81 FR 88854 - Recognition and Deferral of Section 987 Gain or Loss
DEPARTMENT OF THE TREASURY
Internal Revenue Service Federal Register Volume 81, Issue 236 (December 8, 2016)
Internal Revenue Service
Federal Register Volume 81, Issue 236 (December 8, 2016)
| Page Range | 88854-88880 | |
| FR Document | 2016-28380 |
[Federal Register Volume 81, Number 236 (Thursday, December 8, 2016)] [Rules and Regulations] [Pages 88854-88880] From the Federal Register Online [www.thefederalregister.org] [FR Doc No: 2016-28380] [[Page 88853]] Vol. 81 Thursday, No. 236 December 8, 2016 Part IV Department of the Treasury ----------------------------------------------------------------------- Internal Revenue Service ----------------------------------------------------------------------- 26 CFR Part 1 Recognition and Deferral of Section 987 Gain or Loss; Final Rule Federal Register / Vol. 81 , No. 236 / Thursday, December 8, 2016 / Rules and Regulations [[Page 88854]] ----------------------------------------------------------------------- DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9795] RIN 1545-BL12 Recognition and Deferral of Section 987 Gain or Loss AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Final and temporary regulations. ----------------------------------------------------------------------- SUMMARY: This document contains temporary regulations under section 987 of the Internal Revenue Code (Code) relating to the recognition and deferral of foreign currency gain or loss under section 987 with respect to a qualified business unit (QBU) in connection with certain QBU terminations and certain other transactions involving partnerships. This document also contains temporary regulations under section 987 providing: an annual deemed termination election for a section 987 QBU; an elective method, available to taxpayers that make the annual deemed termination election, for translating all items of income or loss with respect to a section 987 QBU at the yearly average exchange rate; rules regarding the treatment of section 988 transactions of a section 987 QBU; rules regarding QBUs with the U.S. dollar as their functional currency; rules regarding combinations and separations of section 987 QBUs; rules regarding the translation of income used to pay creditable foreign income taxes; and rules regarding the allocation of assets and liabilities of certain partnerships for purposes of section 987. Finally, this document contains temporary regulations under section 988 requiring the deferral of certain section 988 loss that arises with respect to related-party loans. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the Proposed Rules section in this issue of the Federal Register. In addition, in the Rules and Regulations section of this issue of the Federal Register, final regulations are being issued under section 987 to provide general guidance under section 987 regarding the determination of the taxable income or loss of a taxpayer with respect to a QBU. DATES: Effective date. These regulations are effective on December 7, 2016. Applicability date. For dates of applicability, see Sec. Sec. 1.987-1T(h), 1.987-2T(e), 1.987-3T(f), 1.987-4T(h), 1.987-6T(d), 1.987- 7T(d), 1.987-8T(g), 1.987-12T(j), 1.988-1T(j), and 1.988-2T(j). FOR FURTHER INFORMATION CONTACT: Steven D. Jensen at (202) 317-6938 (not a toll-free number). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act These temporary regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545-2265. Responses to this collection of information are mandatory. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number. For further information concerning this collection of information, the accuracy of the estimated burden and suggestions for reducing this burden, and where to submit comments on the collection of information, please refer to the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register. Books and records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background This document contains temporary regulations under section 987 of the Code relating to the recognition and deferral of foreign currency gain or loss under section 987 with respect to a QBU in connection with certain QBU terminations and certain other transactions involving partnerships. This document also contains temporary regulations under section 987 providing (i) an annual deemed termination election for a section 987 QBU; (ii) an elective method, available to taxpayers that make the annual deemed termination election, for translating all items of income or loss with respect to a section 987 QBU at the yearly average exchange rate; (iii) rules regarding the treatment of section 988 transactions of a section 987 QBU; (iv) rules regarding QBUs with the U.S. dollar as their functional currency; (v) rules regarding combinations and separations of section 987 QBUs; (vi) rules regarding the translation of income used to pay creditable foreign income taxes; and (vii) rules regarding the allocation of assets and liabilities of certain partnerships for purposes of section 987. Finally, this document contains temporary regulations under section 988 requiring the deferral of certain section 988 loss that arises with respect to related-party loans. Section 987 generally provides that, when a taxpayer owns one or more QBUs with a functional currency other than the U.S. dollar and such functional currency is different than that of the taxpayer, the taxable income or loss of the taxpayer with respect to each such QBU is determined by computing the taxable income or loss of each QBU separately in its functional currency and translating such income or loss at the appropriate exchange rate. Section 987 further requires the taxpayer to make ``proper adjustments'' (as prescribed by the Secretary of the Treasury (the Secretary)) for transfers of property between QBUs having different functional currencies, including by treating post-1986 remittances from each such QBU as made on a pro rata basis out of post- 1986 accumulated earnings, by treating section 987 gain or loss as ordinary income or loss, and by sourcing such gain or loss by reference to the source of the income giving rise to post-1986 accumulated earnings. Section 989(c) directs the Secretary to ``prescribe such regulations as may be necessary or appropriate to carry out the purposes of [subpart J], including regulations . . . limiting the recognition of foreign currency loss on certain remittances from qualified business units . . . [and] providing for the appropriate treatment of related party transactions (including transactions between qualified business units of the same taxpayer). . . .'' On September 6, 2006, the Treasury Department and the IRS issued proposed regulations under section 987 (REG-208270-86, 71 FR 52876) (the 2006 proposed regulations). The Treasury Department and the IRS received many written comments in response to the 2006 proposed regulations and, after consideration of those comments, are issuing final regulations (TD 9794) under section 987 (the final regulations) that are being published contemporaneously with these temporary regulations. These temporary regulations also reflect the consideration of comments received on the 2006 proposed regulations, as well as other considerations described in this preamble. [[Page 88855]] Explanation of Provisions 1. Deferral of Section 987 Gain or Loss on Certain Terminations and Other Transactions Involving Partnerships A. Background Under the final regulations, the owner of a section 987 QBU that terminates includes in income all of the net unrecognized section 987 gain or loss with respect to the section 987 QBU in the year it terminates. See Sec. Sec. 1.987-5(c)(3) and 1.987-8(e). Section 1.987- 8(b) and (c) describe the circumstances in which a section 987 QBU terminates, which include the transfer (or deemed transfer) of substantially all of the assets of the section 987 QBU and when the section 987 QBU's owner ceases to exist (except in connection with certain liquidations or reorganizations described in section 381(a)). Under these rules, a termination can result solely from a transfer of a section 987 QBU between related parties or, when a QBU is owned by an entity that is disregarded as an entity separate from its owner for Federal tax purposes (DE), from the deemed transfer that occurs when an election is made to treat the DE as a corporation for Federal tax purposes, notwithstanding that the QBU's assets continue to be used in the same trade or business. The preamble to the 2006 proposed regulations requested comments regarding whether inbound liquidations under section 332 and inbound asset reorganizations under section 368(a) should result in terminations of section 987 QBUs. The preamble also requested comments on the interaction of the rules of Sec. 1.1502-13 regarding intercompany transactions with the 2006 proposed regulations, including whether section 987 gain or loss resulting from the transfer of assets and liabilities of a section 987 QBU between members of the same consolidated group in a section 351 transaction should be deferred under Sec. 1.1502-13. Many comments recommended that such a section 351 exchange should not trigger the recognition of section 987 gain or loss. Because a termination can result in the deemed remittance of all the assets of a section 987 QBU in circumstances in which the assets continue to be used by a related person in the conduct of the same trade or business that formerly was conducted by the section 987 QBU, terminations can facilitate the selective recognition of section 987 losses. Section 989(c)(2) provides the Treasury Department and the IRS with authority to ``limit[] the recognition of foreign currency loss on certain remittances from qualified business units.'' The Treasury Department and the IRS have determined that terminations of section 987 QBUs generally should not be permitted to achieve the selective recognition of losses when the assets and liabilities of the section 987 QBU are transferred to a related person and remain subject to section 987 in the hands of the transferee, as in the case, for example, of a section 351 transfer of a section 987 QBU within a consolidated group. Similar policy considerations arise when the transfer of a partnership interest to a related person results in deemed transfers that cause the recognition of section 987 loss with respect to a section 987 QBU owned through the partnership, notwithstanding that the trade or business of the section 987 QBU continues without interruption and remains subject to section 987. In order to address these policy concerns, as described in greater detail in Part 1.C of this Explanation of Provisions, the temporary regulations defer section 987 losses resulting from certain termination events and partnership transactions in which the assets and liabilities of the section 987 QBU remain within a single controlled group (defined as all persons with the relationships to each other described in sections 267(b) or 707(b)) and remain subject to section 987. The Treasury Department and the IRS also acknowledge, however, that part of the rationale for deferring section 987 losses--that is, the continuity of ownership of the section 987 QBU within a single controlled group--applies equally to section 987 gains that otherwise would be triggered when taxpayers transfer a section 987 QBU within a single controlled group. Thus, consistent with the recommendations of comments on the 2006 proposed regulations, the temporary regulations generally apply to defer the recognition of section 987 gains as well as losses when the transferee is subject to section 987 with respect to the assets of the section 987 QBU. The Treasury Department and the IRS have determined, however, that gain should not be deferred to the extent the assets of a section 987 QBU are transferred by a U.S. person to a related foreign person. Since recognition of the deferred gain generally would occur only as a result of remittances to the foreign owner, the IRS could face administrative difficulty in attempting to ensure that such deferred gain is appropriately recognized and not indefinitely deferred. Treating gains differently than losses in the context of transfers to related foreign persons generally is consistent with the policies underlying sections 267 and 367. In particular, this rule is consistent with the policy of recognizing foreign currency gains and not losses with respect to property transferred outbound in a nonrecognition transaction. See section 367(a)(3)(B)(iii). In addition, the Treasury Department and the IRS have determined that selective recognition of losses should not be permitted in the context of certain outbound transfers even when the assets do not remain subject to section 987 in the hands of the transferee (because, for example, the transferee has the same functional currency as the QBU). Accordingly, consistent with the principles of sections 267 and 367(a), the temporary regulations also provide special rules to prevent the selective recognition of section 987 losses in certain other transactions involving outbound transfers. B. Scope of Application of Sec. 1.987-12T Section 1.987-12T provides for the deferral of certain net unrecognized section 987 gain or loss that otherwise would be recognized in connection with specified events under Sec. 1.987-5, which governs the recognition of section 987 gain or loss by the owner of a section 987 QBU to which the final regulations apply. In addition, because the policy concerns that motivate Sec. 1.987-12T exist regardless of whether section 987 gain or loss is computed pursuant to the final regulations or some other reasonable method, Sec. 1.987-12T applies to any foreign currency gain or loss realized under section 987(3), including foreign currency gain or loss realized under section 987 with respect to a QBU to which the final regulations generally are not applicable. In order to achieve this, the temporary regulations specify that references in Sec. 1.987-12T to section 987 gain or loss refer to any foreign currency gain or loss realized under section 987(3) and that references to a section 987 QBU refer to any eligible QBU (as defined in Sec. 1.987-1(b)(3)(i), but without regard to Sec. 1.987-1(b)(3)(ii)) that is subject to section 987. Additionally, the temporary regulations specify that references in Sec. 1.987-12T to the recognition of section 987 gain or loss under Sec. 1.987-5 encompass any determination and recognition of gain or loss under section 987(3) that would occur but for Sec. 1.987-12T. Accordingly, the temporary regulations require an owner of a QBU that is not subject to Sec. 1.987-5 to adapt the rules set forth in Sec. 1.987-12T to recognize section 987 gains or losses consistent with the principles of Sec. 1.987-12T. [[Page 88856]] The policy concerns regarding selective realization of section 987 losses do not apply, however, with respect to a section 987 QBU that has made the annual deemed termination election described in Part 2 of this Explanation of Provisions, because all section 987 gain and loss is recognized annually under that election. Accordingly, Sec. 1.987- 12T is not applicable to section 987 gain or loss of a section 987 QBU with respect to which the annual deemed termination election is in effect. Finally, in order to avoid any compliance burden associated with applying Sec. 1.987-12T in circumstances involving relatively small amounts of section 987 gain or loss, Sec. 1.987-12T includes a de minimis rule. That rule provides that Sec. 1.987-12T does not apply to a section 987 QBU if the net unrecognized section 987 gain or loss of the section 987 QBU that, as a result of Sec. 1.987-12T, would not be recognized under Sec. 1.987-5 does not exceed $5 million. Section 1.987-12T defers the recognition of section 987 gains and losses in connection with two types of specified events, which are referred to as ``deferral events'' and ``outbound loss events.'' Parts 1.C and 1.D of this Explanation of Provisions describe the rules governing deferral events and outbound loss events, respectively. C. Deferral Events As described in greater detail below, the temporary regulations provide that, notwithstanding Sec. 1.987-5, the owner of a section 987 QBU with respect to which a deferral event occurs (a deferral QBU) must defer section 987 gain or loss that otherwise would be taken into account under Sec. 1.987-5 in connection with the deferral event to the extent determined under Sec. 1.987-12T(b)(3) and (c). Such deferred gain or loss is taken into account based on subsequent events in accordance with Sec. 1.987-12T(c). i. Deferral Events The temporary regulations provide that a deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy two conditions. Under the first condition, the transaction or series of transactions must be described in one of two categories. The first category, which is set forth in Sec. 1.987- 12T(b)(2)(ii)(A), is any termination of a section 987 QBU other than (i) a termination described in Sec. 1.987-8(b)(3) (that is, a termination that results from the owner of the section 987 QBU ceasing to be a controlled foreign corporation (as defined in section 957(a)) (CFC) after certain related-party transactions); (ii) a termination described in Sec. 1.987-8(c) (that is, a termination that results from a liquidation or asset reorganization described in section 381(a) involving an inbound or outbound transfer, a transfer by a CFC to a related non-CFC foreign corporation, or a transfer to a transferee that has the same functional currency as the section 987 QBU); \1\ or (iii) a termination described solely in Sec. 1.987-8(b)(1) (that is, a termination that results solely from the cessation of the trade or business of the section 987 QBU). Thus, the first category generally involves terminations that occur as a result of a transfer of substantially all the assets of a section 987 QBU other than a transfer as part of a transaction described in section 381(a) in which the owner ceases to exist. (A termination that results from an outbound section 381(a) transaction, however, may be an outbound loss event.) --------------------------------------------------------------------------- \1\ The transfer of a section 987 QBU as part of a liquidation or asset reorganization described in section 381(a) in which the transferor and transferee have the same tax status is not a termination under Sec. 1.987-8(b) and (c) and, therefore, cannot constitute a deferral event under the first category. --------------------------------------------------------------------------- The second category, which is described in Sec. 1.987- 12T(b)(ii)(B), encompasses certain partnership transactions that result in a net deemed transfer from a section 987 QBU to its owner as a result of which section 987 gain or loss otherwise would be recognized under Sec. 1.987-5. The second category refers to two types of transactions involving partnerships. First, the second category includes a disposition of part of an interest in a DE or partnership. Under Sec. 1.987-2(c)(5), a transfer of part of an interest in a DE or section 987 aggregate partnership results in deemed transfers to the owner of a section 987 QBU held through that DE or partnership that may result in a remittance, but that generally do not cause a termination. For an illustration of the application of Sec. 1.987-12T to a deferral event resulting from the conversion of a disregarded entity into a section 987 aggregate partnership, see Sec. 1.987-12T(h), Example 4. The second type of transaction included in the second category is a contribution of assets by a related person to a partnership or DE through which a section 987 QBU is held, provided that the contributed assets are not included on the books and records of an eligible QBU and the contribution causes a net transfer from a section 987 QBU owned through the partnership or DE. The rules of Sec. 1.987-2 must be applied to determine whether the contribution would cause a net transfer from any section 987 QBUs held through a partnership. For example, if two partners (Partner A and Partner B) each own a 50% interest in an existing section 987 aggregate partnership with a single section 987 QBU, and Partner A contributes cash that is included on the books of the section 987 QBU after the contribution and Partner B contributes an equal amount of non-portfolio stock, the contributions would not cause either Partner A nor Partner B to have a net transfer from the section 987 QBU under Sec. 1.987-2 and there would be no section 987 gain or loss to defer. As a result of the broad scope of application for Sec. 1.987-12T specified in Sec. 1.987-12T(a)(2), the second category includes transactions involving partnerships that are not section 987 aggregate partnerships even though QBUs that are held through such partnerships generally are not subject to the final regulations. Accordingly, Sec. 1.987-12T applies to a disposition of a partnership interest or a contribution to a partnership if it otherwise would result in recognition of gain or loss under a taxpayer's reasonable method of applying section 987. The second condition described in Sec. 1.987-12T(b)(2) is that, immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor QBU. For this purpose, a successor QBU with respect to a section 987 QBU (original QBU) generally means a section 987 QBU on whose books and records assets of the original QBU are reflected immediately after the deferral event, provided that, immediately after the deferral event, the section 987 QBU is owned by a member of the controlled group that includes the person that owned the original QBU immediately before the deferral event. This relatedness requirement would not be met, for example, if the person that owned the original QBU ceased to exist in connection with the deferral event. However, if the owner of the original QBU is a U.S. person, then a successor QBU does not include a section 987 QBU owned by a foreign person, except in the case of a deferral event that is solely described in the second category of transactions involving partnership and DE interests. This limitation on the definition of a successor QBU in the context of outbound transfers serves two purposes. First, consistent with the general policy of recognizing foreign currency gains upon an outbound transfer, the limitation ensures that section 987 gain is recognized to the extent section 987 QBU assets are transferred outbound in connection with a termination. Second, the [[Page 88857]] limitation coordinates the deferral event rules with the outbound loss event rules described in Part 1.D of this Explanation of Provisions, which contain different rules for the recognition of section 987 loss attributable to assets of a section 987 QBU that are transferred outbound in connection with a termination of the section 987 QBU. ii. Recognition of Section 987 Gain or Loss Under Sec. 1.987-5 in the Taxable Year of a Deferral Event The temporary regulations provide that, in the taxable year of a deferral event, the owner of the deferral QBU generally recognizes section 987 gain or loss as determined under Sec. 1.987-5, except that, solely for purposes of applying Sec. 1.987-5, all assets and liabilities of the deferral QBU that, immediately after the deferral event, are properly reflected on the balance sheet of a successor QBU are treated as not having been transferred and therefore as remaining on the balance sheet of the deferral QBU, notwithstanding the deferral event. The effect of these rules is that, in the taxable year of a deferral event, only assets and liabilities of the deferral QBU that are not reflected on the books and records of a successor QBU immediately after the deferral event are taken into account in determining the amount of a remittance from the deferral QBU. Section 987 gain or loss that, as a result of these rules, is not recognized under Sec. 1.987-5 in the taxable year of the deferral event is referred to as deferred section 987 gain or loss. As discussed in Part 1.D of this Explanation of Provisions, if the deferral event also constitutes an outbound loss event, the amount of loss recognized by the owner may be further limited under the rules applicable to outbound loss events. iii. Recognition of Deferred Section 987 Gain or Loss in the Taxable Year of a Deferral Event and in Subsequent Taxable Years The temporary regulations provide rules for determining when a deferral QBU owner recognizes deferred section 987 gain or loss. For this purpose, a deferral QBU owner means, with respect to a deferral QBU, the owner of the deferral QBU immediately before the deferral event with respect to the deferral QBU or the owner's qualified successor. The temporary regulations define a qualified successor with respect to a corporation (transferor corporation) as another corporation (acquiring corporation) that acquires the assets of the transferor corporation in a transaction described in section 381(a), but only if (A) the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or (B) the acquiring corporation is a CFC and the transferor corporation was a CFC. A qualified successor of a corporation includes a qualified successor of a qualified successor of the corporation. As described in the remainder of this Part 1.C.iii, the temporary regulations provide that deferred section 987 gain or loss is recognized upon subsequent remittances from a successor QBU, or upon a deemed remittance that occurs when a successor QBU ceases to be owned by a member of the deferral QBU owner's controlled group, subject to an exception that applies when a successor QBU terminates in an outbound transfer. In general, these rules depend on the continued existence of a deferral QBU owner (which includes a qualified successor) and a successor QBU and preserve the location of the deferred section 987 gain or loss as gain or loss of the deferral QBU owner. a. Subsequent Remittances A deferral QBU owner generally recognizes deferred section 987 gain or loss in the taxable year of a remittance from a successor QBU to the owner of the successor QBU (successor QBU owner). The amount of deferred section 987 gain or loss that a deferral QBU owner recognizes upon a remittance is the outstanding deferred section 987 gain or loss (that is, the deferred section 987 gain or loss not previously recognized) multiplied by the remittance proportion of the successor QBU owner with respect to the successor QBU for the taxable year as determined under Sec. 1.987-5(b) and, to the extent relevant, Sec. 1.987-12T. For an illustration of this rule, see Sec. 1.987-12T(h), Example 5. In certain cases, there may be multiple successor QBUs with respect to a single deferral QBU. For instance, there may be multiple successor QBUs if the owner of a section 987 aggregate partnership interest transfers part of its interest or if a successor QBU separates into two or more separated QBUs under Sec. 1.987-2T(c)(9)(ii). To ensure that a deferral QBU owner recognizes the appropriate amount of deferred section 987 gain or loss in connection with a remittance in such cases, the temporary regulations provide that multiple successor QBUs of the same deferral QBU are treated as a single successor QBU for purposes of determining the amount of deferred section 987 gain or loss that is recognized. For example, if the owner (Corp A) of a section 987 aggregate partnership interest transfers part of its interest to another member of Corp A's consolidated group (Corp B), the transfer would give rise to a deferral event with respect to the section 987 QBU (QBU A) that Corp A indirectly owns through the partnership. QBU A would be considered a deferral QBU, and Corp A would be considered a deferral QBU owner. In addition, QBU A would be considered a successor QBU with respect to itself, and the section 987 QBU (QBU B) that Corp B owns indirectly through the partnership interest it acquired also would be considered a successor QBU with respect to QBU A. In determining the amount of deferred section 987 gain or loss recognized upon subsequent remittances from successor QBUs, the two successor QBUs are treated as a single successor QBU, such that their remittance proportion is determined under Sec. 1.987-5 on a combined basis, taking into account the assets and remittances of both successor QBUs. b. Deemed Remittance When a Successor QBU Ceases To Be Owned by a Member of the Deferral QBU Owner's Controlled Group Solely for purposes of determining a deferral QBU owner's recognition of any outstanding deferred section 987 gain or loss, a successor QBU owner is treated as having a remittance proportion of 1 in a taxable year in which its successor QBU ceases to be owned by a member of a controlled group that includes the deferral QBU owner, including as a result of the deferral QBU owner ceasing to exist without having a qualified successor. Accordingly, a deferral QBU owner would recognize all outstanding deferred section 987 gain or loss upon a successor QBU ceasing to be owned by a member of the deferral QBU owner's