determined for the taxable year pursuant to paragraphs (b)(1) through
(b)(3) of this section.
(2) Net worth. Net worth of a QBU at the end of any taxable year
equals the aggregate dollar amount representing assets on the QBU's
balance sheet at the end of the taxable year less the aggregate dollar
amount representing liabilities on the balance sheet. Notwithstanding
any other provision in this paragraph (d)(2), the district director may
adjust the amount of any asset or liability if a purpose for acquiring
(or disposing of) the asset or incurring (or discharging) the liability
is to manipulate the composition of the balance sheet for any period
during the taxable year in order to avoid tax. The taxpayer shall
determine net worth by--
(i) Preparing a balance sheet as of the end of the taxable year
from the QBU's books and records (within the meaning of Sec. 1.989(a)-
1(d)) as recorded in the QBU's hyperinflationary currency;
(ii) Making adjustments necessary to conform such balance sheet to
United States generally accepted accounting principles and tax
accounting principles (including reversing monetary correction
adjustments required by local accounting principles); and
(iii) Translating the asset and liability amounts shown on the
balance sheet into United States dollars in accordance with paragraph
(d)(5) of this section.
(3) Positive adjustments. The items described in this paragraph
(d)(3) are dividend distributions for the taxable year and any items
that decrease net worth for the taxable year but that generally do not
affect income or loss or earnings and profits (or a deficit in earnings
and profits). Such items include a transfer to the home office of a QBU
branch and a return of capital. Except as otherwise provided by ruling
or administrative pronouncement, the amount of a transfer to the home
office of a QBU branch, a dividend, or a distribution that is a return
of capital shall be translated into dollars at the exchange rate on the
date the amount is paid.
(4) Negative adjustments. The items described in this paragraph
(d)(4) are items that increase net worth for the taxable year but that
generally do not affect income or loss or earnings and profits (or a
deficit in earnings and profits). Such items include a capital
contribution or a transfer from a home office to a QBU branch. Except
as otherwise provided by ruling or administrative pronouncement, if the
contribution or transfer is not in dollars, the amount of a capital
contribution or transfer shall be translated into dollars at the
exchange rate on the date made.
(5) Translation of balance sheet. Asset and liability amounts shown
on the balance sheet in hyperinflationary currency (adjusted pursuant
to paragraph (d)(2)(ii) of this section) shall be translated into
dollars as provided in this paragraph (d)(5). However, if the QBU
previously changed its functional currency to the dollar and the rules
of Sec. 1.985-5 (or, if applicable, Sec. 1.985-5T, as contained in the
April 1, 1993 edition of 26 CFR part 1 (1.908 to 1.1000)) applied in
translating its balance sheet amounts into dollars, then the spot
exchange rate applied under those rules shall be used to translate any
amount that would otherwise be translated at a rate determined by
reference to a translation period prior to the change in functional
currency. For example, the basis of real property acquired while the
QBU had a nondollar functional currency shall be translated into
dollars at the spot rate on the last day of the taxable year before the
year of change to a dollar functional currency, rather than at the rate
for the period in which the cost was incurred.
(i) Closing inventory. Amounts representing items of inventory
included in the closing inventory balance shall be translated in
accordance with paragraph (c)(3)(iii) of this section.
(ii) Bad debt reserves. Amounts representing bad debt reserves
shall be translated at the exchange rate for the last translation
period for the taxable year.
(iii) Prepaid income or expense. Amounts representing expenses or
income paid or received in a prior taxable year shall be translated in
accordance with paragraph (c)(5) of this section.
(iv) Hyperinflationary currency. Amounts of the hyperinflationary
currency and hyperinflationary demand deposit balances shall be
translated at the exchange rate for the last translation period of the
taxable year.
(v) Certain assets--(A) In general. Amounts representing plant,
real property, equipment, goodwill, and patents and other intangibles
shall be translated at the exchange rate for the translation period in
which the cost of the asset was incurred.
(B) Adjustment to certain assets. Amounts representing
depreciation, depletion, and amortization reserves shall be translated
in accordance with paragraph (c)(4) of this section.