controlled group if there is only one successor QBU, but would recognize only a proportional amount if there are multiple successor QBUs, one or more of which remain in the deferral QBU owner's controlled group. c. Recognition of Deferred Section 987 Loss in Certain Outbound Successor QBU Terminations Notwithstanding that deferred section 987 gain or loss generally is recognized upon remittances from a successor QBU, Sec. 1.987-12T(c)(3) provides that, if assets of a successor QBU are transferred (or deemed transferred) in an exchange that would constitute an outbound loss event if the successor QBU had a net accumulated section 987 loss at the time of the exchange, the deferral QBU owner recognizes any outstanding deferred section 987 loss on a similar basis as it would if it originally had transferred the [[Page 88858]] deferral QBU in an outbound loss event. Any outstanding deferred section 987 loss with respect to the deferral QBU that, as a result of this rule, is not recognized is recognized by the deferral QBU owner in the first taxable year in which the deferral QBU owner (including any qualified successor) and the acquirer of the assets of the successor QBU (or any qualified successor) cease to be members of the same controlled group. Section 1.987-12T(c)(4) ensures that the policy concerns that motivate the treatment of outbound loss events under the temporary regulations apply in comparable circumstances involving successor QBUs. See Part 1.D of this Explanation of Provisions for an explanation of outbound loss events. d. Special Rules Regarding Successor QBUs The temporary regulations include three special rules regarding successor QBUs that are relevant to the recognition of deferred section 987 gain or loss. First, if a section 987 QBU is a successor QBU with respect to a deferral QBU that is a successor QBU with respect to another deferral QBU, the first-mentioned section 987 QBU is considered a successor QBU with respect to the second-mentioned deferral QBU. For example, if QBU A is a successor QBU with respect to QBU B, and QBU B is a successor QBU with respect to QBU C, then QBU A is a successor QBU with respect to QBU C. Second, if a successor QBU with respect to a deferral QBU separates into two or more separated QBUs (as defined in Sec. 1.987- 2T(c)(9)(iii)), each separated QBU is considered a successor QBU with respect to the deferral QBU. Third, if a successor QBU with respect to a deferral QBU combines with another section 987 QBU of the same owner, resulting in a combined QBU (as defined in Sec. 1.987-2T(c)(9)(i)), the combined QBU is considered a successor QBU with respect to the deferral QBU. iv. Source and Character of Deferred Section 987 Gain and Loss The temporary regulations provide that the source and character of deferred section 987 gain or loss is determined under Sec. 1.987-6 as if such gain or loss had been recognized with respect to the deferral QBU under Sec. 1.987-5 on the date of the deferral event that gave rise to the deferred section 987 gain or loss. Thus, the source and character of deferred section 987 gain or loss is determined under Sec. 1.987-6 without regard to the timing rules of Sec. 1.987-12T. D. Outbound Loss Events Section 1.987-12T(d) of the temporary regulations contains rules that defer section 987 loss to the extent assets of a section 987 QBU are transferred outbound to a related foreign person in connection with an ``outbound loss event.'' Specifically, the temporary regulations provide that, notwithstanding Sec. 1.987-5, the owner of a section 987 QBU with respect to which an outbound loss event occurs (outbound loss QBU) includes in taxable income in the year of the outbound loss event section 987 loss with respect to that section 987 QBU only to the extent provided in Sec. 1.987-12T(d)(3). Sections 1.987-12T(d)(4) and (5) provide rules for the subsequent recognition of losses that are deferred under Sec. 1.987-12T(d) that differ from the remittance-based rules that generally apply following deferral events. Like the definition of deferral event, an outbound loss event includes two categories of transactions with respect to a section 987 QBU with net unrecognized section 987 loss. First, an outbound loss event includes any termination of the section 987 QBU in connection with a transfer of assets of the section 987 QBU by a U.S. person to a foreign person that was a member of the same controlled group as the U.S. transferor immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person). The second category of outbound loss events includes any transfer by a U.S. person of part of an interest in a section 987 aggregate partnership or DE through which the U.S. person owns the section 987 QBU to a related foreign person that has the same functional currency as the section 987 QBU. The second category also includes a contribution of assets by such a related foreign person to the partnership or DE if the contribution has the effect of reducing the U.S. person's interest in the section 987 QBU (and therefore causes a deemed transfer of assets and liabilities to the U.S. person from the section 987 QBU) and the contributed assets are not included on the books and records of an eligible QBU of the partnership or DE. The second category would be implicated, for example, if a U.S. person transferred part of the interest in a DE through which it owned a section 987 QBU to a foreign corporation that had the same functional currency as the section 987 QBU in an outbound section 351 transaction. Under these rules, the owner of the outbound loss QBU recognizes section 987 loss in the taxable year of the outbound loss event as determined under Sec. 1.987-5 and the deferral event rules of Sec. 1.987-12T(b) and (c), except that, solely for purposes of applying Sec. 1.987-5, certain assets and liabilities of the outbound loss QBU are treated as not having been transferred and therefore as remaining on the balance sheet of the section 987 QBU, notwithstanding the outbound loss event. In the first category of outbound loss event (involving outbound asset transfers resulting in terminations), assets and liabilities that, immediately after the outbound loss event, are properly reflected on the books and records of the related foreign person or a section 987 QBU of the related foreign person are treated as not having been transferred. In the second category of outbound loss event (involving certain partnership and DE transactions), assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the eligible QBU from which the assets and liabilities of the outbound loss QBU are allocated, and not on the books and records of a section 987 QBU, are treated as not having been transferred. The difference between the amount that otherwise would have been recognized and the amount actually recognized under this rule is referred to as outbound section 987 loss. Although an outbound loss event in the second category also would constitute a deferral event, the rules governing deferral events only defer section 987 loss of a deferral QBU to the extent assets and liabilities are reflected on the books and records of a successor QBU immediately after the deferral event. Assets and liabilities of a deferral QBU that are reflected on the books and records of an eligible QBU of a partnership and allocated to a partner that has the same functional currency as the eligible QBU, as would occur in an outbound loss event, are not reflected on the books and records of a successor QBU and so would not cause section 987 loss to be deferred under the deferral event rules. Thus, there is no overlap in terms of the effect of the outbound loss event rules and the deferral event rules. If an outbound loss event results from the transfer of assets of the outbound loss QBU in a nonrecognition transaction, the basis of the stock that is received in the transaction is increased by an amount equal to the outbound section 987 loss. In effect, this rule converts a section 987 loss into an unrealized stock loss, which may be recognized upon a recognition event with respect to the stock. This treatment [[Page 88859]] is similar to the treatment under section 367(a) of foreign currency losses with respect to foreign-currency denominated property that is transferred outbound in a nonrecognition event to a foreign corporation that has as its functional currency the currency in which the property is denominated. Outbound section 987 loss attributable to an outbound loss event that does not occur in connection with a nonrecognition transaction is recognized by the owner of the outbound loss QBU in the first taxable year in which the owner (or any qualified successor) and the related foreign person that participated in the outbound loss event (or any qualified successor) cease to be members of the same controlled group. In many circumstances this treatment will provide similar results as converting section 987 loss into stock basis as in the case of outbound loss events that result from a nonrecognition transaction. The temporary regulations provide that, if loss is recognized on the sale or exchange of stock within two years of an outbound loss event that gave rise to an adjustment to the basis of the stock, then, to the extent of the outbound section 987 loss, the source and character of the loss recognized on the sale or exchange will be determined under Sec. 1.987-6 as if such loss were section 987 loss recognized pursuant to Sec. 1.987-5 without regard to Sec. 1.987-12T on the date of the outbound loss event. E. Anti-Abuse Rule The temporary regulations provide an anti-abuse rule to address transactions structured to avoid the deferral rules in Sec. 1.987-12T. This rule provides that no section 987 loss is recognized under Sec. 1.987-5 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of Sec. 1.987-12T. This rule would apply, for example, if, with a principal purpose of recognizing a deferred section 987 loss, a taxpayer engaged in a transaction that caused a deferral QBU owner to cease to exist without a qualified successor or caused a successor QBU to cease to exist, such that deferred section 987 loss otherwise would be recognized under Sec. 1.987-12T(c). F. Coordination With Fresh Start Transition Method The temporary regulations require adjustments to coordinate the application of Sec. 1.987-12T with the fresh start transition method described in Sec. 1.987-10(b) for transitioning to the final regulations. If a deferral QBU owner is required under Sec. 1.987- 10(a) to apply the fresh start transition method with respect to the deferral QBU on the transition date, or if a deferral QBU owner would have been so required if it had owned the deferral QBU on the transition date, the outstanding deferred section 987 gain or loss of the deferral QBU owner with respect to the deferral QBU must be adjusted on the transition date to equal the amount of outstanding deferred section 987 gain or loss that the deferral QBU owner would have had with respect to the deferral QBU on the transition date if, immediately before the deferral event, the deferral QBU had transitioned to the final regulations pursuant to the fresh start transition method. Additionally, if the owner of an outbound loss QBU is required under Sec. 1.987-10(a) to apply the fresh start transition method with respect to the outbound loss QBU on the transition date, or if the owner would have been so required if it had owned the outbound loss QBU on the transition date, the basis of any stock that was subject to a basis adjustment under Sec. 1.987-12T as a result of the outbound loss event must be adjusted to equal the basis that such stock would have had on the transition date if, immediately prior to the outbound loss event, the outbound loss QBU had transitioned to the final regulations pursuant to the fresh start transition method. Outbound section 987 loss that is not reflected in stock basis but that will be recognized when the owner and the related foreign person that participated in the outbound loss event cease to be members of the same controlled group must be adjusted in a similar manner. These adjustments to coordinate the application of Sec. 1.987-12T with the fresh start transition method must be made even if the deferral QBU owner or the owner of the outbound loss QBU continues to own the deferral QBU or the outbound loss QBU on the transition date, as in the case of a deferral event or outbound loss event resulting from a transfer of part of an interest in a section 987 aggregate partnership that does not result in the termination of the deferral QBU or outbound loss QBU. G. Effective Date The temporary regulations under Sec. 1.987-12T generally apply to any deferral event or outbound loss event that occurs on or after January 6, 2017. However, if the deferral event or outbound loss event is undertaken with a principal purpose of recognizing section 987 loss, the 30 day delayed effective date does not apply and Sec. 1.987-12T is effective immediately on December 7, 2016. 2. Annual Deemed Termination Election A comment on the 2006 proposed regulations recommended that taxpayers be permitted to make a one-time election under Sec. 1.987-5 to deem a section 987 QBU as having terminated at the end of each year, thereby requiring the owner to recognize all section 987 gains or losses with respect to the QBU on an annual basis. The comment suggested that such an election would allow taxpayers to reduce the complexity and administrative cost of complying with section 987 because taxpayers would not be required to track transactions between an owner and its section 987 QBU or unrecognized section 987 gains and losses carried over from previous years. The Treasury Department and the IRS have determined that an annual deemed termination election would not obviate the need to track transactions between an owner and its section 987 QBU, since the net transfer would remain relevant to the annual calculation of section 987 gain or loss. Nonetheless, the Treasury Department and the IRS agree that an annual deemed termination election could enhance administrability of the final regulations by reducing the recordkeeping requirements necessary to apply the final regulations. Additionally, when an annual deemed termination election is in effect, taxpayers could not strategically time remittances in order to selectively recognize section 987 losses but not section 987 gains. Eliminating this planning opportunity would obviate the need for the deferral provisions of Sec. 1.987-12T. Furthermore, as discussed in Part 3 of this Explanation of Provisions, an annual deemed termination election would address a policy concern with permitting the hybrid approach to section 987 suggested by comments on the 2006 proposed regulations. Based on the foregoing considerations, Sec. 1.987-8T(d) provides an election for a taxpayer to deem its section 987 QBUs to terminate on the last day of each taxable year for which the election is in effect. Because the considerations supporting an annual deemed termination election generally are relevant regardless of whether a taxpayer is subject to the final regulations, the election under Sec. 1.987-8T(d) is available to any taxpayer without regard to the applicability of the final regulations to that taxpayer or any of its section 987 QBUs. A section 987 QBU to which this election applies is treated as having made a remittance of all of its gross assets to its owner [[Page 88860]] immediately before the section 987 QBU terminates on the last day of each taxable year, resulting in the recognition of any net unrecognized section 987 gain or loss of the section 987 QBU. See Sec. Sec. 1.987- 5(c)(3) and 1.987-8(e). The owner is then treated as having transferred all of the assets and liabilities of the terminated section 987 QBU to a new section 987 QBU on the first day of the following taxable year. As noted in Part 1 of this Explanation of Provisions, the temporary regulations provide that the deferral provisions of Sec. 1.987-12T do not apply with respect to section 987 QBUs for which the annual deemed termination election is in effect. Consequently, a taxpayer that finds the annual deemed termination election preferable to Sec. 1.987-12T based on ease of compliance or other reasons may make the annual deemed termination election. Moreover, as discussed in Part 3 of this Explanation of Provisions, a taxpayer that makes the annual deemed termination election with respect to a section 987 QBU may reduce the compliance burden associated with computing taxable income or loss under the final regulations by electing to translate taxable income or loss of the section 987 QBU into the owner's functional currency at the yearly average exchange rate without any adjustments. The Treasury Department and the IRS have determined that special consistency and effective date rules are needed for the annual deemed termination election to prevent taxpayers from using the election to selectively recognize section 987 losses without recognizing section 987 gains. Unless the annual deemed termination election is required to be made with respect to all section QBUs owned by related persons at the time of the election, taxpayers could choose to make the election only with respect to section 987 QBUs that have net unrecognized section 987 losses at the time of the election. Accordingly, Sec. 1.987-1T(g)(2)(i)(B)(1) provides that the annual deemed termination election generally applies to all section 987 QBUs owned by an electing taxpayer, as well as to all section 987 QBUs owned by any person that has a relationship to the taxpayer described in section 267(b) or section 707(b) (substituting ``and the profits interest'' for ``or the profits interest'' in section 707(b)(1)(A) and substituting ``and profits interests'' for ``or profits interests'' in section 707(b)(1)(B)) on the last day of the first taxable year for which the election applies to the taxpayer (a related person). A taxpayer that is subject to the final regulations and that must transition to the final regulations under the fresh start transition method of Sec. 1.987-10(b) (fresh start taxpayer) may make the annual deemed termination election only if the first taxable year for which the election would apply is either (i) the first taxable year beginning on or after the transition date (as defined in Sec. 1.987-11(c)) with respect to the taxpayer or (ii) a subsequent taxable year in which the ``taxpayer's controlled group aggregate section 987 loss'' (if any) does not exceed $5 million. For this purpose, a ``taxpayer's controlled group aggregate section 987 loss'' means the aggregate net amount of section 987 gain or loss that would be recognized pursuant to the election under Sec. 1.987-8T(d) by the taxpayer and all related persons in the first taxable year of each person for which the election would apply. Taxpayers that used a method based on a reasonable application of the 2006 proposed regulations prior to the transition date, and which therefore are not subject to the fresh start transition method pursuant to Sec. 1.987-10(c), and taxpayers for which the final regulations are not applicable, must follow the election rules for fresh start taxpayers if any related party is a fresh start taxpayer. If no related party is a fresh start taxpayer, the annual deemed termination election may be made only if the first taxable year for which the election would apply is either (i) the first taxable year beginning on or after December 7, 2016, in which the election is relevant in determining section 987 taxable income or loss or section 987 gain or loss or (ii) a subsequent taxable year in which the ``taxpayer's controlled group aggregate section 987 loss'' (if any) does not exceed $5 million. If a taxpayer makes the annual deemed termination election, the election will apply to the first taxable year of a related person that ends with or within a taxable year of the taxpayer to which the taxpayer's election applies. Once made, the annual deemed termination election may not be revoked. As provided in Sec. 1.987-1T(g)(2)(i)(B)(2), the special consistency and effective date rules in Sec. 1.987-1T(g)(2)(i)(B)(1) do not apply and a taxpayer may make a separate election under Sec. 1.987-8T(d) with respect to any section 987 QBU owned by the taxpayer if the first taxable year for which the election would apply to the taxpayer with respect to the section 987 QBU is a taxable year in which the deemed termination results in the recognition of section 987 gain with respect to the section 987 QBU or the deemed termination results in the recognition of $1 million or less of section 987 loss with respect to the section 987 QBU. 3. Election To Translate All Items at the Yearly Average Exchange Rate As discussed in the preamble to the final regulations, comments on the 2006 proposed regulations recommended a hybrid approach that would combine the methodology of the regulations proposed under section 987 in 1991 (INTL-965-86, 56 FR 48457) for computing a section 987 QBU's net income with the methodology of the 2006 proposed regulations for computing section 987 gain or loss. Under the proposed hybrid approach, section 987 gain or loss generally would be determined under the method of the 2006 proposed regulations, but taxable income or loss would be translated into the owner's functional currency at the yearly average exchange rate without any adjustments. Although a hybrid approach would simplify the calculation of section 987 taxable income or loss, the preamble to the final regulations observes that the hybrid approach gives rise to offsetting effects in section 987 taxable income or loss and in the foreign exchange exposure pool (FEEP) that raise concerns similar to those addressed by Congress in enacting section 1092. In particular, under the hybrid approach, exchange rate effects with respect to historic assets would be reflected in section 987 taxable income or loss to the extent of any cost recovery deductions with respect to those assets, but equal and offsetting amounts would be reflected in the FEEP and would be recognized only upon remittances. Thus, offsetting effects arising from a single asset would be taken into account at different times. The Treasury Department and the IRS have determined that it would be inappropriate for regulations under section 987 to permit distortions to section 987 taxable income or loss that have the effect of causing potentially large offsetting amounts of loss or gain to be reflected in the FEEP with respect to the same asset, since the loss or gain in the FEEP would be recognized only upon voluntary remittances from the QBU. Nonetheless, the Treasury Department and the IRS acknowledge the concerns expressed in comments regarding the complexity of the 2006 proposed regulations that underlie the recommendation to adopt the hybrid approach. Concerns about offsetting amounts recognized at different times under the hybrid approach would not [[Page 88861]] arise for taxpayers that make the annual deemed termination election set forth in Sec. 1.987-8T(d). A taxpayer that recognizes all section 987 gain or loss with respect to its section 987 QBUs annually would take into account in recognized section 987 gain or loss the exchange rate effects with respect to historic assets that are reflected in the FEEP in the same taxable year in which the offsetting effects are taken into account in section 987 taxable income or loss. Although the hybrid approach could result in differences in character of exchange gain or loss relative to the final regulations even for taxpayers that make the annual deemed termination election, the Treasury Department and the IRS have determined that the administrative convenience of allowing taxpayers to translate a section 987 QBU's taxable income at the yearly average exchange rate outweighs that consideration. Accordingly, the temporary regulations provide that a taxpayer that is otherwise generally subject to the final regulations may elect to apply the hybrid approach with respect to a section 987 QBU that is subject to the annual deemed termination election. In particular, Sec. 1.987-3T(d) provides that, notwithstanding the rules of Sec. 1.987- 3(c) for translating items determined under Sec. 1.987-3(b) in a section 987 QBU's functional currency into the owner's functional currency, a taxpayer may elect to translate all items of income, gain, deduction, and loss of a section 987 QBU with respect to which the annual deemed termination election described in Sec. 1.987-8T(d) is in effect into the owner's functional currency, if necessary, at the yearly average exchange rate for the taxable year. An owner of multiple section 987 QBUs may make the election described in Sec. 1.987-3T(d) with respect to all of its section 987 QBUs or only certain designated section 987 QBUs. 4. Section 988 Transactions of a Section 987 QBU A. Background Regarding the Treatment of Section 988 Transactions Under the Proposed Regulations The 2006 proposed regulations reflected a two-pronged approach to the application of section 988 to transactions of a section 987 QBU, with different consequences generally depending on whether a transaction is denominated in (or determined by reference to) the owner's functional currency or a currency that is a nonfunctional currency with respect to both the owner and the section 987 QBU (third currency). As a general rule, Sec. 1.987-3(e)(1) of the 2006 proposed regulations provided that section 988 applies to section 988 transactions attributable to a section 987 QBU and that the timing of any gain or loss is determined under the applicable provisions of the Code, but the 2006 proposed regulations did not clearly specify whether section 988 gain or loss would be determined with respect to the functional currency of the section 987 QBU or the owner's functional currency. Assets and liabilities giving rise to section 988 transactions were defined under proposed Sec. 1.987-1(d) and (e) as historic items. Under Sec. 1.987-3(e)(2) of the 2006 proposed regulations, transactions of a section 987 QBU described in section 988(c)(1)(B)(i) (relating to the acquisition of, or becoming an obligor under, a debt instrument), section 988(c)(1)(B)(ii) (relating to accrual of items of expense or gross income or receipts) or section 988(c)(1)(C) (relating to the disposition of nonfunctional currency) that are denominated in (or determined by reference to) the owner's functional currency, however, were not treated as section 988 transactions of the section 987 QBU, and no gain or loss was recognized under section 988 with respect to such transactions. Assets and liabilities giving rise to such transactions were required to be reflected on the balance sheet of the section 987 QBU in the owner's functional currency under Sec. 1.987-2(d)(2) of the 2006 proposed regulations. Additionally, Sec. 1.987-3(d) of the 2006 proposed regulations provided that an item of income, gain, deduction, or loss of a section 987 QBU denominated in a currency other than the functional currency of the owner is translated at the spot rate on date the item is appropriately taken into account. Under Sec. 1.987-3(c) of the 2006 proposed regulations, an item of income, gain, deduction, or loss of a section 987 QBU denominated in the owner's functional currency is not translated and is taken into account by the section 987 QBU in the owner's functional currency. One comment indicated that the 2006 proposed regulations were unclear regarding the interaction of the rules for the treatment of section 988 transactions denominated in a third currency with the treatment of assets that give rise to section 988 transactions as historic assets. Upon the disposition of a historic asset, the 2006 proposed regulations required translation of the basis of the historic asset at the historic rate and the amount realized with respect to the asset at the yearly average exchange rate for the taxable year of the disposition or, if properly elected, the appropriate spot rate. Yet, Sec. 1.987-3(f), Example 10 of the 2006 proposed regulations illustrated the determination of section 988 gain or loss on a third- currency section 988 transaction in, and by reference to, the section 987 QBU's functional currency and translation of that amount into the owner's functional currency at the yearly average exchange rate. Under the approach of the example, historic asset basis is effectively translated at the yearly average exchange rate rather than the appropriate historic rate. B. General Rules for Section 988 Transactions in the Temporary Regulations In light of the comment regarding the uncertain application of section 988 to transactions of a section 987 QBU under the 2006 proposed regulations and further consideration of the appropriate rules, the temporary regulations clarify and elaborate upon the application of section 988 to transactions attributable to a section 987 QBU. In this regard, the Treasury Department and the IRS have determined that computing section 988 gain or loss by reference to the functional currency of the section 987 QBU, rather than the owner's functional currency, and translating that amount at the yearly average exchange rate would be inconsistent with the treatment of items that give rise to section 988 transactions as historic items. Such items were treated as historic items under the 2006 proposed regulations because they do not economically expose the owner to fluctuations in the section 987 QBU's functional currency. Taking these considerations into account, the Treasury Department and the IRS have determined that it is appropriate to continue to treat assets and liabilities giving rise to section 988 transactions of a section 987 QBU as historic items under Sec. Sec. 1.987-1(d) and (e) of the final regulations. Thus, for example, a note denominated in a nonfunctional currency that gives rise to a section 988 transaction when acquired is a historic asset. However, the temporary regulations generally provide that section 988 gain or loss arising from section 988 transactions of a section 987 QBU is determined by reference to the owner's functional currency, rather than the functional currency of the section 987 QBU. See Sec. 1.987-3T(b)(4)(i). Accordingly, in determining section 988 gain or loss with respect to a section 988 transaction of a section 987 QBU, the amounts required under section 988 to be translated on the applicable booking date or payment date with respect to the section 988 transaction are translated from the currency in which the amounts are denominated (or by reference to [[Page 88862]] which they are determined) into the owner's functional currency at the rate required under section 988 and the section 988 regulations, which provide for translation at the appropriate spot rate. When a section 987 QBU recognizes gain or loss on the disposition of a historic asset that gives rise to a section 988 transaction, some or all of the total gain or loss that is realized on the disposition may be section 988 gain or loss that, under section 988, is ordinary income that is sourced by reference to the residence of the section 987 QBU. For example, on the disposition of a nonfunctional currency note, the total gain or loss realized may be comprised of section 988 gain or loss that reflects exchange rate changes and other gain or loss that reflects other factors, such as changes in prevailing interest rates or in the creditworthiness of the note issuer. The total gain or loss on the disposition of a historic asset that gives rise to a section 988 transaction is determined under the general rules of section 987 by reference to the functional currency of the section 987 QBU. Section 988 gain or loss on the note is determined under Sec. Sec. 1.988- 2(b)(5) and (8) and 1.987-3T(b)(4)(i) by comparing the section 987 QBU's acquisition price for the note in nonfunctional currency translated into the owner's functional currency at the spot rates on the date of acquisition and the date of disposition, respectively. See Sec. 1.987-3T(e), Example 11. To provide for consistent translation rates for determining both the total gain or loss on such a historic asset and the portion of the total gain or loss that is section 988 gain or loss, Sec. 1.987-3T(c)(2)(ii) specifies that the spot rate also must be used to translate the amount received with respect to a historic asset if the acquisition of the historic asset gave rise to a section 988 transaction. Additionally, consistent with the regulations under Sec. 1.988-1(d) regarding the use of spot rate conventions for section 988 transactions, Sec. 1.987-1T(c)(1)(ii)(B) specifies that the election in Sec. 1.987-1(c)(1)(ii)(A) to use a spot rate convention generally does not apply for purposes of determining section 987 taxable income or loss with respect to a historic item (as defined in Sec. 1.987-1(e)) if acquiring, accruing, or entering into such item gave rise to a section 988 transaction or a specified owner functional currency transaction (discussed in this Part B). Because assets and liabilities that give rise to section 988 transactions generally are historic items that have a spot rate as the historic rate under Sec. 1.987-1T(c)(3)(i)(E), such assets and liabilities are translated at historic rates and do not give rise to section 987 gain or loss. Thus, when the general rules for section 988 transactions of a section 987 QBU apply, the owner will take into account under subpart J foreign currency exposure with respect to a section 988 transaction of a section 987 QBU only to the extent of the owner's economic exposure to fluctuations of its functional currency relative to the currency in which the section 988 transaction is denominated. Additionally, consistent with the 2006 proposed regulations, the temporary regulations confirm that certain transactions that are denominated in (or determined by reference to) the owner's functional currency are not subject to section 988. Specifically, Sec. 1.987- 3T(b)(4)(ii) provides that specified owner functional currency transactions, which are defined as transactions described in section 988(c)(1)(B)(i) or (ii) or section 988(c)(1)(C) (including the acquisition of nonfunctional currency described in Sec. 1.988-1(a)(1)) that are denominated in (or determined by reference to) the owner's functional currency, other than certain transactions described in Sec. 1.987-3T(b)(4)(iii)(A) that are subject to a mark-to-market regime (discussed in Part 4.C of this Explanation of Provisions), are not treated as section 988 transactions. Although the temporary regulations do not follow the 2006 proposed regulations in specifying that assets and liabilities that give rise to specified owner functional currency transactions must be reflected on the balance sheet of the section 987 QBU in the owner's functional currency, the temporary regulations treat items that give rise to specified owner functional currency transactions as historic items that generally have a spot rate as the historic rate under Sec. 1.987-1T(c)(3)(i)(E) and provide under Sec. 1.987-3T(b)(2)(ii) that the basis and amount realized of a historic asset that gives rise to a specified owner functional currency transactions are not translated if denominated in the owner's functional currency. Together, these rules have the same effect as the treatment of specified owner functional currency transactions under the 2006 proposed regulations. C. Special Rules To Allow Greater Conformity With the Financial Accounting Treatment for Certain Section 988 Transactions As discussed in the preamble to the final regulations, under the financial accounting standard described in Accounting Standards Codification, Foreign Currency Matters, section 830 (ASC 830), gains and losses from changes in exchange rates with respect to transactions that are denominated in a currency other than the entity's functional currency are referred to as ``transaction'' gains and losses. The category of foreign currency transactions that give rise to transaction gains and losses for financial accounting purposes overlaps considerably with the definition of a section 988 transaction for tax purposes, such that transaction gains and losses under financial accounting rules are conceptually similar to section 988 gains and losses. The financial accounting rules require the inclusion of transaction gains and losses in net income for the period in which the exchange rate changes occur. See ASC 830-20-35-1. Moreover, transaction gain or loss is always determined by reference to the functional currency of the entity that entered into the transaction. Thus, the financial accounting rules differ from the general tax rules applicable to section 988 transactions entered into by a section 987 QBU in two respects. First, the financial accounting rules require transaction gain or loss to be determined on a mark-to-market basis, whereas gain or loss from a section 988 transaction generally is not recognized until there is a realization event under general tax principles and the applicable provisions of the Code. Second, the financial accounting rules require transaction gain or loss to be determined by reference to the entity's functional currency, even when it differs from the reporting currency used in the consolidated financial statements and the transaction is denominated in the reporting currency. As noted in the preamble to the final regulations, comments on the 2006 proposed regulations expressed a preference for greater consistency of the section 987 regulations with financial accounting rules. Taking these comments into account, the Treasury Department and the IRS have determined that providing treatment similar to the financial accounting treatment for certain section 988 transactions of section 987 QBUs will enhance administrability of the section 987 regulations with respect to such transactions and is consistent with the policies of sections 987 and 988. Accordingly, as discussed in Part 1.C.i of this Explanation of Provisions, the temporary regulations permit a taxpayer to elect to determine section 987 gain or loss with respect to qualified short-term section 988 transactions (described in Part 1.C.i of this Explanation of Provisions) of a section 987 QBU under a foreign currency mark-to- market method of accounting. In addition, as discussed in Part 4.C.ii of this [[Page 88863]] Explanation of Provisions, the temporary regulations provide that section 988 gain or loss with respect to qualified short-term section 988 transactions that are accounted for under a mark-to-market method of accounting for Federal tax purposes (including the elective method described in Part 1.C.i of this Explanation of Provisions) is determined in, and by reference to, the functional currency of the section 987 QBU rather than the functional currency of its owner. i. Election To Apply a Foreign Currency Mark-to-Market Method of Accounting for Certain Section 988 Transactions The Treasury Department and the IRS have determined that allowing a taxpayer to mark to market foreign currency gain or loss with respect to qualified short-term section 988 transactions of a section 987 QBU will enhance administrability by aligning the timing for recognizing gain or loss with respect to such transactions with the financial accounting rules. Accordingly, a taxpayer may elect, on a QBU-by-QBU basis, under Sec. 1.987-3T(b)(4)(iii)(C) to apply the foreign currency mark-to-market method of accounting to qualified short-term section 988 transactions. Under this election, the timing of section 988 gain or loss is determined for applicable transactions under the principles of section 1256(a)(1). Thus, when the election applies, section 988 gain or loss with respect to a qualified short-term section 988 transaction is recognized on an annual basis, but other gain or loss with respect to any property underlying the transaction (e.g., gain or loss on a debt instrument due to interest rate fluctuations) is determined under the otherwise applicable recognition provisions. A qualified short-term section 988 transaction is defined in Sec. 1.987-3T(b)(4)(iii)(B) as a section 988 transaction, including a transaction denominated in the owner's functional currency, that both (1) occurs in the ordinary course of the section 987 QBU's business and (2) has an original term of one year or less on the day it is entered into by the section 987 QBU. The holding of currency that is nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) to the section 987 QBU in the ordinary course of a section 987 QBU's trade or business also is treated as a qualified short-term section 988 transaction. ii. Special Rule Requiring Gain or Loss From Certain Section 988 Transactions That Are Subject to a Mark-to-Market Method of Accounting To Be Determined by Reference to the Functional Currency of the Section 987 QBU The temporary regulations include a special rule for determining section 988 gain or loss with respect to qualified short-term section 988 transactions (as described in Part 4.C.i of this Explanation of Provisions) of a section 987 QBU that are accounted for under a mark- to-market method of accounting. Specifically, Sec. 1.987- 3T(b)(4)(iii)(A) provides that section 988 gain or loss with respect to qualified short-term section 988 transactions of a section 987 QBU, and certain related hedges, that are accounted for under a mark-to-market method of accounting under section 475, section 1256, or Sec. 1.987- 3T(b)(4)(iii)(C) (discussed in Part 4.C.i of this Explanation of Provisions) is determined in, and by reference to, the functional currency of the section 987 QBU rather than the owner's functional currency. Items that give rise to qualified short-term section 988 transactions for which section 988 gain or loss is determined under Sec. 1.987-3T(b)(4)(iii)(A) by reference to the section 987 QBU's functional currency are treated as marked items under Sec. 1.987- 1T(d)(3), with the result that gain or loss attributable to such items is translated at the yearly average exchange rate and that such items give rise to net unrecognized section 987 gain or loss. Under the rules for qualified short-term section 988 transactions accounted for under a mark-to-market method of accounting, a section 987 QBU owner will take into account the full amount of its economic foreign currency exposure arising from such transactions, but the effects of such exposure generally will be bifurcated into a component reflected in section 987 taxable income or loss and a component reflected in the FEEP pool and recognized upon a remittance. These components could offset each other if the currency in which the section 988 transaction is denominated and the owner's functional currency moved in opposite directions relative to the section 987 QBU's functional currency. Restricting this treatment to qualified short-term section 988 transactions accounted for under a mark-to-market method of accounting limits the potential for abusive planning. In particular, the restriction to transactions accounted for under a mark-to-market method of accounting prevents selective realization of section 988 losses that would be taken into account in section 987 taxable income or loss in situations in which an offsetting gain is reflected in the FEEP. Additionally, short-term, ordinary-course section 988 transactions are less likely than other section 988 transactions to give rise to substantial offsetting effects in section 987 taxable income or loss and in the FEEP. 5. Application of Section 987 to QBUs With the U.S. Dollar as a Functional Currency Consistent with the opening clause of section 987, which indicates that section 987 applies to the determination of the taxable income of any taxpayer ``having 1 or more qualified business units with a functional currency other than the dollar,'' Sec. 1.987-1T(b)(6)(i) sets forth a general rule that section 987 and the regulations thereunder do not apply with respect to an eligible QBU (determined without regard to the scope limitations of Sec. 1.987-1(b)(3)(ii)) that has the U.S. dollar as its functional currency and that would be subject to section 987 if it had a functional currency other than the U.S. dollar (dollar QBU). The Treasury Department and the IRS have determined, however, that it is appropriate for a CFC that is the owner of a dollar QBU to recognize foreign currency gain or loss with respect to transactions of the dollar QBU that would be section 988 transactions if entered into directly by the owner. Accordingly, pursuant to the authority granted in section 985(a), Sec. 1.987-1T(b)(6)(ii)(A) provides that the CFC owner of a dollar QBU will be subject to section 988 with respect to any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU. For purposes of applying section 988 to such items, Sec. 1.987-1T(b)(6)(ii)(A) provides that such items are treated as properly reflected on the books and records of the dollar QBU's owner. Thus, except as provided in the special rule described later in this Part 5 of this Explanation of Provisions for computing income that is effectively connected with the conduct of a trade or business within the United States (ECI), a CFC would determine section 988 gain or loss from transactions of a dollar QBU by reference to the CFC's functional currency. For example, for purposes of determining its earnings and profits, a CFC that has a euro functional currency and that is the owner of a dollar QBU with a U.S. dollar-denominated liability [[Page 88864]] would apply section 988 with respect to that U.S. dollar-denominated liability, measuring section 988 gain or loss on the section 988 transaction arising from the liability by reference to the euro. As a result of treating such items as properly reflected on the books and records of the CFC, instead of those of the dollar QBU, the CFC's section 988 gain or loss with respect to such items generally would be treated as foreign source income because section 988(a)(3) generally provides that the source of section 988 gain or loss is determined by reference to the residence of the taxpayer or QBU on whose books the asset, liability, or other item giving rise to the section 988 transaction is properly reflected. Section 1.988-4 then would apply to determine whether the section 988 gain or loss would be treated as ECI. Because a QBU with ECI must have the U.S. dollar as its functional currency (Sec. 1.985-1(b)(1)(v)), section 988 gain or loss measured by reference to the owner CFC's functional currency would not be ECI. However, the temporary regulations provide a special rule for certain section 988 transactions of a dollar QBU (including section 988 transactions denominated in the owner's functional currency) that arise from the conduct of a United States trade or business. The special rule applies to a CFC owner of a dollar QBU that would have a section 988 transaction that would give rise to section 988 gain or loss that would be treated as ECI under Sec. 1.988-4(c) if the item that would give rise to the section 988 transaction were treated as properly reflected on the books and records of the dollar QBU. Under Sec. 1.987-1T(b)(6)(ii)(B), solely for purposes of determining the amount of section 988 gain or loss of the CFC that is ECI, any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU and, consequently, is determined by reference to the U.S. dollar. The application of Sec. 1.987-1T(b)(6)(ii) to a section 988 transaction that is denominated in a third currency (that is, neither the CFC's functional currency nor the U.S. dollar) could result in the same section 988 transaction generating ECI (determined by reference to the U.S. dollar) and generating subpart F income (determined by reference to the CFC owner's functional currency), subject to any limitation imposed by section 952(b). Under section 952(b), if the amount determined under Sec. 1.987-1T(b)(6)(ii)(A) by reference to the owner's functional currency and the amount of ECI determined under Sec. 1.987-1T(b)(6)(ii)(B) were both gains, only the excess, if any, of the gain determined by reference to the owner's functional currency over the ECI gain would be taken into account in determining subpart F income. If the amount determined under Sec. 1.987-1T(b)(6)(ii)(A) by reference to the owner's functional currency and the amount of ECI determined under Sec. 1.987-1T(b)(6)(ii)(B) were both losses, the loss determined by reference to the owner's functional currency would be taken into account in determining subpart F income only to the extent it exceeds the ECI loss. The Treasury Department and the IRS recognize the potential administrative burden associated with applying the foregoing rules to a dollar QBU, which may give rise to a large number of section 988 transactions. Accordingly, Sec. 1.987-1T(b)(6)(iii) provides an election for a CFC that directly or indirectly owns a dollar QBU to apply section 987 and the regulations thereunder in lieu of applying section 988 pursuant to Sec. 1.987-1T(b)(6)(ii). The Treasury Department and the IRS have determined that, when this election applies, the source of foreign currency gain or loss that is determined under section 987 pursuant to the election should be consistent with the source that would have been determined under section 988 in the absence of the election. Accordingly, consistent with the source rule in section 988(a)(3), Sec. 1.987-6T(b)(4) provides that the source of section 987 gain or loss determined with respect to a dollar QBU for which the owner has elected to apply section 987 is determined by reference to the residence of the CFC owner. Thus, such section 987 gain or loss will have a foreign source. As is the case for dollar QBUs of CFCs that do not make the election under Sec. 1.987-1T(b)(6)(iii) to apply section 987, CFCs that make the election and that have a dollar QBU that engages in a U.S. trade or business must apply a special rule to determine the amount of ECI that arises from transactions that would give rise to section 988 gain or loss if determined by reference to the dollar QBU's U.S. dollar functional currency. This special rule for determining the amount of ECI applies only to dollar QBUs that generate ECI because, under Sec. 1.985-1(b)(1)(v), a QBU that produces income or loss that is, or is treated as, ECI must use the dollar as its functional currency. The special rule is needed for dollar QBUs that elect to be treated as section 987 QBUs because, under the general rules of Sec. 1.987-3T(b)(4)(i) and (ii), which apply to all section 987 QBUs other than with respect to certain short-term transactions described in Sec. 1.987-3T(b)(4)(iii)(B) that are accounted for under a mark-to-market method of accounting, section 988 gain or loss of a section 987 QBU with respect to transactions denominated in a third currency is determined in, and by reference to, the functional currency of the owner of the section 987 QBU, and section 988 gain or loss generally is not determined with respect to specified owner functional currency transactions described in Part 4.B of this Explanation of Provisions. Thus, in order to determine the appropriate amount of ECI from transactions of a dollar QBU for which an election to apply section 987 is in effect, Sec. 1.987-1T(b)(6)(iii)(B) provides that, solely for purposes of determining the amount of section 988 gain or loss that is ECI, any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under Sec. 1.988-4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating the item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. For purposes of determining the amount of section 988 gain or loss for other purposes, including to determine the earnings and profits of the CFC, the rules in Sec. 1.987-3T(b)(4)(i) and (ii) continue to apply. As is the case for a CFC that has not made the election to apply section 987 in lieu of section 988, a transaction to which the special rule applies could generate both ECI and subpart F income. 6. Combinations and Separations of QBUs A. Combinations and Separations Do Not Give Rise to Transfers Under Sec. 1.987-2(c), an asset or liability is treated as transferred to a section 987 QBU from its owner if, as a result of a disregarded transaction, the asset or liability is reflected on the books and records of the section 987 QBU. Similarly, an asset or liability is treated as transferred from a section 987 QBU to its owner if, as a result of a disregarded transaction, the asset or liability is no longer reflected on the books and records of the section 987 QBU. For this purpose, a disregarded transaction generally means a [[Page 88865]] transaction that is not regarded for Federal income tax purposes. Absent a special rule, the combination of multiple section 987 QBUs that have the same owner, or the separation of a section 987 QBU into two or more section 987 QBUs that have the same owner, would give rise to a transfer between an owner and one or more section 987 QBUs under the final regulations. Consistent with the policy of deferring section 987 gain or loss under Sec. 1.987-12T when assets of a section 987 QBU are reflected on the books and records of another section 987 QBU in the same controlled group as a result of certain transactions that result in deemed transfers, the Treasury Department and the IRS have determined that it would not be appropriate for combinations or separations of section 987 QBUs of the same owner to give rise to transfers to or from the section 987 QBUs. Accordingly, under the temporary regulations, section 987 gain or loss generally is not recognized when two or more section 987 QBUs (combining QBUs) with the same owner combine into a single section 987 QBU (combined QBU) or when a section 987 QBU (separating QBU) separates into multiple section 987 QBUs (each, a separated QBU). Specifically, notwithstanding the general rule of the final regulations, Sec. 1.987-2T(c)(9)(i) provides that the combination of two or more combining QBUs that have the same owner into a combined QBU does not give rise to a transfer of any combining QBU's assets or liabilities to the owner. In addition, Sec. 1.987-2T(c)(9)(i) provides that transactions between the combining QBUs occurring in the taxable year of the combination, which otherwise would give rise to transfers, do not result in a transfer of the combining QBUs' assets or liabilities to the owner under Sec. 1.987-2(c). For this purpose, a combination occurs when the assets and liabilities that are properly reflected on the books and records of two or more combining QBUs begin to be properly reflected on the books and records of a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which combining QBUs become a combined QBU. Similarly, Sec. 1.987-2T(c)(9)(iii) provides that the separation of a separating QBU into two or more separated QBUs that have the same owner after the separation does not give rise to a transfer of any of the separating QBU's assets or liabilities to the owner. For this purpose, a separation occurs when assets and liabilities that are properly reflected on the books and records of a separating QBU begin to be properly reflected on the books and records of two or more separated QBUs. A separation may result from any transaction or series of transactions in which the separating QBU becomes two or more separated QBUs. B. Determination of Net Unrecognized Section 987 Gain or Loss of Combined QBUs and Separated QBUs The temporary regulations generally require combining the aggregate net unrecognized section 987 gain or loss of combining QBUs for purposes of determining net unrecognized section 987 gain or loss of the combined QBU and require apportioning the net unrecognized section 987 gain or loss of a separating QBU among separated QBUs in proportion to their respective shares of the aggregate adjusted basis of the separating QBU's gross assets. Specifically, Sec. 1.987-4T(f)(1) provides that the net unrecognized section 987 gain or loss of a combined QBU for a taxable year is determined by taking into account the net accumulated unrecognized section 987 gain or loss of each combining QBU for all prior taxable years for which the final regulations apply and treating the combining QBUs as having combined immediately prior to the beginning of the taxable year of combination. Additionally, Sec. 1.987-4T(f)(2) provides that the net unrecognized section 987 gain or loss of a separated QBU for a taxable year is determined by taking into account the separated QBU's share of the net accumulated unrecognized section 987 gain or loss of the separating QBU for all prior taxable years for which the final regulations apply and treating the separating QBU as having separated immediately prior to the beginning of the taxable year of separation. No transactions are deemed to occur between the separating QBUs in the taxable year of separation prior to the completion of the separation. A separated QBU's share of the separating QBU's net accumulated unrecognized section 987 gain or loss for all prior taxable years is determined by apportioning the separating QBU's net accumulated unrecognized section 987 gain or loss for all prior taxable years to each separated QBU in proportion to the aggregate adjusted basis of the gross assets properly reflected on the books and records of each separated QBU immediately after the separation. The temporary regulations also clarify at Sec. 1.987-2T(c)(9)(ii) that, if a combining section 987 QBU has a different functional currency than the combined QBU, the combining section 987 QBU will be deemed to have automatically changed its functional currency to the functional currency of the combined section 987 QBU immediately prior to the combination. A combining section 987 QBU that is deemed to change its functional currency under this paragraph must make the adjustments described in Sec. 1.985-5. 