(vi) Hyperinflationary debt obligations. Except as provided in
paragraph (d)(5)(vii) of this section, amounts representing a
hyperinflationary debt obligation (including accounts receivable and
payable) shall be translated at the exchange rate for the last
translation period for the taxable year.
(vii) Accrued foreign income taxes. Amounts representing an accrued
but unpaid foreign income tax shall be translated at the exchange rate
on the last day of the last translation period of the taxable year of
accrual.
(viii) Certain hyperinflationary financial instruments. Amounts
representing any item described in section 988(c)(1)(B)(iii) (relating
to forward contracts, futures contracts, options, or similar financial
instruments) denominated in or determined by reference to the
hyperinflationary currency shall be translated at the exchange rate for
the last translation period for the taxable year.
(ix) Other assets and liabilities. Amounts representing assets and
liabilities, other than those described in paragraphs (d)(5)(i) through
(viii) of this section, shall be translated at the exchange rate for
the translation period in which the cost of the asset or the amount of
the liability was incurred.
(6) Dollar transactions. Notwithstanding any other provisions of
this paragraph (d), where the amount representing an item shown on the
balance sheet reflects a dollar transaction (described in paragraph
(c)(8) of this section), the transaction shall be taken into account in
accordance with that paragraph.
(7) Third currency transactions. A taxpayer may use any reasonable
method of accounting for transactions described in section 988(c)(1)(B)
and (C) that are denominated in, or determined by reference to, a
currency other than the QBU's hyperinflationary currency or the dollar
(third currency transactions), so long as such method is consistent
with its method of financial accounting.
(8) Character. The amount of DASTM gain or loss determined under
paragraph (d)(1) of this section shall be ordinary income or loss.
(9) Example. The provisions of this paragraph (d) are illustrated
by the following example:
Example. (i) S, an accrual method calendar year foreign
corporation, uses DASTM. S's hyperinflationary currency is the
``h.'' S's net worth at December 31, 1993 was $3,246,495. For 1994,
S's operating profit is 81,340,000h, or $2,038,200. S made a
5,000,000h distribution in April and again in December of 1994. S's
translation period is the month. None of S's assets or liabilities
reflect a dollar or third currency transaction described in
paragraph (c)(8) or (c)(9) of this section, respectively. The
exchange rate for each month in 1994 is as follows:
January..................................................... 32h:$1
Feb.-Mar.................................................... 33:1
April-May................................................... 34:1
June........................................................ 35:1
July........................................................ 36:1
Aug.-Sept................................................... 37:1
Oct......................................................... 38:1
Nov......................................................... 39:1
Dec......................................................... 40:1
(ii) At the end of 1994, S's assets and liabilities, as adjusted
and translated pursuant to paragraphs (d)(2) and (d)(5) of this
section, are as follows:
----------------------------------------------------------------------------------------------------------------
Hyperin-
flationary Exchange rate U.S. dollar
----------------------------------------------------------------------------------------------------------------
Hyperinflationary cash on hand.................................. 40,000h 40:1 $1,000
Checking account.............................................. 400,000 40:1 10,000
Accounts Receivable- 30 Day Accounts............................ 20,000,000 \1\40:1 500,000
60 Day Accounts............................................. 25,000,000 40:1 625,000
Inventory....................................................... 65,000,000 (\2\) 2,500,000
Fixed assets--Property.......................................... 90,000,000 27:1 3,333,333
Plant....................................................... 190,000,000 (\3\) 6,785,714
Accumulated Depreciation................................ (600,000) (\3\) (21,428)
Equipment................................................... 10,000,000 (\4\) 340,000
Accumulated Depreciation................................ (400,000) (\4\) (13,333)
Common Stock--Stock A........................................... 500,000 34:1 14,706
Stock B................................................... 400,000 26:1 15,385
Preferred Stock................................................. 1,000,000 32:1 31,250
C.D.s........................................................... 5,000,000 40:1 125,000
Total Assets.............................................. 406,340,000 14,246,627
Accounts Payable Long-term liabilities: 35,000,000 40:1 875,000
Liability A................................................. 150,000,000 40:1 3,750,000
Liability B................................................. 80,000,000 40:1 2,000,000
Liability C................................................. 30,000,000 40:1 750,000
---------------- ---------------
Total Liabilities......................................... 295,000,000h $7,375,000
----------------------------------------------------------------------------------------------------------------
\1\S ages its accounts receivable and groups them into two categories--those outstanding for 30 days and those
outstanding for 60 days.