7. Translation of Foreign Taxes Claimed as a Foreign Tax Credit and Related Income Under the general rule of Sec. 1.987-3(c)(1), the owner of a section 987 QBU uses the yearly average exchange rate (as defined in Sec. 1.987-1(c)(2)) to translate an item of income, gain, deduction, or loss of a section 987 QBU into the owner's functional currency. Alternatively, the owner of a section 987 QBU may elect to use the spot rate (as defined in Sec. 1.987-1(c)(1)) for the day each item is taken into account. Under section 986(a)(1)(A), for purposes of determining the amount of its foreign tax credit, a taxpayer that takes foreign income taxes into account when accrued generally translates the amount of any foreign income taxes (and any adjustments thereto) into dollars using the average exchange rate for the taxable year to which such taxes relate. However, sections 986(a)(1)(B) and (C) contain exceptions to this general rule, including for taxes that are not paid within two years of the close of the taxable year to which the taxes relate (two- year rule). In addition, section 986(a)(1)(D) provides that a taxpayer may elect to translate foreign income taxes denominated in a functional currency other than the taxpayer's functional currency using a spot rate in lieu of using the yearly average exchange rate. Section 986(a)(2)(A) generally provides that, for purposes of determining the amount of the foreign tax credit with respect to any foreign income taxes not subject to section 986(a)(1)(A) (or section 986(a)(1)(E), which provides a special rule for regulated investment companies), including by reason of the two-year rule or an election under section 986(a)(1)(D), the taxes are translated into dollars using the spot rate on the date such taxes were paid. Adjustments to such taxes are subject to the same rule, except that any refund or credit is translated into dollars using the exchange rate that applied to the original payment of such foreign income taxes. Taking into account the translation rules of Sec. 1.987-3(c) and section 986(a), [[Page 88866]] a mismatch could arise between the owner functional currency value of income used to pay foreign income taxes and the owner functional currency value of the foreign income taxes claimed as a credit. In the case of foreign income taxes deemed paid under section 902, section 78 generally prevents such a mismatch at the level of the domestic shareholder claiming the credit by requiring the domestic shareholder to include in income an amount equal to the taxes deemed paid, but where a U.S. person claims a credit under section 901 that is not for taxes deemed paid under section 902 or section 960, foreign income taxes and the income used to pay those taxes could be translated at different translation rates. To address this potential mismatch, Notice 89-74, 1989-1 C.B. 739, provides that when a U.S. taxpayer with a foreign branch that has a functional currency other than the dollar claims a foreign tax credit with respect to a foreign tax, the taxpayer is required to translate a functional currency amount equal to the foreign taxes paid on branch income using the exchange rate at the time of payment of such taxes. Consistent with Notice 89-74, Sec. 1.987-3T(c)(2)(v) includes a special translation rule providing that income in an amount equal to the functional currency amount of the section 987 QBU's foreign income taxes claimed as a credit must be translated at the same rate used to translate the taxes. This translation rule applies to the owner of a section 987 QBU claiming a credit under section 901 for foreign income taxes, other than income taxes deemed paid under section 902 or section 960, that are properly reflected on the books of the section 987 QBU. Mechanically, this rule requires the owner to reduce the amount of section 987 taxable income or loss that otherwise would be determined under Sec. 1.987-3 by an amount equal to the creditable tax amount, translated into U.S. dollars at the yearly average exchange rate for the taxable year in which the creditable tax is accrued, and then to increase the resulting amount by an amount equal to the creditable tax amount translated into U.S. dollars at the same exchange rate used to translate the creditable taxes into U.S. dollars under section 986(a). If the foreign taxes and the income are both translated at the same rate (that is, the same yearly average exchange rate), no adjustment is necessary under Sec. 1.987-3T(c)(2)(v). 8. Determination of a Partner's Share of Assets and Liabilities of a Section 987 Aggregate Partnership As discussed in the preamble to the final regulations, the final regulations apply an aggregate approach with respect to section 987 aggregate partnerships, which are defined in Sec. 1.987-1(b)(5) as partnerships for which all of the capital and profits interests are owned, directly or indirectly, by persons that are related within the meaning of section 267(b) or section 707(b). This approach is consistent with the aggregate approach to partnerships reflected in the 2006 proposed regulations, but the 2006 proposed regulations would have applied to all partnerships. Under the aggregate approach, assets and liabilities reflected on the books and records of an eligible QBU of a partnership are allocated to each partner, which is considered an indirect owner of the eligible QBU. If the eligible QBU has a different functional currency than its indirect owner, then the assets and liabilities of the eligible QBU that are allocated to the partner are treated as a section 987 QBU of the indirect owner. The 2006 proposed regulations provided a rule for determining a partner's share of the assets and liabilities of an eligible QBU that is owned indirectly through a section 987 aggregate partnership. Specifically, proposed Sec. 1.987-7(b) provided that a partner's share of assets and liabilities reflected on the books and records of an eligible QBU owned through a section 987 aggregate partnership must be determined in a manner consistent with how the partners have agreed to share the economic benefits and burdens corresponding to partnership assets and liabilities, taking into account the rules and principles of subchapter K. One comment noted that this rule for allocating assets and liabilities to a partner's indirectly owned section 987 QBU was ambiguous and that the rules and principles of subchapter K do not provide sufficient guidance in this regard. The Treasury Department and the IRS acknowledge the ambiguity in the 2006 proposed regulations regarding the manner in which assets and liabilities of a partnership are allocated to a partner's indirectly owned section 987 QBU under the aggregate approach. Accordingly, the temporary regulations provide more specific rules for determining a partner's share of the assets and liabilities reflected on the books and records of an eligible QBU owned indirectly through a section 987 aggregate partnership. Specifically, Sec. 1.987-7T(b) provides that, in any taxable year, a partner's share of each asset and liability of a section 987 aggregate partnership is proportional to the partner's liquidation value percentage with respect to the aggregate partnership. A partner's liquidation value percentage is defined as the ratio of the liquidation value of the partner's interest in the partnership to the aggregate liquidation value of all the partners' interests in the partnership. The liquidation value of the partner's interest in the partnership is the amount of cash the partner would receive with respect to its interest if, immediately following the applicable determination date, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in Sec. 1.752-7), paid an unrelated third party to assume all of its Sec. 1.752-7 liabilities in a fully taxable transaction, and then liquidated. In general, the temporary regulations provide that the determination date for determining a partner's liquidation value percentage is the date of the most recent event described in Sec. 1.704-1(b)(2)(iv)(f)(5) or Sec. 1.704-1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether the capital accounts of the partners are adjusted under Sec. 1.704-1(b)(2)(iv)(f), or, if there has been no revaluation event, the date of the formation of the partnership. However, if a partnership agreement provides for the allocation of any item of income, gain, deduction, or loss from partnership property to a partner other than in accordance with the partner's liquidation value percentage in a particular taxable year, the determination date is the last day of the partner's taxable year, or, if the partner's section 987 QBU owned indirectly through a section 987 aggregate partnership terminates during the partner's taxable year, the date such section 987 QBU is terminated. Without this requirement to redetermine liquidation value percentages at year-end when such an allocation is in effect, the allocation could result in section 987 taxable income or loss, which necessarily would reflect the allocation, being taken into account in determining section 987 gain or loss under Sec. 1.987-4 even though the allocation was not taken into account in computing the owner functional currency value of the section 987 QBU, such that distortions would arise in the computation of section 987 gain or loss. The Treasury Department and the IRS have determined that the liquidation value percentage methodology reflected [[Page 88867]] in Sec. 1.987-7T(b) reflects an administrable approach to allocating assets and liabilities of a section 987 aggregate partnership to eligible QBUs of its partners in a manner consistent with the partners' economic interests in the assets and liabilities of the partnership. The Treasury Department and the IRS request comments on the application of the liquidation value percentage approach reflected in the temporary regulations, including whether any alternative measure could better satisfy the criteria of administrability and consistency with the economics of the partners' arrangement. 9. Deferral of Certain Section 988 Loss Realized by a Debtor With Respect to a Related-Party Loan Section 267(a)(1) provides that no deduction is allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons who have a relationship described in section 267(b). Section 267(f)(2) modifies the general rule of section 267(a)(1) in the case of a sale or exchange of property between corporations that are members of the same controlled group (as defined in section 267(f)(1)), generally providing that a loss realized upon such a sale or exchange is deferred until the property is transferred outside the group such that there would be recognition of loss under consolidated return principles. Section 267(f)(3)(C) provides that, to the extent provided in regulations, section 267(a)(1) does not apply to any loss sustained by a member of a controlled group on the repayment of a loan made to another member of such controlled group if such loan is payable or denominated in a foreign currency and attributable to a reduction in the value of that foreign currency. Section 1.267(f)-1(e) provides that section 267(a) generally does not apply to an exchange loss realized with respect to a loan of nonfunctional currency to another controlled group member if the transaction that causes the realization of the loss does not have as a significant purpose the avoidance of Federal income tax. Additionally, Sec. 1.267(f)-1(h) provides that if a transaction is engaged in with a principal purpose to avoid the purposes of Sec. 1.267(f)-1, including by distorting the timing of losses, adjustments may be made to carry out such purposes. Section 1.988-2(b)(16)(i) cross-references the regulations under section 267 regarding the coordination of sections 267 and 988 with respect to the treatment of a creditor under a debt instrument, but Sec. 1.988-2(b)(16)(ii) is reserved with respect to the treatment of a debtor. The temporary regulations correct the cross-reference in Sec. 1.988-2(b)(16)(i) to refer to Sec. 1.267(f)-1(e) rather than Sec. 1.267(f)-1(h). The Treasury Department and the IRS have determined that the policy considerations underlying section 267(f)(3)(C) and Sec. 1.267(f)-1(e) with respect to creditors on loans to related persons also apply with respect to debtors on such loans and that there is no reason to distinguish between a creditor and debtor with regard to the application of an anti-avoidance rule to the same transaction. Accordingly, pursuant to the authority granted to the Secretary in section 989(c)(5) to prescribe regulations providing for the appropriate treatment of related-party transactions, Sec. 1.988- 2T(b)(16)(ii) provides that exchange loss of a debtor with respect to a loan (original loan) from a person with whom the debtor has a relationship described in section 267(b) or section 707(b) is deferred if the transaction resulting in realization of the loss has a principal purpose of avoiding Federal income tax. Such deferred loss will be recognized at the end of the term of the original loan. Special Analyses Certain IRS regulations, including these, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory assessment is not required. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), please refer to the Special Analyses section in the preamble to the cross-referenced notice of proposed rulemaking in the Proposed Rules section of this issue of the Federal Register. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business. Drafting Information The principal author of these regulations is Mark E. Erwin of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Amendment to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PART 1--INCOME TAXES 0 Paragraph 1. The authority citation for part 1 continues to read in part as follows: Authority: 26 U.S.C. 985, 987, 989(c) and 7805 * * * 0 Par. 2. Section 1.987-0 is amended by adding entries for Sec. Sec. 1.987-6(b)(4) and 1.987-12(a) through (h) to read as follows: Sec. 1.987-0 Section 987; table of contents. * * * * * Sec. 1.987-6 Character and source of section 987 gain or loss. * * * * * (b) * * * (4) [Reserved]. * * * * * Sec. 1.987-12 Deferral of section 987 gain or loss. (a) through (h) [Reserved]. 0 Par. 3. Section 1.987-1 is amended by adding paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(B) and (C), and (g)(3)(i)(E) through (H) to read as follows: Sec. 1.987-1 Scope, definitions, and special rules. * * * * * (b) * * * (1) * * * (iii) [Reserved]. For further guidance, see Sec. 1.987- 1T(b)(1)(iii). * * * * * (b) * * * (6) [Reserved]. For further guidance, see Sec. 1.987-1T(b)(6). * * * * * (c) * * * (1) * * * (ii) * * * (B) [Reserved]. For further guidance, see Sec. 1.987- 1T(c)(1)(ii)(B). * * * * * (c) * * * (3) * * * (i) * * * (E) [Reserved]. For further guidance, see Sec. 1.987- 1T(c)(3)(i)(E). * * * * * (d) * * * (3) [Reserved]. For further guidance, see Sec. 1.987-1T(d)(3). * * * * * (f) [Reserved]. For further guidance, see Sec. 1.987-1T(f). * * * * * (g) * * * (2) * * * (i) * * * (B) through (C) [Reserved]. For further guidance, see Sec. 1.987- 1T(g)(2)(i)(B) through (C). * * * * * [[Page 88868]] (g) * * * (3) * * * (i) * * * (E) through (H) [Reserved]. For further guidance, see Sec. 1.987- 1T(g)(3)(i)(E) through (H). * * * * * 0 Par. 4. Section 1.987-1T is added to read as follows: Sec. 1.987-1T Scope, definitions, and special rules (temporary). (a) through (b)(1)(ii) [Reserved]. For further guidance, see Sec. 1.987-1(a) through (b)(1)(ii). (iii) Certain provisions applicable to all taxpayers. Notwithstanding Sec. 1.987-1(b)(1)(ii), paragraphs (b)(6) and (g)(3)(i)(E) of this section and Sec. 1.987-6T(b)(4) apply to any taxpayer that is an owner of a dollar QBU (as defined in paragraph (b)(6) of this section), and paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of this section and Sec. Sec. 1.987-8T(d) and 1.987-12T apply to any taxpayer that is an owner of an eligible QBU (determined without regard to Sec. 1.987-1(b)(3)(ii)) that is subject to section 987. (b)(2) through (b)(5) [Reserved]. For further guidance, see Sec. 1.987-1(b)(2) through (b)(5). (6) Dollar QBUs--(i) In general. Except as provided in paragraphs (b)(1)(iii) and (b)(6)(iii) of this section, section 987 and the regulations thereunder do not apply with respect to an eligible QBU (determined without regard to Sec. 1.987-1(b)(3)(ii)) that has the U.S. dollar as its functional currency and that would be subject to section 987 if it had a functional currency other than the dollar (dollar QBU). This paragraph (b)(6) applies to all taxpayers, including entities described in Sec. 1.987-1(b)(1)(ii). (ii) Application of section 988 to a dollar QBU--(A) In general. Except as provided in paragraphs (b)(6)(ii)(B) and (b)(6)(iii) of this section, a controlled foreign corporation (as defined in section 957(a)) (CFC) that is the owner of a dollar QBU applies section 988 with respect to any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU. Except as provided in paragraph (b)(6)(ii)(B) of this section, for purposes of determining the amount of section 988 gain or loss of the CFC, any item that is properly reflected on the books and records of the dollar QBU and that would give rise to a section 988 transaction if such item were acquired, accrued, or entered into directly by the owner of the dollar QBU is treated as properly reflected on the books and records of the owner of the dollar QBU, such that the amount of section 988 gain or loss with respect to such item is determined by reference to the owner's functional currency. (B) Section 988 gain or loss characterized as effectively connected income. Solely for the purpose of determining the amount of section 988 gain or loss of a CFC described in paragraph (b)(6)(ii)(A) of this section that is effectively connected with the conduct of a trade or business within the United States (ECI), any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under Sec. 1.988-4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. (iii) Election for a CFC to apply section 987 to a dollar QBU--(A) In general. A CFC that is the owner of a dollar QBU may elect to apply section 987 and the regulations thereunder with respect to the dollar QBU in lieu of applying section 988 pursuant to paragraph (b)(6)(ii) of this section. If the dollar QBU or CFC is described in Sec. 1.987- 1(b)(1)(ii), however, the CFC must apply section 987 to the dollar QBU using the method it applied to the dollar QBU immediately prior to the effective date of this paragraph (b)(6) as provided in paragraph (h) of this section, provided such method was a reasonable interpretation of section 987, or, if no such method exists, a reasonable method. (B) Section 988 gain or loss characterized as effectively connected income. Solely for the purpose of determining the amount of section 988 gain or loss of a dollar QBU that is the subject of an election described in paragraph (b)(6)(iii)(A) of this section that is ECI, Sec. 1.987-3T(b)(4)(i) and (ii) do not apply, and any section 988 gain or loss that would be determined under section 988 as a result of the acquisition or accrual of any item and treated as ECI under Sec. 1.988-4(c) if the item were treated as properly reflected on the books and records of the dollar QBU is determined by treating such item as properly reflected on the books and records of the dollar QBU. Consequently, solely for that purpose, such section 988 gain or loss is determined by reference to the U.S. dollar. See Sec. 1.987-6T(b)(4) for rules regarding the source of section 987 gain or loss with respect to a dollar QBU for which the CFC owner has made the election described in this paragraph. (b)(7) through (c)(1)(ii)(A) [Reserved]. For further guidance, see Sec. 1.987-1(b)(7) through (c)(1)(ii)(A). (B) Election inapplicable with respect to certain amounts. Except as provided in this paragraph (c)(1)(ii)(B), the election provided in Sec. 1.987-1(c)(1)(ii)(A) does not apply for purposes of determining section 987 taxable income or loss (as defined in Sec. 1.987-3(a)) with respect to a historic item (as defined in Sec. 1.987-1(e)) if acquiring, accruing, or entering into such item gives rise to a section 988 transaction or specified owner functional currency transaction. However, the election provided in Sec. 1.987-1(c)(1)(ii)(A) does apply for purposes of determining section 987 taxable income or loss with respect to a payable or receivable described in Sec. 1.988-1(d)(3) under the circumstances described in Sec. 1.988-1(d)(3). (c)(2) through (c)(3)(i)(D) [Reserved]. For further guidance, see Sec. 1.987-1(c)(2) through (c)(3)(i)(D). (E) Section 988 transactions and specified owner functional currency transactions. If acquiring, accruing, or entering into a historic item gives rise to a section 988 transaction of a section 987 QBU or a specified owner functional currency transaction described in Sec. 1.987-3T(b)(4)(ii), the historic rate is the spot rate (as defined in paragraph (c)(1) of this section) on the date such item is acquired, accrued, or entered into. For this purpose, use of a spot rate convention under Sec. 1.987-1(c)(1)(ii) is permitted only with respect to a payable or receivable described in Sec. 1.988-1(d)(3) and only to the extent provided therein. (c)(3)(ii) through (d)(2) [Reserved]. For further guidance, see Sec. 1.987-1(c)(3)(ii) through (d)(2). (3) Gives rise to a qualified short-term section 988 transaction (as defined in Sec. 1.987-3T(b)(4)(iii)(B)) of the section 987 QBU, whether denominated in the functional currency of the owner or other nonfunctional currency with respect to the section 987 QBU, for which section 988 gain or loss is determined under Sec. 1.987- 3T(b)(4)(iii)(A) in, and by reference to, the functional currency of the section 987 QBU. (e) [Reserved]. For further guidance, see Sec. 1.987-1(e). (f) Examples. The following examples illustrate the application of Sec. 1.987-1(d) and (e). Example 1. U.S. Corp is a domestic corporation with the U.S. dollar as its [[Page 88869]] functional currency and is the owner of Business A, a section 987 QBU that has the pound as its functional currency. Assume all transactions of Business A are entered into in the ordinary course of its business. U.S. Corp has not made an election under Sec. 1.987-3T(b)(4)(iii)(C) to adopt a foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions. Items reflected on Business A's balance sheet include [pound]10,000, $1,000, a building with a basis of [pound]100,000, a light general purpose truck with a basis of [pound]30,000, a computer with a basis of [pound]1,000, a 60-day receivable for [yen]15,000, an account payable of [pound]5,000, and a foreign currency contract within the meaning of section 1256(g)(2) that requires Business A to exchange [pound]100 for $125 in 90 days. Under paragraph (d) of this section, the [pound]10,000, the [pound]5,000 account payable and the [pound]/$ section 1256 foreign currency contract are marked items. The other items are historic items under this paragraph (e) of this section. Example 2. The facts are the same as Example 1 except that U.S. Corp has elected under Sec. 1.987-3T(b)(4)(iii)(C) to adopt the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions of Business A. Under paragraphs (d) and (e) of this section, the [pound]10,000, the $1,000, the [yen]15,000 receivable, the [pound]5,000 account payable, and the [pound]/$ section 1256 foreign currency contract are marked items. (g)(1) through (g)(2)(i)(A) [Reserved]. For further guidance, see Sec. 1.987-1(g)(1) through (g)(2)(i)(A). (B) Annual deemed termination election--(1) In general. Except as provided in paragraph (g)(2)(i)(B)(2) of this section, an election under Sec. 1.987-8T(d) (annual deemed termination election) applies to all section 987 QBUs owned by the taxpayer, as well as to all section 987 QBUs owned by any person that has a relationship to the taxpayer described in section 267(b) or section 707(b) (substituting ``and the profits interest'' for ``or the profits interest'' in section 707(b)(1)(A) and substituting ``and profits interests'' for ``or profits interests'' in section 707(b)(1)(B)) on the last day of the first taxable year for which the election applies (a related person). If a taxpayer makes the election under Sec. 1.987-8T(d), the first taxable year of a related person for which the election applies is the first taxable year that ends with or within a taxable year of the taxpayer for which the taxpayer's election applies. An election under Sec. 1.987-8T(d) may not be revoked. (i) Fresh start taxpayers. A taxpayer to which Sec. 1.987-10 applies that is required under Sec. 1.987-10(a) to apply the fresh start transition method described in Sec. 1.987-10(b) (fresh start taxpayer) may make the election under Sec. 1.987-8T(d) only if the first taxable year for which the election would apply to the taxpayer is either the first taxable year beginning on or after the transition date (as defined in Sec. 1.987-11(c)) in which the election is relevant or a subsequent taxable year in which the taxpayer's controlled group aggregate section 987 loss, if any, does not exceed $5 million. For purposes of this paragraph (g)(2)(i)(B), a taxpayer's controlled group aggregate section 987 loss means the aggregate net amount of section 987 loss that would be recognized pursuant to the election by the taxpayer and all other persons to whom the taxpayer's election would apply in the first taxable year of each person for which the election would apply. (ii) Other taxpayers. Other taxpayers, including taxpayers described in Sec. 1.987-1(b)(1)(ii) and taxpayers described in Sec. 1.987-10(c), must follow the election rules provided in paragraph (g)(2)(i)(B)(1)(i) of this section if any related party is a fresh start taxpayer. If no related party is a fresh start taxpayer, the election under Sec. 1.987-8T(d) may be made only if the first taxable year for which the election would apply to the taxpayer is either the first taxable year beginning on or after December 7, 2016, in which the election is relevant or a subsequent taxable year in which the taxpayer's controlled group aggregate section 987 loss, if any, does not exceed $5 million. (2) QBU-by-QBU elections in certain circumstances. Notwithstanding paragraph (g)(2)(i)(B)(1) of this section, a taxpayer may make a separate election under Sec. 1.987-8T(d) with respect to any section 987 QBU owned by the taxpayer if the first taxable year for which the election would apply to the taxpayer with respect to the section 987 QBU is a taxable year in which there is a section 987 gain recognized with respect to the section 987 QBU pursuant to the election, or is a taxable year in which there is a section 987 loss of $1 million or less that would be recognized with respect to the section 987 QBU pursuant to the election (C) Election to translate all items at the yearly average exchange rate. An election under Sec. 1.987-3T(d) (election to translate all items at the yearly average exchange rate) may be made with respect to a section 987 QBU only if the first taxable year for which the election would apply is the first taxable year for which an election under Sec. 1.987-8T(d) (annual deemed termination election) applies with respect to the section 987 QBU. (g)(2)(ii) through (g)(3)(i)(D) [Reserved]. For further guidance, see Sec. 1.987-1(g)(2)(ii) through (g)(3)(i)(D). (E) Election for a CFC to apply section 987 to a dollar QBU. An election under Sec. 1.987-1T(b)(6)(iii) for a CFC to apply section 987 to a dollar QBU must be titled ``Section 987 Election for a CFC to Apply Section 987 to a Dollar QBU Under Sec. 1.987-1T(b)(6)(iii)'' and must provide the name and address of each QBU for which the election is being made. (F) Election to apply the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions. An election under Sec. 1.987-3T(b)(4)(iii)(C) to apply the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions must be titled ``Section 987 Election to Use Foreign Currency Mark-to-Market Method of Accounting for Qualified Short-Term Section 988 Transactions Under Sec. 1.987- 3(b)T(4)(iii)(C)'' and must provide the name and address of each section 987 QBU for which the election is being made. (G) Election to translate all items at the yearly average exchange rate. An election under Sec. 1.987-3T(d) to translate all items at the yearly average exchange rate must be titled ``Section 987 Election to Translate All Items at the Yearly Average Exchange Rate Under Sec. 1.987-3T(d)'' and must provide the name and address of each section 987 QBU for which the election is being made. (H) Annual deemed termination election. An election under Sec. 1.987-8T(d) for an owner to deem all of its section 987 QBUs to terminate on the last day of each taxable year must be titled ``Section 987 Annual Deemed Termination Election Under Sec. 1.987-8T(d)'' and must provide the name and address of each section 987 QBU to which the election applies, including a section 987 QBU owned by a related person (within the meaning of paragraph (g)(2)(i)(B)(1) of this section). (g)(4) through (6) [Reserved]. For further guidance, see Sec. 1.987-1(g)(4) through (6). (h) Effective/applicability date. Paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of this section apply to the first taxable year beginning on or after December 7, 2016. Paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and (g)(3)(i)(E) through (G) of this section apply to taxable years beginning