\2\Translated the same as closing inventory under paragraph (c)(3)(iii).
\3\The cost of S's plant was incurred in several translation periods. Therefore, the dollar cost and dollar
depreciation reflect several translation rates.
\4\S has a variety of equipment. Therefore, S's dollar basis represents the sum of the hyperinflationary cost of
each, translated according to the exchange rate for the translation period incurred.
(iii) The DASTM gain of S for 1994 is computed as follows:
Net worth--1994......................... .............. $6,871,627
Less--Net worth--1993................... .............. $3,246,495
Plus--1994 Dividends:
April............................... $149,254
December............................ \1\126,582 275,836
Less Operating Profit--1994............. .............. 2,038,200
DASTM Gain.............................. .............. $1,862,768
===============
\1\The exchange rates on the date of the April and December dividends
were 33.5h:$1 and 39.5h:$1, respectively.
(iv) Thus, total profit = $2,038,200 + $1,862,768 = $3,900,968
(e) Effect of DASTM gain or loss on gross income, taxable income,
or earnings and profits--(1) In general. For all purposes of subtitle
A, the amount of DASTM gain or loss of a QBU determined under paragraph
(d) of this section is taken into account by the QBU for purposes of
determining the amount of its gross income, taxable income or loss,
earnings and profits (or deficit in earnings and profits), and, where
necessary, particular items of income, expense or other amounts. DASTM
gain or loss is allocated under one of two methods. Certain small QBUs
may elect the small QBU DASTM allocation described in paragraph (e)(2)
of this section. All other QBUs must use the 9-step procedure described
in paragraph (e)(3) of this section.
(2) Small QBU DASTM allocation--(i) Election threshold. A taxpayer
may elect to use the small QBU DASTM allocation described in paragraph
(e)(2)(iv) of this section with respect to a QBU that has an adjusted
basis in assets (translated as provided in paragraph (d)(5) of this
section) of $10 million or less at the end of any taxable year. In
calculating the $10 million threshold, a QBU shall be treated as owning
all of the assets of each related QBU (as defined in paragraph
(e)(2)(vi) of this section) having its residence (as defined in section
988(a)(3)(B)) in the QBU's country of residence (related same- country
QBU). For this purpose, appropriate adjustment shall be made to
eliminate the double counting of assets created in transactions between
related QBUs resident in the same country. For example, assume QBU-1,
resident in country X, sells inventory to related QBU-2, also resident
in country X, in exchange for an account receivable. For purposes of
determining the assets of QBU-1 under this paragraph (e)(2)(i), the
taxpayer shall take into account either the inventory shown on the
books of QBU-2 or QBU-1's receivable from QBU-2 (but not both).
(ii) Consent to election. The election of the small QBU DASTM
allocation or subsequent application of the rules of paragraph (e)(3)
of this section due to an increase in the adjusted basis of the QBU's
assets shall be deemed to have been made with the consent of the
Commissioner. Once the election under paragraph (e)(2)(iii) of this
section is made, it shall apply for all years in which the adjusted
basis of the assets of the QBU (and any related same-country QBU) is
$10 million or less, unless revoked with the Commissioner's consent. If
the adjusted basis of the assets of the QBU (and any related same-
country QBU) exceeds $10 million at the end of any taxable year, the
rules of paragraph (e)(3) of this section shall apply to that QBU (and
any related same-country QBU) for such year and each subsequent year
unless such QBU again qualifies, and applies for and obtains the
Commissioner's consent, to use the small QBU DASTM allocation. However,
if a QBU acquires assets with a principal purpose of avoiding the
application of paragraph (e)(2)(iv) of this section, the Commissioner
may disregard the acquisition of such assets.
(iii) Manner of making election--(A) QBUs that are branches of
United States persons. For the first year in which this election is
effective, in the case of a QBU branch of a United States person, a
statement shall be attached to the United States person's timely filed
Federal income tax return (taking extensions into account). The
statement shall identify the QBU (or QBUs) for which the election is
being made by describing its business and its country of residence,
state the adjusted basis of the assets of the QBU (and any related
same-country QBUs) to which the election applies, and include a
statement that the election is being made pursuant to Sec. 1.985-
3(e)(2).