one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and (g)(3)(i)(E) through (G) of this section apply to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. [[Page 88870]] (i) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 5. Section 1.987-2 is amended by adding paragraph (c)(9) to read as follows: Sec. 1.987-2 Attribution of items to eligible QBUs; definition of a transfer and related rules. * * * * * (c) * * * (9) [Reserved]. For further guidance, see Sec. 1.987-2T(c)(9). * * * * * 0 Par. 6. Section 1.987-2T is added to read as follows: Sec. 1.987-2T Attribution of items to eligible QBUs; definition of a transfer and related rules (temporary). (a) through (c)(8) [Reserved]. For further guidance, see Sec. 1.987-2(a) through (c)(8). (9) Certain disregarded transactions not treated as transfers--(i) Combinations of section 987 QBUs. The combination of two or more separate section 987 QBUs (combining QBUs) that are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, into one section 987 QBU (combined QBU) does not give rise to a transfer of any combining QBU's assets or liabilities to the owner under Sec. 1.987- 2(c). In addition, transactions between the combining QBUs occurring in the taxable year of the combination do not result in a transfer of the combining QBUs' assets or liabilities to the owner under Sec. 1.987- 2(c). For this purpose, a combination occurs when the assets and liabilities that are properly reflected on the books and records of two or more combining QBUs begin to be properly reflected on the books and records of a combined QBU and the separate existence of the combining QBUs ceases. A combination may result from any transaction or series of transactions in which the combining QBUs become a combined QBU. For rules regarding the determination of net unrecognized section 987 gain or loss of a combined QBU, see Sec. 1.987-4T(f)(1). (ii) Change in functional currency from a combination. If, following a combination of section 987 QBUs described in paragraph (c)(9)(i) of this section, the combined section 987 QBU has a different functional currency than one or more of the combining section 987 QBUs, any such combining section 987 QBU is treated as changing its functional currency and the owner of the combined section 987 QBU must comply with the regulations under section 985 regarding the change in functional currency. See Sec. Sec. 1.985-1(c)(6) and 1.985-5. (iii) Separation of section 987 QBUs. The separation of a section 987 QBU (separating QBU) into two or more section 987 QBUs (separated QBUs) that, after the separation, are directly owned by the same owner, or that are indirectly owned by the same partner through a single section 987 aggregate partnership, does not give rise to a transfer of the separating QBU's assets or liabilities to the owner under Sec. 1.987-2(c). Additionally, transactions that occurred between the separating QBUs in the taxable year of the separation prior to the completion of the separation do not give rise to transfers for purposes of section 987. For this purpose, a separation occurs when the assets and liabilities that are properly reflected on the books and records of a separating QBU begin to be properly reflected on the books and records of two or more separated QBUs. A separation may result from any transaction or series of transactions in which a separating QBU becomes two or more separated QBUs. A separation may also result when a section 987 QBU that is subject to a grouping election under Sec. 1.987- 1(b)(2)(ii)(A) changes its functional currency. For rules regarding the determination of net unrecognized section 987 gain or loss of a separated QBU, see Sec. 1.987-4T(f)(2). (c)(10) through (d) [Reserved]. For further guidance see Sec. 1.987-2(c)(10) through (d). (e) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (f) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 7. Section 1.987-3 is amended by adding paragraphs (b)(2)(ii), (b)(4), (c)(2)(ii) and (v), and (d), and Example 9 through Example 14 at the end of paragraph (e) to read as follows: Sec. 1.987-3 Determination of section 987 taxable income or loss of an owner of a section 987 QBU. * * * * * (b) * * * (2) * * * (ii) [Reserved]. For further guidance, see Sec. 1.987- 3T(b)(2)(ii). * * * * * (b) * * * (4) [Reserved]. For further guidance, see Sec. 1.987-3T(b)(4). * * * * * (c) * * * (2) * * * (ii) [Reserved]. For further guidance, see Sec. 1.987- 3T(c)(2)(ii). * * * * * (c) * * * (2) * * * (v) through (d) [Reserved]. For further guidance, see Sec. 1.987- 3T(c)(2)(v) through (d). (e) Examples. * * * Example 9 through Example 14 [Reserved]. For further guidance, see Sec. 1.987-3T(e), Example 9 through Example 14. 0 Par. 8. Section 1.987-3T is added to read as follows: Sec. 1.987-3T Determination of section 987 taxable income or loss of an owner of a section 987 QBU (temporary). (a) through (b)(2)(i) [Reserved]. For further guidance, see Sec. 1.987-3(a) through (b)(2)(i). (ii) No translation of basis or amount realized with respect to a specified owner functional currency transaction treated as a historic asset. If the acquisition of a historic asset gives rise to a specified owner functional currency transaction described in paragraph (b)(4)(ii) of this section, the basis of the historic asset, and any amount realized on a disposition of the historic asset, is not translated if the amount is denominated in the owner's functional currency. (3) [Reserved]. For further guidance, see Sec. 1.987-3(b)(3). (4) Special rule for section 988 transactions--(i) In general. Section 988 and the regulations thereunder apply to section 988 transactions of a section 987 QBU. For this purpose, whether a transaction is a section 988 transaction is determined by reference to the functional currency of the section 987 QBU. (But see paragraph (b)(4)(ii) of this section, providing that specified owner functional currency transactions are not treated as section 988 transactions.) However, except as provided in paragraph (b)(4)(iii)(A) of this section, section 988 gain or loss is determined in, and by reference to, the functional currency of the owner of the section 987 QBU rather than the functional currency of the section 987 QBU. Accordingly, in determining section 988 gain or loss of a section 987 QBU with respect to a section 988 transaction of the section 987 QBU, the amounts required under section 988 and the regulations thereunder to be translated on the [[Page 88871]] applicable booking date or payment date with respect to the section 988 transaction are translated into the owner's functional currency at the rate required under section 988 and the regulations thereunder. (ii) Specified owner functional currency transactions not treated as section 988 transactions. Transactions of a section 987 QBU described in sections 988(c)(1)(B)(i), 988(c)(1)(B)(ii), and 988(c)(1)(C) (including the acquisition of nonfunctional currency as described in Sec. 1.988-1(a)(1)), other than transactions described in paragraph (b)(4)(iii)(A) of this section, that are denominated in (or determined by reference to) the owner's functional currency (specified owner functional currency transactions) are not treated as section 988 transactions. Thus, no currency gain or loss is recognized by a section 987 QBU under section 988 with respect to such transactions. (iii) Determination of section 988 gain or loss for qualified short-term section 988 transactions--(A) Determination by reference to the section 987 QBU's functional currency for certain transactions subject to a mark-to-market method of accounting. Section 988 gain or loss with respect to section 988 transactions described in paragraph (b)(4)(iii)(B) of this section that are accounted for under a mark-to- market method of accounting for Federal income tax purposes or under the foreign currency mark-to-market method of accounting described in paragraph (b)(4)(iii)(C) of this section, and any hedges entered into to manage risk with respect to such transactions within the meaning of Sec. 1.1221-2(c)(4) (related hedges), must be determined in, and by reference to, the functional currency of the section 987 QBU (rather than the functional currency of its owner). (B) Qualified short-term section 988 transaction. A qualified short-term section 988 transaction is a section 988 transaction that occurs in the ordinary course of a section 987 QBU's business and has an original term of one year or less on the date the transaction is entered into by the section 987 QBU. The holding of currency that is nonfunctional currency (within the meaning of section 988(c)(1)(C)(ii)) to the section 987 QBU in the ordinary course of a section 987 QBU's trade or business also is treated as a qualified short-term section 988 transaction. Any transaction that is denominated in, or determined by reference to, a hyperinflationary currency, including the holding of hyperinflationary currency, is not considered a qualified short-term section 988 transaction. See Sec. Sec. 1.988-2(b)(15), 1.988-2(d)(5), and 1.988-2(e)(7) for rules relating to transactions denominated in, or determined by reference to, a hyperinflationary currency. (C) Election to use a foreign currency mark-to-market method of accounting. A taxpayer may elect under this paragraph (b)(4)(iii)(C) to apply the foreign currency mark-to-market method of accounting described in this paragraph for all qualified short-term section 988 transactions described in paragraph (b)(4)(iii)(B) of this section, and any related hedges, that are properly attributable to a section 987 QBU on or after the effective date of the election and that are not otherwise accounted for under a mark-to-market method of accounting under section 475 or section 1256. Under the foreign currency mark-to- market method of accounting, the timing of section 988 gain or loss on section 988 transactions is determined under the principles of section 1256(a)(1). Thus, only section 988 gain or loss is taken into account under the foreign currency mark-to-market method of accounting. Appropriate adjustments must be made to prevent the section 988 gain or loss from being taken into account again under section 988 or another provision of the Code or regulations. A section 988 transaction subject to this election is not subject to the ``netting rule'' of section 988(b) and Sec. 1.988-2(b)(8), under which exchange gain or loss is limited to overall gain or loss realized in a transaction, in taxable years prior to the taxable year in which section 988 gain or loss would be recognized with respect to such section 988 transaction but for this election. (iv) Examples. Examples 10 through 13 of paragraph (e) of this section illustrate the application of this paragraph (b)(4). (c)(1) through (c)(2)(i) [Reserved]. For further guidance, see Sec. 1.987-3(c)(1) through (c)(2)(i). (ii) Amount realized with respect to historic assets that are section 988 transactions. If the acquisition of a historic asset gave rise to a section 988 transaction described in paragraph (b)(4)(i) of this section, then in computing the total gain or loss on a disposition of the historic asset (some or all of which total gain or loss may be section 988 gain or loss described in section 988(b) and paragraph (b)(4)(i) of this section), the amount realized (determined, if necessary, under Sec. 1.987-3(b)(2)(i)) is translated into the owner's functional currency using the spot rate on the date such item is properly taken into account, subject to the limitation under Sec. 1.987-1T(c)(1)(ii)(B) regarding the use of a spot rate convention. (iii) through (iv) [Reserved]. For further guidance, see Sec. 1.987-3(c)(2)(iii) through (iv). (v) Translation of income to account for certain foreign income tax claimed as a credit. The owner of a section 987 QBU claiming a credit under section 901 for foreign income taxes, other than foreign income taxes deemed paid under section 902 or section 960, that are properly reflected on the books and records of the section 987 QBU (the creditable tax amount) must determine section 987 taxable income or loss attributable to the section 987 QBU by reducing the amount of section 987 taxable income or loss that otherwise would be determined under this section by an amount equal to the creditable tax amount, translated into U.S. dollars using the yearly average exchange rate for the taxable year in which the creditable tax is accrued, and by increasing the resulting amount by an amount equal to the creditable tax amount, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section 986(a). See Example 14 of paragraph (e) of this section,, for an illustration of this rule. (d) Election to translate all items at the yearly average exchange rate. Notwithstanding Sec. 1.987-3(c), a taxpayer that has made the annual deemed termination election described in Sec. 1.987-8T(d) may elect under this paragraph (d) to translate all items of income, gain, deduction, and loss with respect to a section 987 QBU determined under Sec. 1.987-3(b) in the functional currency of the section 987 QBU into the owner's functional currency, if necessary, at the yearly average exchange rate for the taxable year. Example 9 of paragraph (e) of this section illustrates the application of this election. (e) Example 1 through Example 8 [Reserved]. For further guidance, see Sec. 1.987-3(e), Example 1 through Example 8. Example 9. The facts are the same as in Example 7, except that U.S. Corp properly elects under paragraph (d) of this section to translate all items of income, gain, deduction, and loss with respect to Business A at the yearly average exchange rate. Accordingly, Business A's [euro]2,000 gain on the sale of the land is translated at the yearly average exchange rate for 2021 of [euro]1 = $1.05, and the amount of gain reported by U.S. Corp on the sale of the land is $2,100. Example 10. Business A acquires [pound]100 on August 27, 2021, for [euro]120 and sells the pounds on November 17, 2021, for [euro]125. The dollar-pound spot rate (without the use of a spot rate convention) is [pound]1 = $1 on August [[Page 88872]] 27, 2021, and [pound]1 = $1.10 on November 17, 2021. The disposition of the pounds is a section 988 transaction of Business A under paragraph (b)(4)(i) of this section, and the pounds are a historic asset under Sec. 1.987-1(e). Section 988 gain or loss with respect to the disposition of the pounds is determined under paragraph (b)(4)(i) of this section and Sec. 1.988-2(a)(2) by reference to the dollar functional currency of Business A's owner. The dollar amount realized for the pounds is determined under paragraph (c)(2)(ii) of this section by translating [pound]100 into $110 using the dollar-pound spot rate on November 17, 2021, without the use of a spot rate convention. The dollar basis in the pounds is determined under Sec. 1.987-3(c)(2)(i) by translating [pound]100 into $100 using the historic rate described in Sec. 1.987-1T(c)(3)(i)(E), which is the dollar-pound spot rate on August 27, 2021, without the use of a spot rate convention. Thus, U.S. Corp takes into account $10 of section 988 gain with respect to Business A's disposition of [pound]100. Example 11. (i) Business A purchases a [pound]100 2-year note for [euro]75 on October 1, 2021, and receives a [pound]100 repayment of principal with respect to the note on December 31, 2021. At the spot rates on October 1, 2021 (as defined in Sec. 1.987-1(c)(1)), without the use of a spot rate convention, Business A's [euro]75 purchase price translates into [pound]80 and $95. At the spot rates on December 31, 2021, without the use of a spot rate convention, the [pound]100 principal amount on the note translates into [euro]90 and $130, and [pound]80 translates into $104. (ii) The acquisition of the note is a section 988 transaction of Business A under paragraph (b)(4)(i) of this section, and the note is a historic asset under Sec. 1.987-1(e). To determine its section 987 taxable income or loss with respect to Business A, U.S. Corp must determine Business A's total gain or loss on the disposition of the note in U.S. Corp's dollar functional currency. Consistent with Sec. 1.988-2(b)(8), U.S. Corp also must determine whether some or all of that gain or loss constitutes section 987 gain or loss described in section 988(b). (iii) To determine Business A's total gain or loss on the disposition of the note, Business A's basis and amount realized on the note must be determined in euros under Sec. 1.987-3(b), if necessary, and translated into dollars under Sec. 1.987-3(c). Business A has a [euro]75 basis in the note that is translated into $95 under Sec. 1.987-3(c)(2)(i) at the historic rate described in Sec. 1.987-1T(c)(3)(i)(E), which is the spot rate on the date the note was acquired without the use of a spot rate convention. Business A's [pound]100 amount realized on the note is translated into [euro]90 under Sec. 1.987-3(b)(2)(i) using the spot rate on December 31, 2021, without the use of a spot rate convention. That [euro]90 amount realized is then translated into $130 under paragraph (c)(2)(ii) of this section using the spot rate on December 31, 2021, without the use of a spot rate convention. Accordingly, the total gain with respect to the disposition of the note that is included in section 987 taxable income is $35 ($130 less $95). (iv) U.S. Corp must determine whether some or all of the $35 total gain with respect to the note constitutes section 988 gain. The amount of section 988 gain realized with respect to the note is determined under Sec. 1.988-2(b)(5), which requires a comparison of the functional currency value of the principal amount of the note on the booking date and payment date spot rates, respectively, and defines the principal amount of the note as Business A's purchase price in units of nonfunctional currency, which is [pound]80. Under paragraph (b)(4)(i) of this section, section 988 gain or loss with respect to the note is determined by reference to U.S. Corp's dollar functional currency, such that the amounts required under section 988 to be translated on the booking date and payment date are translated into the dollars at the booking date and payment date spot rates. Accordingly, Business A's [pound]80 principal amount with respect to the note is translated at the booking date and payment date spots rates into $95 and $104, respectively. Thus, $9 ($104 less $95) of the $35 total gain taken into account by U.S. Corp as section 987 taxable income with respect to the note is section 988 gain. The remaining $26 of gain, which may be attributable to credit risk or another factor unrelated to currency fluctuations, is sourced and characterized without regard to section 988. Example 12. The facts are the same as in Example 11, except that Business A is owned by a foreign corporation with a pound functional currency. Under paragraph (b)(4)(ii) of this section, the acquisition of the [pound]100 2-year note is a specified owner functional currency transaction that is not treated as a section 988 transaction of Business A. Because the note is a historic asset under Sec. 1.987-1(e), Business A's [euro]75 basis in the note translates into [pound]80 at the historic rate described in Sec. 1.987-1T(c)(3)(i)(E), which provides that the historic rate is the spot rate for the date the note was acquired without the use of a spot rate convention. (If, instead, Business A had purchased the 5- year note for [pound]80 rather than [euro]75, then pursuant to paragraph (b)(2)(ii) of this section, Business A's basis in the note would have been determined without translating the [pound]80 purchase price because it is denominated in the owner's functional currency.) Under paragraph (b)(2)(ii) of this section, the [pound]100 amount realized with respect to the note is not translated because it is denominated in the owner's functional currency. Thus, the owner takes into account [pound]20 ([pound]100 less [pound]80) of section 987 taxable income in 2021 with respect to the note. Example 13. (i) Business A receives and accrues $100 of income from the provision of services on January 1, 2021. Business A continues to hold the $100 as a U.S. dollar-denominated demand deposit at a bank on December 31, 2021. U.S. Corp has elected under paragraph (b)(4)(iii)(C) of this section to use the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions entered into by Business A. The euro-dollar spot rate without the use of a spot rate convention is [euro]1 = $1 on January 1, 2021, and [euro]1 = $2 on December 31, 2021, and the yearly average exchange rate for 2021 is [euro]1 = $1.50. (ii) Under Sec. 1.987-3(b)(2)(i), the $100 earned by Business A is translated into [euro]100 at the spot rate on January 1, 2021, as defined in Sec. 1.987-1(c)(1) without the use of a spot rate convention. In determining U.S. Corp's taxable income, the [euro]100 of service income is translated into $150 at the yearly average exchange rate for 2021, as provided in Sec. 1.987-3(c)(1). (iii) The $100 demand deposit constitutes a qualified short-term section 988 transaction under paragraph (b)(4)(iii)(B) of this section because the demand deposit is treated as nonfunctional currency within the meaning of section 988(c)(1)(C)(ii). Because Business A uses the foreign currency mark-to-market method of accounting for qualified short-term section 988 transactions, under paragraph (b)(4)(iii)(A) of this section, section 988 gain or loss for such transactions is determined in, and by reference to, euros, the functional currency of Business A. Accordingly, section 988 gain or loss must be determined on Business A's holding of the $100 demand deposit in, and by reference to, the euro. Under Sec. 1.988- 2(a)(2), Business A is treated as having an amount realized of [euro]50 when the $100 is marked to market at the end of 2021 under paragraph (b)(4)(iii)(C) of this section. Marking the dollars to market gives rise to a section 988 loss of [euro]50 ([euro]50 amount realized, less Business A's [euro]100 basis in the $100). In determining U.S. Corp's taxable income, that [euro]50 loss is translated into a $75 loss at the yearly average exchange rate for 2021, as provided in Sec. 1.987-3(c)(1). Example 14. (i) Facts. Business A earns [euro]100 of revenue from the provision of services and incurs [euro]30 of general expenses and [euro]10 of depreciation expense during 2021. Except as otherwise provided, U.S. Corp uses the yearly average exchange rate described in Sec. 1.987-1(c)(2) to translate items of income, gain, deduction, and loss of Business A. Business A is subject to income tax in Country X at a 25 percent rate. U.S. Corp claims a credit with respect to Business A's foreign income taxes and elects under section 986(a)(1)(D) to translate the foreign income taxes at the spot rate on the date the taxes were paid. The yearly average exchange rate for 2021 is [euro]1 = $1.50. The historic rate used to translate the depreciation expense is [euro]1 = $1.00. The spot rate on the date that Business A paid its foreign income taxes was [euro]1 = $1.60. (ii) Analysis. Because U.S. Corp has elected to translate foreign income taxes at the spot rate on the date such taxes were paid rather than at the yearly average exchange rate, U.S. Corp must make the adjustments described in paragraph (c)(2)(v) of this section. Accordingly, U.S. Corp determines its section 987 taxable income by reducing the section 987 taxable income or loss that otherwise would be determined under this section by [euro]15, translated into U.S. dollars at the yearly average exchange rate ([euro]1 = $1.50), and increasing the resulting amount by [euro]15, translated using the same exchange rate that is used to translate the creditable taxes into U.S. dollars under section 986(a) ([euro]1 = $1.60). Following these adjustments, Business A's section 987 taxable income for 2021 is $96.50, computed as follows: [[Page 88873]] ---------------------------------------------------------------------------------------------------------------- Amount in Translation [euro] rate Amount in $ ---------------------------------------------------------------------------------------------------------------- Revenue......................................................... [euro]100 [euro]1 = $150.00 $1.50 General Expenses................................................ (30) [euro]1 = (45.00) $1.50 Depreciation.................................................... (10) [euro]1 = (10.00) $1.00 ----------------------------------------------- Tentative section 987 taxable income............................ [euro]60 .............. $95.00 Adjustments under paragraph (c)(2)(v) of this section: Decrease by [euro]15 tax translated at yearly average .............. .............. ($22.50) exchange rate ([euro]1 = $1.50)............................ Increase by [euro]15 tax translated at spot rate on payment .............. .............. 