(B) Other QBUs. In the case of a QBU other than one described in
paragraph (e)(2)(iii)(A) of this section, an election must be made in
the manner prescribed in Sec. 1.964-1. The statement filed with the
Internal Revenue Service as required under Sec. 1.964-1 must include
the information required under paragraph (e)(2)(iii)(A) of this
section.
(iv) Effect of election. If a taxpayer elects under this paragraph
(e)(2) to use the small QBU DASTM allocation, DASTM gain or loss, as
determined under paragraph (d) of this section, of a small QBU shall be
allocated ratably to all items of the QBU's gross income (determined
prior to adjustment for DASTM gain or loss). Therefore, for purposes of
the foreign tax credit, DASTM gain or loss shall be allocated on the
basis of the relative amounts of gross income in each separate category
as defined in Sec. 1.904-5(a)(1). In the case of a controlled foreign
corporation (within the meaning of section 957 or 953(c)(1)(B)), for
purposes of section 952, DASTM gain or loss shall be allocated to
subpart F income in a separate category in the same ratio that the
gross subpart F income in that category for the taxable year bears to
its total gross income in that category for the taxable year.
(v) Conformity. If a person (or a QBU of such person) makes an
election under this paragraph (e)(2) to use the small QBU DASTM
allocation, then each QBU of any related person (as defined in
paragraph (e)(2)(vi) of this section) that satisfies the threshold
requirement of paragraph (e)(2)(i) of this section (after application
of the aggregation rule of paragraph (e)(2)(i) of this section) shall
be deemed to have made the election.
(vi) Related person. The term related person means any person with
a relationship to the QBU (or to the United States or foreign person of
which the electing QBU is a part) that is defined in section 267(b) or
section 707(b).
(3) DASTM 9-step procedure--(i) Step 1--prepare balance sheets. The
taxpayer shall prepare an opening and a closing balance sheet for the
QBU for each balance sheet period during the taxable year. The balance
sheet period is the most frequent period for which balance sheet data
are reasonably available (but in no event less frequently than
quarterly). The balance sheet period may not be changed without the
consent of the district director. The balance sheets must be prepared
under the principles of paragraph (d)(2) of this section.
(ii) Step 2--identify certain assets and liabilities. The taxpayer
shall identify each item on the balance sheet that is described in
section 988(c)(1)(B) or (C) and that would have been translated under
paragraph (d)(5) of this section into dollars at the exchange rate for
the last translation period for the taxable year (or the exchange rate
on the last day of the last translation period of the taxable year in
the case of an accrued foreign income tax liability).
(iii) Step 3--characterize the assets. The taxpayer shall
characterize and group the assets identified in paragraph (e)(3)(ii) of
this section (Step 2) according to the source and the type of income
that they generate, have generated, or may reasonably be expected to
generate by applying the principles of Sec. 1.861-9T(g)(3) or its
successor regulation (relating to characterization of assets for
purposes of interest expense allocation). If a purpose for a taxpayer's
business practices is to manipulate asset characterization or
groupings, the district director may allocate or apportion DASTM gain
or loss attributable to the assets. Thus, if a taxpayer that previously
did not separately state interest on accounts receivable begins to
impose an interest charge and a purpose for the change was to
manipulate tax characterizations or groupings, then the district
director may require that none of the DASTM gain or loss attributable
to those receivables be allocated or apportioned to interest income.
(iv) Step 4--determine DASTM gain or loss attributable to certain
assets--(A) General rule. The taxpayer shall determine the dollar
amount of DASTM gain or loss attributable to assets in each group
identified in paragraph (e)(3)(iii) of this section (Step 3) as
follows:
[(bb+eb)2] x [er-br]
where
bb = the hyperinflationary currency adjusted basis of the assets in the
group at the beginning of the balance sheet period.
eb = the hyperinflationary currency adjusted basis of the assets in the
group at the end of the balance sheet period.
er = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the end of the balance sheet period.
br = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the beginning of the balance sheet
period.