24.00 date ([euro]1 = $1.60)..................................... ----------------------------------------------- Section 987 taxable income...................................... .............. .............. $96.50 ---------------------------------------------------------------------------------------------------------------- (f) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (g) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 9. Section 1.987-4 is amended by adding paragraphs (c)(2) and (f) to read as follows: Sec. 1.987-4 Determination of net unrecognized section 987 gain or loss of a section 987 QBU. * * * * * (c) * * * (2) [Reserved]. For further guidance, see Sec. 1.987-4T(c)(2). * * * * * (f) [Reserved]. For further guidance, see Sec. 1.987-4T(f). * * * * * 0 Par. 10. Section 1.987-4T is added to read as follows: Sec. 1.987-4T Determination of net unrecognized section 987 gain or loss of a section 987 QBU (temporary). (a) through (c)(1) [Reserved]. For further guidance, see Sec. 1.987-4(a) through (c)(1). (2) Coordination with Sec. 1.987-12T. For purposes of paragraph (c)(1) of this section, amounts taken into account under Sec. 1.987-5 are determined without regard to Sec. 1.987-12T. (d) through (e) [Reserved]. For further guidance, see Sec. 1.987- 4(d) through (e). (f) Combinations and separations--(1) Combinations. The net unrecognized section 987 gain or loss of a combined QBU (as defined in Sec. 1.987-2T(c)(9)(i)) for a taxable year is determined under Sec. 1.987-4(b) by taking into account the net accumulated unrecognized section 987 gain or loss of each combining QBU (as defined in Sec. 1.987-2T(c)(9)(i)) for all prior taxable years to which the regulations under section 987 apply, as determined under Sec. 1.987-4(c), and by treating the combining QBUs as having combined immediately prior to the beginning of the taxable year of combination. (2) Separations. The net unrecognized section 987 gain or loss of a separated QBU (as defined in Sec. 1.987-2T(c)(9)(iii)) for a taxable year is determined under Sec. 1.987-4(b) by taking into account the separated QBU's share of the net accumulated unrecognized section 987 gain or loss of the separating QBU (as defined in Sec. 1.987- 2T(c)(9)(iii)) for all prior taxable years to which the regulations under section 987 apply, as determined under Sec. 1.987-4(c), and by treating the separating QBU as having separated immediately prior to the beginning of the taxable year of separation. A separated QBU's share of the separating QBU's net accumulated unrecognized section 987 gain or loss for all such prior taxable years is determined by apportioning the separating QBU's net accumulated unrecognized section 987 gain or loss for all such prior taxable years to each separated QBU in proportion to the aggregate adjusted basis of the gross assets properly reflected on the books and records of each separated QBU immediately after the separation. For purposes of determining the owner functional currency net value of the separated QBUs on the last day of the taxable year preceding the taxable year of separation under Sec. 1.987-5(d)(1)(B) and (e), the balance sheets of the separated QBUs on that day will be deemed to reflect the assets and liabilities reflected on the balance sheet of the separating QBU on that day, apportioned between the separated QBUs in a reasonable manner that takes into account the assets and liabilities reflected on the balance sheets of the separated QBUs immediately after the separation. (3) Examples. The following examples illustrate the rules of paragraphs (f)(1) and (2) of this section. Example 1. Combination of two section 987 QBUs that have the same owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in France that constitutes a section 987 QBU (French QBU) that has the euro as its functional currency. French QBU has a net accumulated unrecognized section 987 loss from all prior taxable years to which the regulations under section 987 apply of $100. DC1 also owns Entity B, a DE. Entity B conducts a business in Germany that constitutes a section 987 QBU (German QBU) that has the euro as its functional currency. German QBU has a net accumulated unrecognized section 987 gain from all prior taxable years to which the regulations under section 987 apply of $110. During the taxable year, Entity A and Entity B merge under local law. As a result, the books and records of French QBU and German QBU are combined into a new single set of books and records. The combined entity has the euro as its functional currency. (ii) Analysis. Pursuant to Sec. 1.987-2T(c)(9)(i), French QBU and German QBU are combining QBUs, and their combination does not give rise to a transfer that is taken into account in determining the amount of a remittance (as defined in Sec. 1.987-5(c)). For purposes of computing net unrecognized section 987 gain or loss under Sec. 1.987-4 for the year of the combination, the combination is deemed to have occurred on the last day of the owner's prior taxable year, such that the owner functional currency net value of the combined section 987 QBU at the end of that taxable year described under Sec. 1.987-4(d)(1)(B) takes into account items reflected on the balance sheets of both French QBU and German QBU at that time. Additionally, any transactions between French QBU and German QBU occurring during the year of the merger will not result in transfers to or from a section 987 QBU. Pursuant to paragraph (f)(1) of this section, the combined QBU will have a net accumulated unrecognized section 987 gain from all prior taxable years of $10 (the $100 loss from French QBU plus the $110 gain from German QBU). Example 2. Separation of two section 987 QBUs that have the same owner. (i) Facts. DC1, a domestic corporation, owns Entity A, a DE. Entity A conducts a business in the Netherlands that constitutes a section 987 QBU (Dutch QBU) that has the euro as its functional currency. The business of Dutch QBU consists of manufacturing and selling bicycles and scooters and is recorded on a single set of books and records. On the last day of Year 1, the adjusted basis of the gross assets of Dutch QBU is [euro]1,000. In Year 2, the [[Page 88874]] net accumulated unrecognized section 987 loss of Dutch QBU from all prior taxable years is $200. During Year 2, Entity A separates the bicycle and scooter business such that each business begins to have its own books and records and to meet the definition of a section 987 QBU under Sec. 1.987-1(b)(2) (hereafter, ``bicycle QBU'' and ``scooter QBU''). There are no transfers between DC1 and Dutch QBU before the separation. After the separation, the aggregate adjusted basis of bicycle QBU's assets is [euro]600 and the aggregate adjusted basis of scooter QBU's assets is [euro]400. Each section 987 QBU continues to have the euro as its functional currency. (ii) Analysis. Pursuant to Sec. 1.987-2T(c)(9)(iii), bicycle QBU and scooter QBU are separated QBUs, and the separation of Dutch QBU, a separating QBU, does not give rise to a transfer taken into account in determining the amount of a remittance (as defined in Sec. 1.987-5(c)). For purposes of computing net unrecognized section 987 gain or loss under Sec. 1.987-4 for Year 2, the separation will be deemed to have occurred on the last day of the owner's prior taxable year, Year 1. Pursuant to paragraph (f)(2) of this section, bicycle QBU will have a net accumulated unrecognized section 987 loss of $120 ([euro]600/[euro]1,000 x $200), and scooter QBU will have a net accumulated unrecognized section 987 loss of $80 ([euro]400/[euro]1,000 x $200). (g) [Reserved]. For further guidance, see Sec. 1.987-4(g). (h) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (i) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 11. Section 1.987-6 is amended by adding paragraph (b)(4) to read as follows: Sec. 1.987-6 Character and source of section 987 gain or loss. * * * * * (b) * * * (4) [Reserved]. For further guidance, see Sec. 1.987-6T(b)(4). * * * * * 0 Par. 12. Section 1.987-6T is added to read as follows: Sec. 1.987-6T Character and source of section 987 gain or loss (temporary) (a) through (b)(3) [Reserved]. For further guidance, see Sec. 1.987-6(a) through (b)(3). (4) Source of section 987 gain or loss with respect to a dollar QBU. The source of section 987 gain or loss with respect to a dollar QBU (as defined in Sec. 1.987-1T(b)(6)(i)) for which the CFC owner has elected under Sec. 1.987-1T(b)(6)(iii) to apply section 987 is determined by reference to the residence of the CFC owner. This paragraph (b)(4) applies to any CFC that has made the election under Sec. 1.987-1T(b)(6)(iii), including a CFC described in Sec. 1.987- 1(b)(1)(ii). (c) [Reserved]. For further guidance, see Sec. 1.987-6(c). (d) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (e) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 13. Section 1.987-7 is amended by adding paragraph (b) to read as follows: Sec. 1.987-7 Section 987 aggregate partnerships. * * * * * (b) [Reserved]. For further guidance, see Sec. 1.987-7T(b). * * * * * 0 Par. 14. Section 1.987-7T is added to read as follows: Sec. 1.987-7T Section 987 aggregate partnerships (temporary). (a) [Reserved]. For further guidance, see Sec. 1.987-7(a). (b) Liquidation value percentage methodology--(1) In general. In any taxable year, a partner's share of each asset, including its basis in each asset, and the amount of each liability reflected under Sec. 1.987-2(b) on the books and records of an eligible QBU owned indirectly through a section 987 aggregate partnership is proportional to the partner's liquidation value percentage with respect to the aggregate partnership for that taxable year, as determined under paragraph (b)(2) of this section. (2) Liquidation value percentage--(i) In general. For purposes of this paragraph (b), a partner's liquidation value percentage is the ratio (expressed as a percentage) of the liquidation value of the partner's interest in the partnership to the aggregate liquidation value of all of the partners' interests in the partnership. The liquidation value of a partner's interest in a partnership is the amount of cash the partner would receive with respect to the interest if, immediately following the applicable determination date, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in Sec. 1.752-7), paid an unrelated third party to assume all of its Sec. 1.752-7 liabilities in a fully taxable transaction, and then liquidated. (ii) Determination date.--(A) In general. Except as provided in paragraph (b)(2)(ii)(B) of this section, the determination date is the date of the most recent event described in Sec. 1.704- 1(b)(2)(iv)(f)(5) or Sec. 1.704-1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether the capital accounts of the partners are adjusted under Sec. 1.704-1(b)(2)(iv)(f), or, if there has been no revaluation event, the date of the formation of the partnership. (B) Allocations not in accordance with liquidation value percentage. If a partnership agreement provides for the allocation of any item of income, gain, deduction, or loss from partnership property to a partner other than in accordance with the partner's liquidation value percentage, the determination date is the last day of the partner's taxable year, or, if the partner's section 987 QBU owned indirectly through a section 987 aggregate partnership terminates during the partner's taxable year, the date such section 987 QBU is terminated. (3) Example. The following example illustrates the rule of this paragraph (b). Example. (i) Facts. DC, a domestic corporation, owns all of the stock of FS, a controlled foreign corporation (as defined in section 957(a)) with the U.S. dollar as its functional currency. FS owns a capital and profits interest in FPRS, a foreign partnership. The remaining capital and profits interest in FPRS is owned by DC. FPRS is a section 987 aggregate partnership with the euro as its functional currency. The balance sheet of FPRS reflects one asset (Asset A) with a basis of [euro]60x and a fair market value of [euro]100x, another asset (Asset B) with a basis of [euro]100x and a fair market value of [euro]200x, and a liability (Liability) of [euro]50x. At the end of year 1, the liquidation value percentage, as determined under paragraph (b)(2) of this section, of DC with respect to FPRS is 75 percent, and the liquidation value percentage of FS with respect to FPRS is 25 percent. (ii) Result. Under Sec. 1.987-1(b)(4), DC and FS are each treated as indirectly owning an eligible QBU with a balance sheet that reflects their respective shares of any assets and liabilities of FPRS. Under paragraph (b)(1) of this section, DC and FS's shares of FPRS's assets and liabilities are determined in accordance with DC and FS's respective liquidation value percentages. Accordingly, because DC has a liquidation value percentage of 75 percent with respect to FPRS, [euro]75x of Asset A (with a [euro]45x basis), [euro]150x of Asset B (with a [euro]75x basis), and [[Page 88875]] [euro]37.50x of Liability will be attributed to the DC-FPRS QBU. Additionally, because FS has a liquidation value percentage of 25 percent with respect to FPRS, [euro]25x of Asset A (with a [euro]15x basis), [euro]50x of Asset B (with a [euro]25x basis), and [euro]12.50x of Liability will be attributed to the FS-FPRS QBU. (c) [Reserved]. For further guidance, see Sec. 1.987-7(c). (d) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (e) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 15. Section 1.987-8 is amended by adding paragraph (d) to read as follows: Sec. 1.987-8 Termination of a section 987 QBU. * * * * * (d) [Reserved]. For further guidance, see Sec. 1.987-8T(d). * * * * * 0 Par. 16. Section 1.987-8T is added to read as follows Sec. 1.987-8T Termination of a section 987 QBU (temporary). (a) through (c) [Reserved]. For further guidance, see Sec. 1.987- 8(a) through (c). (d) Annual deemed termination election. A taxpayer, including a taxpayer described in Sec. 1.987-1(b)(1)(ii) to which Sec. Sec. 1.987-1 through 1.987-11 generally do not apply, may elect under this paragraph (d) to deem all of the section 987 QBUs of which it is an owner to terminate on the last day of each taxable year for which the election is in effect. See Sec. 1.987-8(e) regarding the effect of such a deemed termination. The owner of a section 987 QBU that is deemed to terminate under this paragraph is treated as having transferred all of the assets and liabilities attributable to such section 987 QBU to a new section 987 QBU on the first day of the following taxable year. (e) through (f) [Reserved]. For further guidance, see Sec. 1.987- 8(e) through (f). (g) Effective/applicability date. This section applies to taxable years beginning on or after December 7, 2016. (h) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 17. Section 1.987-12 is added to read as follows: Sec. 1.987-12 Deferral of section 987 gain or loss. (a) through (h) [Reserved]. For further guidance, see Sec. 1.987- 12T(a) through (h). 0 Par. 18. Section 1.987-12T is added to read as follows: Sec. 1.987-12T Deferral of section 987 gain or loss (temporary). (a) In general--(1) Overview. This section provides rules that defer the recognition of section 987 gain or loss that, but for this section, would be recognized in connection with certain QBU terminations and certain other transactions involving partnerships. This paragraph (a) provides an overview of this section and describes the section's scope of application, including with respect to QBUs subject to section 987 but to which Sec. Sec. 1.987-1 through 1.987-11 generally do not apply. Paragraph (b) of this section describes the extent to which section 987 gain or loss is recognized under Sec. 1.987-5 or similar principles in the taxable year of a deferral event (as defined in paragraph (b)(2) of this section) with respect to a QBU. Paragraph (c) of this section describes the extent to which section 987 gain or loss that, as a result of paragraph (b), is not recognized under Sec. 1.987-5 or similar principles is recognized upon the occurrence of subsequent events. Paragraph (d) of this section describes the extent to which section 987 loss is recognized under Sec. 1.987-5 or similar principles in the taxable year of an outbound loss event (as defined in paragraph (d)(2) of this section) with respect to a QBU. Paragraph (e) of this section provides rules for determining the source and character of gains and losses that, as a result of this section, are not recognized under Sec. 1.987-5 or similar principles in the taxable year of a deferral event or outbound loss event. Paragraph (f) of this section defines controlled group and qualified successor for purposes of this section. Paragraph (g) of this section provides an anti-abuse rule. Paragraph (h) of this section provides examples illustrating the rules described in this section. (2) Scope. This section applies to any foreign currency gain or loss realized under section 987(3), including foreign currency gain or loss of an entity described in Sec. 1.987-1(b)(1)(ii). References in this section to section 987 gain or loss refer to any foreign currency gain or loss realized under section 987(3), references to a section 987 QBU refer to any eligible QBU (as defined in Sec. 1.987-1(b)(3)(i), but without regard to Sec. 1.987-1(b)(3)(ii)) that is subject to section 987, and references to a section 987 aggregate partnership refer to any partnership for which the acquisition or disposition of a partnership interest could give rise to foreign currency gain or loss realized under section 987(3). Additionally, references to recognition of section 987 gain or loss under Sec. 1.987-5 encompass any determination and recognition of gain or loss under section 987(3) that would occur but for this section. Accordingly, the principles of this section apply to a QBU subject to section 987 regardless of whether the QBU otherwise is subject to Sec. Sec. 1.987-1 through 1.987-11. An owner of a QBU that is not subject to Sec. 1.987-5 must adapt the rules set forth in this section as necessary to recognize section 987 gains or losses that are subject to this section consistent with the principles of this section. (3) Exceptions--(i) Annual deemed termination elections. This section does not apply to section 987 gain or loss of a section 987 QBU with respect to which the annual deemed termination election described in Sec. 1.987-8T(d) is in effect. (ii) De minimis exception. This section does not apply to a section 987 QBU for a taxable year if the net unrecognized section 987 gain or loss of the section 987 QBU that, as a result of this section, would not be recognized under Sec. 1.987-5 in the taxable year does not exceed $5 million. (b) Gain and loss recognition in connection with a deferral event-- (1) In general. Notwithstanding Sec. 1.987-5, the owner of a section 987 QBU with respect to which a deferral event occurs (a deferral QBU) includes in taxable income section 987 gain or loss in connection with the deferral event only to the extent provided in paragraphs (b)(3) and (c) of this section. However, if the deferral event also constitutes an outbound loss event described in paragraph (d) of this section, the amount of loss recognized by the owner may be further limited under that paragraph. (2) Deferral event--(i) In general. A deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy the conditions described in paragraphs (b)(2)(ii) and (b)(2)(iii) of this section. (ii) Transactions. The transaction or series of transactions include either: (A) A termination of the section 987 QBU other than any of the following terminations: a termination described in Sec. 1.987-8(b)(3), a termination described in Sec. 1.987-8(c), or a termination described solely in Sec. 1.987-8(b)(1); or (B) A disposition of part of an interest in a section 987 aggregate partnership or DE through which the section 987 QBU is owned or any contribution by another [[Page 88876]] person to such a partnership or DE of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the contribution gives rise to a deemed transfer from the section 987 QBU to the owner. (iii) Assets on books of successor QBU. Immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor QBU (as defined in paragraph (b)(4) of this section). (3) Gain or loss recognized under Sec. 1.987-5 in the taxable year of a deferral event. In the taxable year of a deferral event with respect to a deferral QBU, the owner of the deferral QBU recognizes section 987 gain or loss as determined under Sec. 1.987-5, except that, solely for purposes of applying Sec. 1.987-5, all assets and liabilities of the deferral QBU that, immediately after the deferral event, are reflected on the books and records of a successor QBU are treated as not having been transferred and therefore as remaining on the books and records of the deferral QBU notwithstanding the deferral event. (4) Successor QBU. For purposes of this section, a section 987 QBU (potential successor QBU) is a successor QBU with respect to a section 987 QBU referred to in paragraph (b)(2)(ii) of this section if, immediately after the transaction or series of transactions described in that paragraph, the potential successor QBU satisfies all of the conditions described in paragraphs (b)(4)(i) through (b)(4)(iii) of this section. (i) The books and records of the potential successor QBU reflect assets that, immediately before the transaction or series of transactions described in paragraph (b)(2)(ii) of this section, were reflected on the books and records of the section 987 QBU referred to in that paragraph. (ii) The owner of the potential successor QBU and the owner of the section 987 QBU referred to in paragraph (b)(2)(ii) of this section immediately before the transaction or series of transactions described in that paragraph are members of the same controlled group. (iii) In the case of a section 987 QBU referred to in paragraph (b)(2)(ii)(A) of this section, if the owner of the section 987 QBU immediately before the transaction or series of transactions described in that paragraph was a U.S. person, the potential successor QBU is owned by a U.S. person. (c) Recognition of deferred section 987 gain or loss in the taxable year of a deferral event and in subsequent taxable years--(1) In general--(i) Deferred section 987 gain or loss. A deferral QBU owner (as defined in paragraph (c)(1)(ii) of this section) recognizes section 987 gain or loss attributable to the deferral QBU that, as a result of paragraph (b) of this section, is not recognized in the taxable year of the deferral event under Sec. 1.987-5 (deferred section 987 gain or loss) in the taxable year of the deferral event and in subsequent taxable years as provided in paragraphs (c)(2) through (4) of this section. (ii) Deferral QBU owner. For purposes of this paragraph (c), a deferral QBU owner means, with respect to a deferral QBU, the owner of the deferral QBU immediately before the deferral event, or the owner's qualified successor. (2) Recognition upon a subsequent remittance--(i) In general. Except as provided in paragraph (c)(3) of this section, a deferral QBU owner recognizes deferred section 987 gain or loss in the taxable year of the deferral event and in subsequent taxable years upon a remittance from a successor QBU to the owner of the successor QBU (successor QBU owner) in the amount described in paragraph (c)(2)(ii) of this section. (ii) Amount. The amount of deferred section 987 gain or loss that is recognized pursuant to this paragraph (c)(2) in a taxable year of the deferral QBU owner is the outstanding deferred section 987 gain or loss (that is, the amount of deferred section 987 gain or loss not previously recognized) multiplied by the remittance proportion of the successor QBU owner with respect to the successor QBU for the taxable year ending with or within the taxable year of the deferral QBU owner, as determined under Sec. 1.987-5(b) (and, to the extent relevant, paragraphs (b) and (c)(2)(iii) of this section) without regard to any election under Sec. 1.987-8T(d). For purposes of computing this remittance proportion, multiple successor QBUs of the same deferral QBU are treated as a single successor QBU. (iii) Deemed remittance when a successor QBU ceases to be owned by a member of the deferral QBU owner's controlled group. For purposes of this paragraph (c)(2), in a taxable year of the deferral QBU owner in which a successor QBU ceases to be owned by a member of a controlled group that includes the deferral QBU owner, the successor QBU owner is treated as having a remittance proportion of 1. Accordingly, if there is only one successor QBU with respect to a deferral QBU and that successor QBU ceases to be owned by a member of the controlled group that includes the deferral QBU owner, all outstanding deferred section 987 gain or loss with respect to that deferral QBU will be recognized. This paragraph (c)(2)(iii) does not affect the application of Sec. Sec. 1.987-1 through 1.987-11 to the successor QBU owner with respect to its ownership of the successor QBU. (3) Recognition of deferred section 987 loss in certain outbound successor QBU terminations. Notwithstanding paragraph (c)(2) of this section, if assets of the successor QBU (transferred assets) are transferred (or deemed transferred) in a transaction that would constitute an outbound loss event if the successor QBU had a net accumulated section 987 loss at the time of the exchange, then the deferral QBU owner recognizes outstanding deferred section 987 loss, if any, to the extent it would recognize loss under paragraph (d)(1) of this section if (i) the deferral QBU owner owned the successor QBU, (ii) the deferral QBU owner had net unrecognized section 987 loss with respect to the successor QBU equal to its outstanding deferred section 987 loss with respect to the deferral QBU, and (iii) the transferred assets were transferred (or deemed transferred) in an outbound loss event. Any outstanding deferred section 987 loss with respect to the deferral QBU that is not recognized as a result of the preceding sentence is recognized by the deferral QBU owner in the first taxable year in which the deferral QBU owner (including any qualified successor) ceases to be a member of a controlled group that includes the acquirer of the transferred assets or any qualified successor of such acquirer. (4) Special rules regarding successor QBUs--(i) Successor QBU with respect to a deferral QBU that is a successor QBU. If a section 987 QBU is a successor QBU with respect to a deferral QBU that is a successor QBU with respect to another deferral QBU, the first-mentioned section 987 QBU is considered a successor QBU with respect to the second- mentioned deferral QBU. For example, if QBU A is a successor QBU with respect to QBU B, and QBU B is a successor QBU with respect to QBU C, then QBU A is a successor QBU with respect to QBU C. (ii) Separation of a successor QBU. If a successor QBU with respect to a deferral QBU separates into two or more separated QBUs (as defined in Sec. 1.987-2T(c)(9)(iii)), each separated QBU is considered a successor QBU with respect to the deferral QBU. (iii) Combination of a successor QBU. If a successor QBU with respect to a deferral QBU combines with another [[Page 88877]] section 987 QBU of the same owner, resulting in a combined QBU (as defined in Sec. 1.987-2T(c)(9)(i)), the combined QBU is considered a successor QBU with respect to the deferral QBU. (d) Loss recognition upon an outbound loss event--(1) In general. Notwithstanding Sec. 1.987-5, the owner of a section 987 QBU with respect to which an outbound loss event occurs (an outbound loss QBU) includes in taxable income in the taxable year of an outbound loss event section 987 loss with respect to that section 987 QBU only to the extent provided in paragraph (d)(3) of this section. (2) Outbound loss event. An outbound loss event means, with respect to a section 987 QBU: (i) Any termination of the section 987 QBU in connection with a transfer by a U.S. person of assets of the section 987 QBU to a foreign person that is a member of the same controlled group as the U.S. transferor immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction (related foreign person), provided that the termination would result in the recognition of section 987 loss with respect to the section 987 QBU under Sec. 1.987-5 and paragraph (b) of this section but for this paragraph (d); (ii) Any transfer by a U.S. person of part of an interest in a section 987 aggregate partnership or DE through which the U.S. person owns the section 987 QBU to a related foreign person that has the same functional currency as the section 987 QBU, or any contribution by such a related foreign person to such a partnership or DE of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the transfer would result in the recognition of section 987 loss with respect to the section 987 QBU under Sec. 1.987-5 and paragraph (b) of this section but for this paragraph (d). (3) Loss recognized upon an outbound loss event. In the taxable year of an outbound loss event with respect to an outbound loss QBU, the owner of the outbound loss QBU recognizes section 987 loss as determined under Sec. 1.987-5 and paragraphs (b) and (c) of this section, except that, solely for purposes of applying Sec. 1.987-5, the following assets and liabilities of the outbound loss QBU are treated as not having been transferred and therefore as remaining on the books and records of the outbound loss QBU notwithstanding the outbound loss event: (i) In the case of an outbound loss event described in paragraph (d)(2)(i) of this section, assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the related foreign person described in that paragraph or of a section 987 QBU owned by such related foreign person; and (ii) In the case of an outbound loss event described in paragraph (d)(2)(ii) of this section, assets and liabilities that, immediately after the outbound loss event, are reflected on the books and records of the eligible QBU from which the assets and liabilities of the outbound loss QBU are allocated and not on the books and records of a section 987 QBU. (4) Adjustment of basis of stock received in certain nonrecognition transactions. If an outbound loss event results from the transfer of assets of the outbound loss QBU in a transaction described in section 351 or section 361, the basis of the stock that is received in the transaction is increased by an amount equal to the section 987 loss that, as a result of this paragraph (d), is not recognized with respect to the outbound loss QBU in the taxable year of the outbound loss event (outbound section 987 loss). (5) Recognition of outbound section 987 loss that is not converted into stock basis. Outbound section 987 loss attributable to an outbound loss event that is not described in paragraph (d)(4) of this section is recognized by the owner of the outbound loss QBU in the first taxable year in which the owner or any qualified successor of the owner ceases to be a member of a controlled group that includes the related foreign person referred to in paragraph (d)(2)(i) or (ii) of this section, or any qualified successor of such person. (e) Source and character--(1) Deferred section 987 gain or loss and certain outbound section 987 loss. The source and character of deferred section 987 gain or loss recognized pursuant to paragraph (c) of this section, and of outbound section 987 loss recognized pursuant to paragraph (d)(5) of this section, is determined under Sec. 1.987-6 as if such deferred section 987 gain or loss were recognized pursuant to Sec. 1.987-5 without regard to this section on the date of the related deferral event or outbound loss event. (2) Outbound section 987 loss reflected in stock basis. If loss is recognized on the sale or exchange of stock described in paragraph (d)(4) of this section within two years of the outbound loss event described in that paragraph, then, to the extent of the outbound section 987 loss, the source and character of the loss recognized on the sale or exchange is determined under Sec. 1.987-6 as if such loss were section 987 loss recognized pursuant to Sec. 1.987-5 without regard to this section on the date of the outbound loss event. (f) Definitions--(1) Controlled group. For purposes of this section, a controlled group means all persons with the relationships to each other specified in sections 267(b) or 707(b). (2) Qualified successor. For purposes of this section, a qualified successor with respect to a corporation (transferor corporation) means another corporation (acquiring corporation) that acquires the assets of the transferor corporation in a transaction described in section 381(a), but only if (A) the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or (B) the acquiring corporation is a controlled foreign corporation (as defined in section 957(a)) (CFC) and the transferor corporation was a CFC. A qualified successor of a corporation includes the qualified successor of a qualified successor of the corporation. (g) Anti-abuse. No section 987 loss is recognized under Sec. 1.987-5 or this section in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section. (h) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the stock of DC2, which is also a domestic corporation, and CFC1 and CFC2 are CFCs. In addition, DC1, DC2, CFC1, and CFC2 are members of a controlled group as defined in paragraph (f)(1) of this section, and the de minimis rule of paragraph (a)(3)(ii) of this section is not applicable. Finally, except as otherwise provided, Business A is a section 987 QBU with the euro as its functional currency, there are no transfers between Business A and its owner, and Business A's assets are not depreciable or amortizable. Example 1. Contribution of a section 987 QBU to a member of the controlled group. (i) Facts. DC1 owns all of the interests in Business A. The balance sheet of Business A reflects assets with an aggregate adjusted basis of [euro]1,000x and no liabilities. DC1 contributes [euro]900x of Business A's assets to DC2 in an exchange to which section 351 applies. Immediately after the contribution, the remaining [euro]100x of Business A's assets are no longer reflected on the books and records of a section 987 QBU. DC2, which has the U.S. dollar as its functional currency, uses the former Business A assets in a business (Business B) that constitutes a section 987 QBU. At the time of the contribution, Business A has net accumulated unrecognized section 987 gain of $100x. (ii) Analysis. (A) Under Sec. 1.987-2(c)(2)(ii), DC1's contribution of [euro]900x of Business A's [[Page 88878]] assets to DC2 is treated as a transfer of all of the assets of Business A to DC1, immediately followed by DC1's contribution of [euro]900x of Business A's assets to DC2. The contribution of Business A's assets is a deferral event within the meaning of paragraph (b)(2) of this section because: (1) The transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, resulting in a termination of Business A under Sec. 1.987-8(b)(2); and (2) immediately after the transaction, assets of Business A are reflected on the books and records of Business B, a section 987 QBU owned by a member of DC1's controlled group and a successor QBU within the meaning of paragraph (b)(4) of this section. Accordingly, Business A is a deferral QBU within the meaning of paragraph (b)(1) of this section, and DC1 is a deferral QBU owner of Business A within the meaning of paragraph (c)(1)(ii) of this section. (B) Under paragraph (b)(3) of this section, DC1's taxable income in the taxable year of the deferral event includes DC1's section 987 gain or loss determined with respect to Business A under Sec. 1.987-5, except that, for purposes of applying Sec. 1.987-5, all assets and liabilities of Business A that are reflected on the books and records of Business B immediately after Business A's termination are treated as not having been transferred and therefore as though they remained on Business A's books and records (notwithstanding the deemed transfer of those assets under Sec. 1.987-8(e)). Accordingly, in the taxable year of the deferral event, DC1 is treated as making a remittance of [euro]100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the [euro]100x remittance by the sum of the remittance and the [euro]900x aggregate adjusted basis of the gross assets deemed to remain on Business A's books at the end of the year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year of the deferral event. DC1's deferred section 987 gain equals $90x, which is the amount of section 987 gain that, but for the application of paragraph (b) of this section, DC1 would have recognized under Sec. 1.987-5 ($100x), less the amount of section 987 gain recognized by DC1 under Sec. 1.987-5 and this section ($10x). Example 2. Election to be classified as a corporation. (i) Facts. DC1 owns all of the interests in Entity A, a DE. Entity A conducts Business A, which has net accumulated unrecognized section 987 gain of $500x. Entity A elects to be classified as a corporation under Sec. 301.7701-3(a). As a result of the election and pursuant to Sec. 301.7701-3(g)(1)(iv), DC1 is treated as contributing all of the assets and liabilities of Business A to newly-formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1's balance sheet. (ii) Analysis. Under Sec. 1.987-2(c)(2)(ii), DC1's contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1's contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, the Business A QBU terminates under Sec. 1.987-8(b)(2). The contribution of Business A's assets is not a deferral event within the meaning of paragraph (b)(2) of this section because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor QBU within the meaning of paragraph (b)(4) of this section due to the fact that the assets of Business A are not reflected on a section 987 QBU immediately after the termination as well as the fact that the requirement of paragraph (b)(4)(iii) of this section is not met. Accordingly, DC1 recognizes section 987 gain with respect to Business A under Sec. 1.987-5 without regard to this section. Because the requirement of paragraph (b)(4)(iii) of this section is not met, the result would be the same even if the assets of Business A were transferred in a section 351 exchange to an existing foreign corporation that had a different functional currency than Business A. Example 3. Outbound loss event. (i) Facts. The facts are the same as in Example 2, except that Business A has net accumulated unrecognized section 987 loss of $500x rather than net accumulated unrecognized section 987 gain of $500x. (ii) Analysis. (A) The analysis of the transactions under Sec. Sec. 1.987-2(c)(2)(ii), 1.987-8(b)(2), and paragraph (b) of this section is the same as in Example 2. However, the termination of Business A as a result of the transfer of the assets of Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a member of DC1's controlled group is an outbound loss event described in paragraph (d)(2) of this section. (B) Under paragraphs (d)(1) and (d)(3) of this section, in the taxable year of the outbound loss event, DC1 includes in taxable income section 987 loss recognized with respect to Business A as determined under Sec. 1.987-5, except that, for purposes of applying Sec. 1.987-5, all assets and liabilities of Business A that are reflected on the books and records of CFC1, a related foreign person described in paragraph (d)(2) of this section, are treated as not having been transferred. Accordingly, DC1's remittance proportion with respect to Business A is 0, and DC1 recognizes no section 987 loss with respect to Business A. DC1's outbound section 987 loss is $500x, which is the amount of section 987 loss that DC1 would have recognized under Sec. 1.987-5 ($500x) without regard to paragraph (d) of this section, less the amount of section 987 loss recognized by DC1 under paragraph (d)(3) of this section ($0). Under paragraph (d)(4) of this section, DC1 must increase its basis in its CFC1 shares by the amount of the outbound section 987 loss ($500x). Example 4. Conversion of a DE to a partnership. (i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A. On the last day of Year 1, DC1 sells 50 percent of its interest in Entity A to DC2 (the Entity A sale). (ii) Analysis. (A) For Federal income tax purposes, Entity A is converted to a partnership when DC2 purchases the 50 percent interest in Entity A. DC2's purchase is treated as the purchase of 50 percent of the assets of Entity A (that is, the assets of Business A), which, prior to the purchase, were treated as held directly by DC1 for Federal income tax purposes. Immediately after DC2's deemed purchase of 50 percent of Business A assets, DC1 and DC2 are treated as contributing their respective interests in Business A assets to a partnership. See Rev. Rul. 99-5 (1999-1 CB 434) (situation 1). These deemed transactions are not taken into account for purposes of this section, but the Entity A sale and resulting existence of a partnership have consequences under section 987 and this section, as described in paragraphs (ii)(B) through (D) of this Example 4. (B) Immediately after the Entity A sale, Entity A is a section 987 aggregate partnership within the meaning of Sec. 1.987-1(b)(5) because DC1 and DC2 own all the interests in partnership capital and profits, DC1 and DC2 are related within the meaning of section 267(b), and the partnership has an eligible QBU (Business A) that would be a section 987 QBU with respect to a partner if owned by the partner directly. As a result of the Entity A sale, 50 percent of the assets and liabilities of Business A ceased to be reflected on the books and records of DC1's Business A section 987 QBU. As a result, such assets and liabilities are treated as if they were transferred from DC1's Business A section 987 QBU to DC1. Additionally, following DC2's acquisition of 50 percent of the interest in Entity A, DC2 is allocated 50 percent of the assets and liabilities of Business A under Sec. Sec. 1.987-2(b), 1.987-7(a), and 1.987-7T(b). Because DC2 and Business A have different functional currencies, DC2's portion of the Business A assets and liabilities constitutes a section 987 QBU. Accordingly, 50 percent of the assets and liabilities of Business A are treated as transferred by DC2 to DC2's Business A section 987 QBU. (C) The Entity A sale is a deferral event described in paragraph (b)(2) of this section because: (1) The sale constitutes the disposition of part of an interest in a DE; and (2) immediately after the transaction, assets of DC1's Business A section 987 QBU are reflected on the books and records of DC1's Business A section 987 QBU and DC2's Business A section 987 QBU, each of which is a successor QBU with respect to DC1's Business A section 987 QBU within the meaning of paragraph (b)(4) of this section. Accordingly, DC1's Business A section 987 QBU is a deferral QBU within the meaning of paragraph (b)(1) of this section, and DC1 is a deferral QBU owner within the meaning of paragraph (c)(1)(ii) of this section. Under paragraph (b)(1) of this section, DC1 includes in taxable income section 987 gain or loss with respect to Business A in connection with the deferral event to the extent provided in paragraphs (b)(3) and (c) of this section. (D) Under paragraph (b) of this section, in the taxable year of the Entity A sale, DC1 includes in taxable income section 987 gain or loss with respect to Business A as determined under Sec. 1.987- 5, except that, for purposes of applying Sec. 1.987-5, all assets and liabilities of Business A that, immediately [[Page 88879]] after the Entity A sale, are reflected on the books and records of successor QBUs are treated as though they were not transferred and therefore as remaining on the books and records of DC1's Business A section 987 QBU notwithstanding the Entity A sale. Accordingly, DC1's remittance amount under Sec. 1.987-5 is $0, and DC1 recognizes no section 987 gain or loss with respect to Business A. Example 5. Partial recognition of deferred gain or loss. (i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A in Country X. During Year 1, DC1 contributes all of its interests in Entity A to DC2 in an exchange to which section 351 applies. At the time of the contribution, Business A has net accumulated unrecognized section 987 gain of $100x. After the contribution, Entity A continues to conduct business in Country X (Business B). In Year 3, as a result of a net transfer of property from Business B to DC2, DC2's remittance proportion with respect to Business B, as determined under Sec. 1.987-5, is 0.25. (ii) Analysis. (A) For the reasons described in Example 1, the contribution of Entity A by DC1 to DC2 results in a termination of Business A and a deferral event with respect to Business A, a deferral QBU; DC1 is a deferral QBU owner within the meaning of paragraph (c)(1)(ii) of this section; Business B is a successor QBU with respect to Business A; DC2 is a successor QBU owner; and the $100x of net accumulated unrecognized section 987 gain with respect to Business A becomes deferred section 987 gain as a result of the deferral event. (B) Under paragraph (c)(1) of this section, DC1 recognizes deferred section 987 gain with respect to Business A in accordance with paragraphs (c)(2) through (4) of this section. Under paragraph (c)(2)(i) of this section, DC1 recognizes deferred section 987 gain in Year 3 as a result of the remittance from Business B to DC2. Under paragraph (c)(2)(ii) of this section, the amount of deferred section 987 gain that DC1 recognizes is $25x, which is DC1's outstanding deferred section 987 gain or loss ($100x) with respect to Business A multiplied by the remittance proportion (0.25) of DC2 with respect to Business B for the taxable year as determined under Sec. 1.987-5(b). (i) Coordination with fresh start transition method--(1) In general. If a taxpayer is a deferral QBU owner, or is or was the owner of an outbound loss QBU, and the taxpayer is required under Sec. 1.987-10(a) to apply the fresh start transition method described in Sec. 1.987-10(b) to the deferral QBU or outbound loss QBU, or would have been so required if the taxpayer had owned the deferral QBU or outbound loss QBU on the transition date (as defined in Sec. 1.987- 11(c)), the adjustments described in paragraphs (i)(2) and (i)(3) of this section, as applicable, must be made on the transition date. (2) Adjustment to deferred section 987 gain or loss. The amount of any outstanding deferred section 987 gain or loss of a deferral QBU owner with respect to a deferral QBU described in paragraph (i)(1) of this section must be adjusted to equal the amount of outstanding deferred section 987 gain or loss that the deferral QBU owner would have had with respect to the deferral QBU on the transition date if, immediately before the deferral event, the deferral QBU had transitioned to the method prescribed by Sec. Sec. 1.987-1 through 1.987-10 pursuant to the fresh start transition method. (3) Adjustments in the case of an outbound loss event. The basis of any stock described in paragraph (d)(4) of this section that was received in connection with the transfer (or deemed transfer) of assets of an outbound loss QBU described in paragraph (i)(1) of this section and that is held on the transition date must be adjusted to equal the basis that such stock would have had on the transition date if, immediately prior to the outbound loss event, the outbound loss QBU had transitioned to the method prescribed by Sec. Sec. 1.987-1 through 1.987-10 pursuant to the fresh start transition method. If no such stock was received, the amount of any outbound section 987 loss with respect to the outbound loss QBU that may be recognized on or after the transition date pursuant to paragraph (d)(5) of this section must be adjusted to equal the amount of such loss that would be outstanding and that may be recognized pursuant to that paragraph if, immediately before the outbound loss event, the outbound loss QBU had transitioned to the method prescribed by Sec. Sec. 1.987-1 through 1.987-10 pursuant to the fresh start transition method. (j) Effective/applicability date--(1) In general. Except as described in paragraph (j)(2) of this section, this section applies to any deferral event or outbound loss event that occurs on or after January 6, 2017. (2) Exception. This section applies to any deferral event or outbound loss event that occurs on or after December 7, 2016, if such deferral event or outbound loss event is undertaken with a principal purpose of recognizing section 987 loss. (k) Expiration date. The applicability of this section expires December 6, 2019. 0 Par. 19. Section 1.988-0 is amended by revising the entry for Sec. 1.988-2(b)(16) and adding an entry for Sec. 1.988-2(i) to read as follows: Sec. 1.988-0 Taxation of gain or loss from a section 988 transaction; Table of contents. * * * * * Sec. 1.988-2 Recognition and computation of exchange gain or loss. * * * * * (b) * * * (16) [Reserved]. * * * * * (i) [Reserved]. 0 Par. 20. Section 1.988-1 is amended by adding paragraph (a)(3) to read as follows: Sec. 1.988-1 Certain definitions and special rules. * * * * * (a) * * * (3) [Reserved]. For further guidance, see Sec. 1.988-1T(a)(3). * * * * * 0 Par. 21. Section 1.988-1T is added to read as follows: Sec. 1.988-1T Certain definitions and special rules (temporary). (a)(1) through (a)(2) [Reserved]. For further guidance, see Sec. 1.988-1(a)(1) through (2). (3) Specified owner functional currency transactions of a section 987 QBU not treated as section 988 transactions. Specified owner functional currency transactions, as defined in Sec. 1.987- 3T(b)(4)(ii), held by a section 987 QBU are not treated as section 988 transactions. Thus, no currency gain or loss shall be recognized by a section 987 QBU under section 988 with respect to such transactions. (4) through (i) [Reserved]. For further guidance, see Sec. 1.988- 1(a)(4) through (i). (j) Effective/applicability date. This section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (k) Expiration date. The applicability of this section expires on December 6, 2019. 0 Par. 22. Section 1.988-2 is amended by revising paragraph (b)(16) and adding paragraph (i) to read as follows: Sec. 1.988-2 Recognition and computation of exchange gain or loss. * * * * * (b) * * * (16) [Reserved]. For further guidance, see Sec. 1.988-2T(b)(16). * * * * * (i) [Reserved]. For further guidance, see Sec. 1.988-2T(i). 0 Par. 23. Section 1.988-2T is added to read as follows: [[Page 88880]] Sec. 1.988-2T Recognition and computation of exchange gain or loss (temporary). (a) through (b)(15) [Reserved]. For further guidance, see Sec. 1.988-2(a) through (b)(15). (16) Deferral of loss on certain related-party debt instruments.-- (i) Treatment of creditor. For rules applicable to a corporation included in a controlled group that is a creditor under a debt instrument see Sec. 1.267(f)-1(e). (ii) Treatment of debtor--(A) In general. Exchange loss realized under Sec. 1.988-2(b)(4) or (b)(6) is deferred if-- (1) The loss is realized by a debtor with respect to a loan from a person that has a relationship to the debtor described in section 267(b) or section 707(b); and (2) The transaction resulting in the realization of exchange loss has as a principal purpose the avoidance of Federal income tax. (B) Recognition of deferred loss. Any exchange loss that is deferred under paragraph (b)(16)(ii)(A) of this section is deferred until the end of the term of the loan, determined immediately prior to the transaction. (17) through (h) [Reserved]. For further guidance, see Sec. 1.988- 2(b)(17) through (h). (i) Special rules for section 988 transactions of a section 987 QBU. For rules regarding section 988 transactions of a section 987 QBU, see Sec. 1.987-3T(b)(4) for section 987 QBUs in general and Sec. 1.987-1T(b)(6) for dollar QBUs. (j) Effective/applicability date. Paragraph (b)(16) of this section applies to any exchange loss realized on or after December 7, 2016. Paragraph (i) of this section applies to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016. Notwithstanding the preceding sentence, if a taxpayer makes an election under Sec. 1.987-11(b), then paragraph (i) of this section applies to taxable years to which Sec. Sec. 1.987-1 through 1.987-10 apply as a result of such election. (k) Expiration date. The applicability of this section expires on December 6, 2019. John Dalrymple, Deputy Commissioner for Services and Enforcement. Approved: November 14, 2016. Mark J. Mazur, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2016-28380 Filed 12-7-16; 8:45 am] BILLING CODE 4830-01-P
![88854 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations
DEPARTMENT OF THE TREASURY 6T(d), 1.987–7T(d), 1.987–8T(g), 1.987– combinations and separations of section
12T(j), 1.988–1T(j), and 1.988–2T(j). 987 QBUs; (vi) rules regarding the
Internal Revenue Service FOR FURTHER INFORMATION CONTACT: translation of income used to pay
Steven D. Jensen at (202) 317–6938 (not creditable foreign income taxes; and
26 CFR Part 1 a toll-free number). (vii) rules regarding the allocation of
assets and liabilities of certain
SUPPLEMENTARY INFORMATION:
[TD 9795] partnerships for purposes of section
Paperwork Reduction Act 987. Finally, this document contains
RIN 1545–BL12 temporary regulations under section 988
These temporary regulations are being
issued without prior notice and public requiring the deferral of certain section
Recognition and Deferral of Section 988 loss that arises with respect to
987 Gain or Loss procedure pursuant to the
Administrative Procedure Act (5 U.S.C. related-party loans.
AGENCY: Internal Revenue Service (IRS), Section 987 generally provides that,
553). For this reason, the collection of
Treasury. when a taxpayer owns one or more
information contained in these
QBUs with a functional currency other
ACTION: Final and temporary regulations has been reviewed and,
than the U.S. dollar and such functional
regulations. pending receipt and evaluation of
currency is different than that of the
public comments, approved by the
SUMMARY: This document contains taxpayer, the taxable income or loss of
Office of Management and Budget under the taxpayer with respect to each such
temporary regulations under section 987 control number 1545–2265. Responses
of the Internal Revenue Code (Code) QBU is determined by computing the
to this collection of information are taxable income or loss of each QBU
relating to the recognition and deferral mandatory.
of foreign currency gain or loss under separately in its functional currency and
An agency may not conduct or translating such income or loss at the
section 987 with respect to a qualified sponsor, and a person is not required to
business unit (QBU) in connection with appropriate exchange rate. Section 987
respond to, a collection of information further requires the taxpayer to make
certain QBU terminations and certain unless the collection of information
other transactions involving ‘‘proper adjustments’’ (as prescribed by
displays a valid control number. the Secretary of the Treasury (the
partnerships. This document also For further information concerning
contains temporary regulations under Secretary)) for transfers of property
this collection of information, the between QBUs having different
section 987 providing: an annual accuracy of the estimated burden and
deemed termination election for a functional currencies, including by
suggestions for reducing this burden, treating post-1986 remittances from
section 987 QBU; an elective method, and where to submit comments on the
available to taxpayers that make the each such QBU as made on a pro rata
collection of information, please refer to basis out of post-1986 accumulated
annual deemed termination election, for the preamble to the cross-referencing
translating all items of income or loss earnings, by treating section 987 gain or
notice of proposed rulemaking loss as ordinary income or loss, and by
with respect to a section 987 QBU at the published in the Proposed Rules section
yearly average exchange rate; rules sourcing such gain or loss by reference
of this issue of the Federal Register. to the source of the income giving rise
regarding the treatment of section 988 Books and records relating to a
transactions of a section 987 QBU; rules to post-1986 accumulated earnings.
collection of information must be Section 989(c) directs the Secretary to
regarding QBUs with the U.S. dollar as retained as long as their contents may ‘‘prescribe such regulations as may be
their functional currency; rules become material in the administration necessary or appropriate to carry out the
regarding combinations and separations of any internal revenue law. Generally, purposes of [subpart J], including
of section 987 QBUs; rules regarding the tax returns and tax return information regulations . . . limiting the recognition
translation of income used to pay are confidential, as required by 26 of foreign currency loss on certain
creditable foreign income taxes; and U.S.C. 6103. remittances from qualified business
rules regarding the allocation of assets units . . . [and] providing for the
and liabilities of certain partnerships for Background
appropriate treatment of related party
purposes of section 987. Finally, this This document contains temporary transactions (including transactions
document contains temporary regulations under section 987 of the between qualified business units of the
regulations under section 988 requiring Code relating to the recognition and same taxpayer). . . .’’
the deferral of certain section 988 loss deferral of foreign currency gain or loss On September 6, 2006, the Treasury
that arises with respect to related-party under section 987 with respect to a QBU Department and the IRS issued
loans. The text of these temporary in connection with certain QBU proposed regulations under section 987
regulations also serves as the text of the terminations and certain other (REG–208270–86, 71 FR 52876) (the
proposed regulations set forth in the transactions involving partnerships. 2006 proposed regulations). The
Proposed Rules section in this issue of This document also contains temporary Treasury Department and the IRS
the Federal Register. In addition, in the regulations under section 987 providing received many written comments in
Rules and Regulations section of this (i) an annual deemed termination response to the 2006 proposed
issue of the Federal Register, final election for a section 987 QBU; (ii) an regulations and, after consideration of
regulations are being issued under elective method, available to taxpayers those comments, are issuing final
section 987 to provide general guidance that make the annual deemed regulations (TD 9794) under section 987
under section 987 regarding the termination election, for translating all (the final regulations) that are being
sradovich on DSK3GMQ082PROD with RULES4
determination of the taxable income or items of income or loss with respect to published contemporaneously with
loss of a taxpayer with respect to a QBU. a section 987 QBU at the yearly average these temporary regulations. These
DATES: Effective date. These regulations exchange rate; (iii) rules regarding the temporary regulations also reflect the
are effective on December 7, 2016. treatment of section 988 transactions of consideration of comments received on
Applicability date. For dates of a section 987 QBU; (iv) rules regarding the 2006 proposed regulations, as well
applicability, see §§ 1.987–1T(h), 1.987– QBUs with the U.S. dollar as their as other considerations described in this
2T(e), 1.987–3T(f), 1.987–4T(h), 1.987– functional currency; (v) rules regarding preamble.
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/1.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88855
Explanation of Provisions from qualified business units.’’ The consistent with the policies underlying
Treasury Department and the IRS have sections 267 and 367. In particular, this
1. Deferral of Section 987 Gain or Loss
determined that terminations of section rule is consistent with the policy of
on Certain Terminations and Other
987 QBUs generally should not be recognizing foreign currency gains and
Transactions Involving Partnerships not losses with respect to property
permitted to achieve the selective
A. Background recognition of losses when the assets transferred outbound in a
Under the final regulations, the owner and liabilities of the section 987 QBU nonrecognition transaction. See section
of a section 987 QBU that terminates are transferred to a related person and 367(a)(3)(B)(iii).
remain subject to section 987 in the In addition, the Treasury Department
includes in income all of the net
hands of the transferee, as in the case, and the IRS have determined that
unrecognized section 987 gain or loss
for example, of a section 351 transfer of selective recognition of losses should
with respect to the section 987 QBU in
a section 987 QBU within a not be permitted in the context of
the year it terminates. See §§ 1.987–
consolidated group. Similar policy certain outbound transfers even when
5(c)(3) and 1.987–8(e). Section 1.987–
considerations arise when the transfer of the assets do not remain subject to
8(b) and (c) describe the circumstances section 987 in the hands of the
in which a section 987 QBU terminates, a partnership interest to a related person
results in deemed transfers that cause transferee (because, for example, the
which include the transfer (or deemed transferee has the same functional
transfer) of substantially all of the assets the recognition of section 987 loss with
respect to a section 987 QBU owned currency as the QBU). Accordingly,
of the section 987 QBU and when the consistent with the principles of
section 987 QBU’s owner ceases to exist through the partnership,
notwithstanding that the trade or sections 267 and 367(a), the temporary
(except in connection with certain regulations also provide special rules to
liquidations or reorganizations business of the section 987 QBU
continues without interruption and prevent the selective recognition of
described in section 381(a)). Under section 987 losses in certain other
these rules, a termination can result remains subject to section 987. In order
to address these policy concerns, as transactions involving outbound
solely from a transfer of a section 987 transfers.