(B) Weighting to prevent distortion. If averaging the adjusted
basis of assets in a group at the beginning and end of a balance sheet
period results in an allocation of DASTM gain or loss that does not
clearly reflect income, as might be the case in the event of a purchase
or disposition of an asset that is not in the normal course of
business, the taxpayer must use a weighting method that reflects the
time the assets are held by the QBU during the translation period.
(C) Example. The provisions of this paragraph (e)(3)(iv) are
illustrated by the following example:
Example. S is a foreign corporation that operates in the
hyperinflationary currency ``h'' and computes its income or loss or
earnings and profits under DASTM. S's adjusted basis in a group of
assets described in section 988(c)(1)(B) or (C) that generate
general limitation foreign source income (as characterized under
paragraph (e)(3)(iii) of this section) at the beginning of the
balance sheet period is 750,000h. S's basis in such assets at the
end of the balance sheet period is 1,250,000h. The exchange rate at
the beginning of the balance sheet period is $1 = 200h. The exchange
rate at the end of the balance sheet period is $1 = 500h. The DASTM
loss attributable to the assets described above is $3,000,
determined as follows:
[(750,000h+1,250,000h)2] x
[($1500h)-($1200h)]=($3000)
(v) Step 5--adjust dollar gross income by DASTM gain or loss from
assets. The taxpayer shall adjust the dollar amount of the QBU's gross
income (computed under paragraphs (b)(1) through (b)(3) of this
section) generated by each group of assets characterized in paragraph
(e)(3)(iii) of this section (Step 3) by the amount of DASTM gain or
loss attributable to those assets computed under paragraph (e)(3)(iv)
of this section (Step 4). Thus, if a group of assets, such as accounts
receivable, generates both a category of income described in section
904(d)(1)(I) (relating to general limitation income) that is not
foreign base company income as defined in section 954 and a DASTM loss
under paragraph (e)(3)(iv) of this section (Step 4), the amount of the
DASTM loss would reduce the amount of the QBU's gross income in that
category. Similarly, if a group of assets, such as short-term bank
deposits, generates both foreign personal holding company income that
is passive income (described in sections 954(c)(1)(A) and 904(d)(1)(A))
and a DASTM loss under paragraph (e)(3)(iv) of this section (Step 4),
the amount of the DASTM loss would reduce the amount of the QBU's
foreign personal holding company income and passive income. See section
904(f) and the regulations thereunder in the case where that section
would apply and DASTM loss attributable to a group of assets exceeds
the income generated by such assets.
(vi) Step 6--determine DASTM gain or loss attributable to
liabilities--(A) General rule. The taxpayer shall determine the dollar
amount of DASTM gain or loss attributable to liabilities identified in
paragraph (e)(3)(ii) of this section (Step 2), and described in
paragraph (e)(3)(vi)(B) of this section as follows:
[(bl+el)2] x [br-er]
where
bl = the hyperinflationary currency amount of liabilities at the
beginning of the balance sheet period.
el = the hyperinflationary currency amount of liabilities at the end of
the balance sheet translation period.
br = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the beginning of the balance sheet
period.
er = one dollar divided by the number of hyperinflationary currency
units that equal one dollar at the end of the balance sheet period.
(B) Separate calculation. The calculation shall be made separately
for interest-bearing liabilities described in paragraph (e)(3)(vii) of
this section (Step 7) and for each of the classes of non-interest-
bearing liabilities described in paragraph (e)(3)(viii) of this section
(Step 8).
(C) Weighting to prevent distortion. Where a distortion would
result from averaging the amount of liabilities at the beginning and
end of a balance sheet period, as might be the case where a taxpayer
incurs or retires a substantial liability, the taxpayer must use a
different method that more clearly reflects the average amount of
liabilities weighted to reflect the time the liability was outstanding
during the balance sheet period.
(vii) Step 7--adjust dollar income and expense by DASTM gain or
loss from interest-bearing liabilities--(A) In general. The taxpayer
shall apply the amount of DASTM gain on interest-bearing liabilities
computed under paragraph (e)(3)(vi) of this section (Step 6) to reduce
interest expense generated by such liabilities (e.g., prior to the
application of Sec. 1.861-9T or its successor regulation). To the
extent DASTM gain on such liabilities exceeds interest expense, it
shall be sourced or otherwise classified in the same manner that
interest expense is allocated and apportioned under Sec. 1.861-9T or
its successor regulation. The amount of DASTM loss on interest-bearing
liabilities computed under paragraph (e)(3)(vi) of this section (Step
6) shall be allocated and apportioned in the same manner that interest
expense is allocated and apportioned under Sec. 1.861-9T or its
successor regulation (without regard to the exceptions to fungibility
in Sec. 1.861-10T or its successor regulation). For purposes of this
section, an interest-bearing liability is a liability that requires
payment of periodic interest (whether fixed or variable), has original
issue discount, or would have interest imputed under subtitle A.
(B) Allocation of DASTM gain or loss from interest-bearing
liabilities that generate related person interest expense. DASTM gain
or loss from interest-bearing liabilities that generate related person
interest expense (as provided in section 954(b)(5)) shall be allocated
for purposes of subtitle A (including sections 904 and 952) in the same
manner that the related person interest expense of that debt is
required to be allocated under the rules of section 954(b)(5) and
Sec. 1.904-5(c)(2).
(C) Modified gross income method. In applying the modified gross
income method described in Sec. 1.861-9T(j) or its successor
regulation, gross income shall be adjusted for any DASTM gain or loss
from assets as provided in paragraph (e)(3)(v) of this section (Step 5)
and any DASTM gain or loss with respect to short-term, non-interest-
bearing trade payables as provided in paragraph (e)(3)(viii)(A) of this
section.
(viii) Step 8--adjust dollar income and expense by DASTM gain or
loss from non-interest bearing liabilities--(A) Short-term, non-
interest-bearing trade payables. The taxpayer shall allocate DASTM gain
or loss on short-term non-interest-bearing trade payables for purposes
of subtitle A (including sections 904 and 952) to the same category or
type of gross income as the cost or expense to which the trade payable
relates. For this purpose, a short-term, non-interest-bearing trade
payable is a non-interest-bearing liability with a term of 183 days or
less that is incurred to purchase property or services to be used by
the obligor in an active trade or business.
(B) Excise tax payables. The taxpayer shall allocate DASTM gain or
loss on excise tax payables for purposes of subtitle A (including
sections 904 and 952) to the same category or type of gross income as
would be derived from the activity to which the excise tax relates.
(C) Other non-interest-bearing liabilities--(1) In general. Except
as provided in paragraphs (e)(3)(viii)(A), (e)(3)(viii)(B), and
(e)(3)(viii)(C)(2) of this section, DASTM gain or loss on non-interest-
bearing liabilities shall be allocated under paragraph (e)(3)(ix) of
this section (Step 9).
(2) Tracing if substantial distortion of income. DASTM gains and
losses on liabilities described in paragraph (e)(3)(viii)(C)(1) of this
section may be attributed to the same section 904(d) separate category
or subpart F category as the transaction to which the liability relates
if the taxpayer demonstrates to the satisfaction of the district
director, or it is determined by the district director, that
application of paragraph (e)(3)(viii)(C)(1) of this section results in
a substantial distortion of income.
(ix) Step 9--allocate residual DASTM gain or loss. If there is a
difference between the net DASTM gain or loss determined under
paragraphs (e)(3)(i) through (viii) of this section (Steps 1 through 8)
and the DASTM gain or loss determined under paragraph (d) of this
section, the amount of the difference must be allocated for purposes of
subtitle A (including sections 904 and 952) to the QBU's gross income
(computed under paragraphs (b)(1) through (3) of this section, as
adjusted under paragraphs (e)(3)(i) through (viii) of this section
(Steps 1 through 8)) on the basis of the relative amounts of each
category or type of gross income.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 8. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805 * * *.
Par. 9. Section 602.101(c) is amended by adding the following
entries to the table in numerical order following to read as follows:
Sec. 602.101 OMB Control Numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control no.
------------------------------------------------------------------------
*****
1.985-3................................................. 1545-1051
*****
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: June 28, 1994.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 94-17570 Filed 7-22-94; 8:45 am]
BILLING CODE 4830-01-U