QBU between related parties or, when a described in greater detail in Part 1.C of
QBU is owned by an entity that is this Explanation of Provisions, the B. Scope of Application of § 1.987–12T
disregarded as an entity separate from temporary regulations defer section 987
Section 1.987–12T provides for the
its owner for Federal tax purposes (DE), losses resulting from certain termination
deferral of certain net unrecognized
from the deemed transfer that occurs events and partnership transactions in
section 987 gain or loss that otherwise
when an election is made to treat the DE which the assets and liabilities of the
would be recognized in connection with
as a corporation for Federal tax section 987 QBU remain within a single specified events under § 1.987–5, which
purposes, notwithstanding that the controlled group (defined as all persons governs the recognition of section 987
QBU’s assets continue to be used in the with the relationships to each other gain or loss by the owner of a section
same trade or business. described in sections 267(b) or 707(b)) 987 QBU to which the final regulations
The preamble to the 2006 proposed and remain subject to section 987. apply. In addition, because the policy
regulations requested comments The Treasury Department and the IRS concerns that motivate § 1.987–12T
regarding whether inbound liquidations also acknowledge, however, that part of exist regardless of whether section 987
under section 332 and inbound asset the rationale for deferring section 987 gain or loss is computed pursuant to the
reorganizations under section 368(a) losses—that is, the continuity of final regulations or some other
should result in terminations of section ownership of the section 987 QBU reasonable method, § 1.987–12T applies
987 QBUs. The preamble also requested within a single controlled group— to any foreign currency gain or loss
comments on the interaction of the rules applies equally to section 987 gains that realized under section 987(3), including
of § 1.1502–13 regarding intercompany otherwise would be triggered when foreign currency gain or loss realized
transactions with the 2006 proposed taxpayers transfer a section 987 QBU under section 987 with respect to a QBU
regulations, including whether section within a single controlled group. Thus, to which the final regulations generally
987 gain or loss resulting from the consistent with the recommendations of are not applicable. In order to achieve
transfer of assets and liabilities of a comments on the 2006 proposed this, the temporary regulations specify
section 987 QBU between members of regulations, the temporary regulations that references in § 1.987–12T to section
the same consolidated group in a generally apply to defer the recognition 987 gain or loss refer to any foreign
section 351 transaction should be of section 987 gains as well as losses currency gain or loss realized under
deferred under § 1.1502–13. Many when the transferee is subject to section section 987(3) and that references to a
comments recommended that such a 987 with respect to the assets of the section 987 QBU refer to any eligible
section 351 exchange should not trigger section 987 QBU. The Treasury QBU (as defined in § 1.987–1(b)(3)(i),
the recognition of section 987 gain or Department and the IRS have but without regard to § 1.987–1(b)(3)(ii))
loss. determined, however, that gain should that is subject to section 987.
Because a termination can result in not be deferred to the extent the assets Additionally, the temporary regulations
the deemed remittance of all the assets of a section 987 QBU are transferred by specify that references in § 1.987–12T to
of a section 987 QBU in circumstances a U.S. person to a related foreign person. the recognition of section 987 gain or
in which the assets continue to be used Since recognition of the deferred gain loss under § 1.987–5 encompass any
by a related person in the conduct of the generally would occur only as a result determination and recognition of gain or
same trade or business that formerly of remittances to the foreign owner, the loss under section 987(3) that would
sradovich on DSK3GMQ082PROD with RULES4
was conducted by the section 987 QBU, IRS could face administrative difficulty occur but for § 1.987–12T. Accordingly,
terminations can facilitate the selective in attempting to ensure that such the temporary regulations require an
recognition of section 987 losses. deferred gain is appropriately owner of a QBU that is not subject to
Section 989(c)(2) provides the Treasury recognized and not indefinitely § 1.987–5 to adapt the rules set forth in
Department and the IRS with authority deferred. Treating gains differently than § 1.987–12T to recognize section 987
to ‘‘limit[] the recognition of foreign losses in the context of transfers to gains or losses consistent with the
currency loss on certain remittances related foreign persons generally is principles of § 1.987–12T.
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/2.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88867
in § 1.987–7T(b) reflects an a debtor. The temporary regulations PART 1—INCOME TAXES
administrable approach to allocating correct the cross-reference in § 1.988–
assets and liabilities of a section 987 2(b)(16)(i) to refer to § 1.267(f)–1(e) ■ Paragraph 1. The authority citation
aggregate partnership to eligible QBUs rather than § 1.267(f)–1(h). for part 1 continues to read in part as
of its partners in a manner consistent The Treasury Department and the IRS follows:
with the partners’ economic interests in have determined that the policy Authority: 26 U.S.C. 985, 987, 989(c) and
the assets and liabilities of the considerations underlying section 7805 * * *
partnership. The Treasury Department 267(f)(3)(C) and § 1.267(f)–1(e) with ■ Par. 2. Section 1.987–0 is amended by
and the IRS request comments on the respect to creditors on loans to related adding entries for §§ 1.987–6(b)(4) and
application of the liquidation value persons also apply with respect to 1.987–12(a) through (h) to read as
percentage approach reflected in the debtors on such loans and that there is follows:
temporary regulations, including no reason to distinguish between a
whether any alternative measure could creditor and debtor with regard to the § 1.987–0 Section 987; table of contents.
better satisfy the criteria of application of an anti-avoidance rule to * * * * *
administrability and consistency with the same transaction. Accordingly,
the economics of the partners’ § 1.987–6 Character and source of section
pursuant to the authority granted to the 987 gain or loss.
arrangement. Secretary in section 989(c)(5) to
* * * * *
9. Deferral of Certain Section 988 Loss prescribe regulations providing for the
(b) * * *
Realized by a Debtor With Respect to a appropriate treatment of related-party (4) [Reserved].
Related-Party Loan transactions, § 1.988–2T(b)(16)(ii)
provides that exchange loss of a debtor * * * * *
Section 267(a)(1) provides that no
with respect to a loan (original loan) § 1.987–12 Deferral of section 987 gain or
deduction is allowed in respect of any
from a person with whom the debtor has loss.
loss from the sale or exchange of
a relationship described in section (a) through (h) [Reserved].
property, directly or indirectly, between
267(b) or section 707(b) is deferred if the ■ Par. 3. Section 1.987–1 is amended by
persons who have a relationship
transaction resulting in realization of adding paragraphs (b)(1)(iii), (b)(6),
described in section 267(b). Section
267(f)(2) modifies the general rule of the loss has a principal purpose of (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f),
section 267(a)(1) in the case of a sale or avoiding Federal income tax. Such (g)(2)(i)(B) and (C), and (g)(3)(i)(E)
exchange of property between deferred loss will be recognized at the through (H) to read as follows:
corporations that are members of the end of the term of the original loan.
§ 1.987–1 Scope, definitions, and special
same controlled group (as defined in Special Analyses rules.
section 267(f)(1)), generally providing
that a loss realized upon such a sale or Certain IRS regulations, including * * * * *
exchange is deferred until the property these, are exempt from the requirements (b) * * *
is transferred outside the group such of Executive Order 12866, as (1) * * *
supplemented and reaffirmed by (iii) [Reserved]. For further guidance,
that there would be recognition of loss
Executive Order 13563. Therefore, a see § 1.987–1T(b)(1)(iii).
under consolidated return principles.
Section 267(f)(3)(C) provides that, to the regulatory assessment is not required. * * * * *
extent provided in regulations, section For applicability of the Regulatory (b) * * *
267(a)(1) does not apply to any loss Flexibility Act (5 U.S.C. chapter 6), (6) [Reserved]. For further guidance,
sustained by a member of a controlled please refer to the Special Analyses see § 1.987–1T(b)(6).
group on the repayment of a loan made section in the preamble to the cross- * * * * *
to another member of such controlled referenced notice of proposed (c) * * *
group if such loan is payable or rulemaking in the Proposed Rules (1) * * *
denominated in a foreign currency and section of this issue of the Federal (ii) * * *
attributable to a reduction in the value Register. Pursuant to section 7805(f) of (B) [Reserved]. For further guidance,
of that foreign currency. Section the Internal Revenue Code, these see § 1.987–1T(c)(1)(ii)(B).
1.267(f)–1(e) provides that section regulations have been submitted to the * * * * *
267(a) generally does not apply to an Chief Counsel for Advocacy of the Small (c) * * *
exchange loss realized with respect to a Business Administration for comment (3) * * *
loan of nonfunctional currency to on their impact on small business. (i) * * *
another controlled group member if the (E) [Reserved]. For further guidance,
Drafting Information see § 1.987–1T(c)(3)(i)(E).
transaction that causes the realization of
the loss does not have as a significant The principal author of these * * * * *
purpose the avoidance of Federal regulations is Mark E. Erwin of the (d) * * *
income tax. Additionally, § 1.267(f)–1(h) Office of Associate Chief Counsel (3) [Reserved]. For further guidance,
provides that if a transaction is engaged (International). However, other see § 1.987–1T(d)(3).
in with a principal purpose to avoid the personnel from the IRS and the Treasury * * * * *
purposes of § 1.267(f)–1, including by Department participated in their (f) [Reserved]. For further guidance,
distorting the timing of losses, development. see § 1.987–1T(f).
adjustments may be made to carry out * * * * *
sradovich on DSK3GMQ082PROD with RULES4
List of Subjects in 26 CFR Part 1
such purposes. Section 1.988–2(b)(16)(i) (g) * * *
cross-references the regulations under Income taxes, Reporting and (2) * * *
section 267 regarding the coordination recordkeeping requirements. (i) * * *
of sections 267 and 988 with respect to (B) through (C) [Reserved]. For further
Amendment to the Regulations guidance, see § 1.987–1T(g)(2)(i)(B)
the treatment of a creditor under a debt
instrument, but § 1.988–2(b)(16)(ii) is Accordingly, 26 CFR part 1 is through (C).
reserved with respect to the treatment of amended as follows: * * * * *
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/14.svg)
![88868 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations
(g) * * * records of the owner of the dollar QBU, or loss with respect to a dollar QBU for
(3) * * * such that the amount of section 988 gain which the CFC owner has made the
(i) * * * or loss with respect to such item is election described in this paragraph.
(E) through (H) [Reserved]. For further determined by reference to the owner’s (b)(7) through (c)(1)(ii)(A) [Reserved].
guidance, see § 1.987–1T(g)(3)(i)(E) functional currency. For further guidance, see § 1.987–1(b)(7)
through (H). (B) Section 988 gain or loss through (c)(1)(ii)(A).
* * * * * characterized as effectively connected (B) Election inapplicable with respect
■ Par. 4. Section 1.987–1T is added to income. Solely for the purpose of to certain amounts. Except as provided
read as follows: determining the amount of section 988 in this paragraph (c)(1)(ii)(B), the
gain or loss of a CFC described in election provided in § 1.987–
§ 1.987–1T Scope, definitions, and special paragraph (b)(6)(ii)(A) of this section 1(c)(1)(ii)(A) does not apply for
rules (temporary). that is effectively connected with the purposes of determining section 987
(a) through (b)(1)(ii) [Reserved]. For conduct of a trade or business within taxable income or loss (as defined in
further guidance, see § 1.987–1(a) the United States (ECI), any section 988 § 1.987–3(a)) with respect to a historic
through (b)(1)(ii). gain or loss that would be determined item (as defined in § 1.987–1(e)) if
(iii) Certain provisions applicable to under section 988 as a result of the acquiring, accruing, or entering into
all taxpayers. Notwithstanding § 1.987– acquisition or accrual of any item and such item gives rise to a section 988
1(b)(1)(ii), paragraphs (b)(6) and treated as ECI under § 1.988–4(c) if the transaction or specified owner
(g)(3)(i)(E) of this section and § 1.987– item were treated as properly reflected functional currency transaction.
6T(b)(4) apply to any taxpayer that is an on the books and records of the dollar However, the election provided in
owner of a dollar QBU (as defined in QBU is determined by treating such § 1.987–1(c)(1)(ii)(A) does apply for
paragraph (b)(6) of this section), and item as properly reflected on the books purposes of determining section 987
paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of and records of the dollar QBU.
this section and §§ 1.987–8T(d) and taxable income or loss with respect to a
Consequently, solely for that purpose, payable or receivable described in
1.987–12T apply to any taxpayer that is such section 988 gain or loss is
an owner of an eligible QBU § 1.988–1(d)(3) under the circumstances
determined by reference to the U.S. described in § 1.988–1(d)(3).
(determined without regard to § 1.987– dollar.
1(b)(3)(ii)) that is subject to section 987. (c)(2) through (c)(3)(i)(D) [Reserved].
(iii) Election for a CFC to apply For further guidance, see § 1.987–1(c)(2)
(b)(2) through (b)(5) [Reserved]. For section 987 to a dollar QBU—(A) In
further guidance, see § 1.987–1(b)(2) through (c)(3)(i)(D).
general. A CFC that is the owner of a (E) Section 988 transactions and
through (b)(5). dollar QBU may elect to apply section
(6) Dollar QBUs—(i) In general. specified owner functional currency
987 and the regulations thereunder with transactions. If acquiring, accruing, or
Except as provided in paragraphs respect to the dollar QBU in lieu of
(b)(1)(iii) and (b)(6)(iii) of this section, entering into a historic item gives rise to
applying section 988 pursuant to
section 987 and the regulations a section 988 transaction of a section
paragraph (b)(6)(ii) of this section. If the
thereunder do not apply with respect to 987 QBU or a specified owner
dollar QBU or CFC is described in
an eligible QBU (determined without functional currency transaction
§ 1.987–1(b)(1)(ii), however, the CFC
regard to § 1.987–1(b)(3)(ii)) that has the described in § 1.987–3T(b)(4)(ii), the
must apply section 987 to the dollar
U.S. dollar as its functional currency historic rate is the spot rate (as defined
QBU using the method it applied to the
and that would be subject to section 987 in paragraph (c)(1) of this section) on
dollar QBU immediately prior to the
if it had a functional currency other the date such item is acquired, accrued,
effective date of this paragraph (b)(6) as
than the dollar (dollar QBU). This or entered into. For this purpose, use of
provided in paragraph (h) of this
paragraph (b)(6) applies to all taxpayers, section, provided such method was a a spot rate convention under § 1.987–
including entities described in § 1.987– reasonable interpretation of section 987, 1(c)(1)(ii) is permitted only with respect
1(b)(1)(ii). or, if no such method exists, a to a payable or receivable described in
(ii) Application of section 988 to a reasonable method. § 1.988–1(d)(3) and only to the extent
dollar QBU—(A) In general. Except as (B) Section 988 gain or loss provided therein.
provided in paragraphs (b)(6)(ii)(B) and characterized as effectively connected (c)(3)(ii) through (d)(2) [Reserved]. For
(b)(6)(iii) of this section, a controlled income. Solely for the purpose of further guidance, see § 1.987–1(c)(3)(ii)
foreign corporation (as defined in determining the amount of section 988 through (d)(2).
section 957(a)) (CFC) that is the owner gain or loss of a dollar QBU that is the (3) Gives rise to a qualified short-term
of a dollar QBU applies section 988 with subject of an election described in section 988 transaction (as defined in
respect to any item that is properly paragraph (b)(6)(iii)(A) of this section § 1.987–3T(b)(4)(iii)(B)) of the section
reflected on the books and records of the that is ECI, § 1.987–3T(b)(4)(i) and (ii) 987 QBU, whether denominated in the
dollar QBU and that would give rise to do not apply, and any section 988 gain functional currency of the owner or
a section 988 transaction if such item or loss that would be determined under other nonfunctional currency with
were acquired, accrued, or entered into section 988 as a result of the acquisition respect to the section 987 QBU, for
directly by the owner of the dollar QBU. or accrual of any item and treated as ECI which section 988 gain or loss is
Except as provided in paragraph under § 1.988–4(c) if the item were determined under § 1.987–
(b)(6)(ii)(B) of this section, for purposes treated as properly reflected on the 3T(b)(4)(iii)(A) in, and by reference to,
of determining the amount of section books and records of the dollar QBU is the functional currency of the section
988 gain or loss of the CFC, any item determined by treating such item as 987 QBU.
sradovich on DSK3GMQ082PROD with RULES4
that is properly reflected on the books properly reflected on the books and (e) [Reserved]. For further guidance,
and records of the dollar QBU and that records of the dollar QBU. see § 1.987–1(e).
would give rise to a section 988 Consequently, solely for that purpose, (f) Examples. The following examples
transaction if such item were acquired, such section 988 gain or loss is illustrate the application of § 1.987–1(d)
accrued, or entered into directly by the determined by reference to the U.S. and (e).
owner of the dollar QBU is treated as dollar. See § 1.987–6T(b)(4) for rules Example 1. U.S. Corp is a domestic
properly reflected on the books and regarding the source of section 987 gain corporation with the U.S. dollar as its
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/15.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88869
functional currency and is the owner of year beginning on or after the transition § 1.987–1T(b)(6)(iii) for a CFC to apply
Business A, a section 987 QBU that has the date (as defined in § 1.987–11(c)) in section 987 to a dollar QBU must be
pound as its functional currency. Assume all which the election is relevant or a titled ‘‘Section 987 Election for a CFC to
transactions of Business A are entered into in
subsequent taxable year in which the Apply Section 987 to a Dollar QBU
the ordinary course of its business. U.S. Corp
has not made an election under § 1.987– taxpayer’s controlled group aggregate Under § 1.987–1T(b)(6)(iii)’’ and must
3T(b)(4)(iii)(C) to adopt a foreign currency section 987 loss, if any, does not exceed provide the name and address of each
mark-to-market method of accounting for $5 million. For purposes of this QBU for which the election is being
qualified short-term section 988 transactions. paragraph (g)(2)(i)(B), a taxpayer’s made.
Items reflected on Business A’s balance sheet controlled group aggregate section 987 (F) Election to apply the foreign
include £10,000, $1,000, a building with a loss means the aggregate net amount of currency mark-to-market method of
basis of £100,000, a light general purpose section 987 loss that would be accounting for qualified short-term
truck with a basis of £30,000, a computer section 988 transactions. An election
recognized pursuant to the election by
with a basis of £1,000, a 60-day receivable for
¥15,000, an account payable of £5,000, and the taxpayer and all other persons to under § 1.987–3T(b)(4)(iii)(C) to apply
a foreign currency contract within the whom the taxpayer’s election would the foreign currency mark-to-market
meaning of section 1256(g)(2) that requires apply in the first taxable year of each method of accounting for qualified
Business A to exchange £100 for $125 in 90 person for which the election would short-term section 988 transactions must
days. Under paragraph (d) of this section, the apply. be titled ‘‘Section 987 Election to Use
£10,000, the £5,000 account payable and the (ii) Other taxpayers. Other taxpayers, Foreign Currency Mark-to-Market
£/$ section 1256 foreign currency contract including taxpayers described in Method of Accounting for Qualified
are marked items. The other items are § 1.987–1(b)(1)(ii) and taxpayers Short-Term Section 988 Transactions
historic items under this paragraph (e) of this described in § 1.987–10(c), must follow Under § 1.987–3(b)T(4)(iii)(C)’’ and
section.
Example 2. The facts are the same as
the election rules provided in paragraph must provide the name and address of
Example 1 except that U.S. Corp has elected (g)(2)(i)(B)(1)(i) of this section if any each section 987 QBU for which the
under § 1.987–3T(b)(4)(iii)(C) to adopt the related party is a fresh start taxpayer. If election is being made.
foreign currency mark-to-market method of no related party is a fresh start taxpayer, (G) Election to translate all items at
accounting for qualified short-term section the election under § 1.987–8T(d) may be the yearly average exchange rate. An
988 transactions of Business A. Under made only if the first taxable year for election under § 1.987–3T(d) to translate
paragraphs (d) and (e) of this section, the which the election would apply to the all items at the yearly average exchange
£10,000, the $1,000, the ¥15,000 receivable, taxpayer is either the first taxable year rate must be titled ‘‘Section 987 Election
the £5,000 account payable, and the £/$ beginning on or after December 7, 2016, to Translate All Items at the Yearly
section 1256 foreign currency contract are
in which the election is relevant or a Average Exchange Rate Under § 1.987–
marked items.
subsequent taxable year in which the 3T(d)’’ and must provide the name and
(g)(1) through (g)(2)(i)(A) [Reserved]. taxpayer’s controlled group aggregate address of each section 987 QBU for
For further guidance, see § 1.987–1(g)(1) section 987 loss, if any, does not exceed which the election is being made.
through (g)(2)(i)(A). $5 million. (H) Annual deemed termination
(B) Annual deemed termination (2) QBU-by-QBU elections in certain election. An election under § 1.987–
election—(1) In general. Except as circumstances. Notwithstanding 8T(d) for an owner to deem all of its
provided in paragraph (g)(2)(i)(B)(2) of paragraph (g)(2)(i)(B)(1) of this section, section 987 QBUs to terminate on the
this section, an election under § 1.987– a taxpayer may make a separate election last day of each taxable year must be
8T(d) (annual deemed termination under § 1.987–8T(d) with respect to any titled ‘‘Section 987 Annual Deemed
election) applies to all section 987 QBUs section 987 QBU owned by the taxpayer Termination Election Under § 1.987–
owned by the taxpayer, as well as to all if the first taxable year for which the 8T(d)’’ and must provide the name and
section 987 QBUs owned by any person election would apply to the taxpayer address of each section 987 QBU to
that has a relationship to the taxpayer with respect to the section 987 QBU is which the election applies, including a
described in section 267(b) or section a taxable year in which there is a section section 987 QBU owned by a related
707(b) (substituting ‘‘and the profits 987 gain recognized with respect to the person (within the meaning of
interest’’ for ‘‘or the profits interest’’ in section 987 QBU pursuant to the paragraph (g)(2)(i)(B)(1) of this section).
section 707(b)(1)(A) and substituting election, or is a taxable year in which (g)(4) through (6) [Reserved]. For
‘‘and profits interests’’ for ‘‘or profits there is a section 987 loss of $1 million further guidance, see § 1.987–1(g)(4)
interests’’ in section 707(b)(1)(B)) on the or less that would be recognized with through (6).
last day of the first taxable year for respect to the section 987 QBU pursuant (h) Effective/applicability date.
which the election applies (a related to the election Paragraphs (g)(2)(i)(B) and (g)(3)(i)(H) of
person). If a taxpayer makes the election (C) Election to translate all items at this section apply to the first taxable
under § 1.987–8T(d), the first taxable the yearly average exchange rate. An year beginning on or after December 7,
year of a related person for which the election under § 1.987–3T(d) (election to 2016. Paragraphs (b)(1)(iii), (b)(6),
election applies is the first taxable year translate all items at the yearly average (c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f),
that ends with or within a taxable year exchange rate) may be made with (g)(2)(i)(C), and (g)(3)(i)(E) through (G) of
of the taxpayer for which the taxpayer’s respect to a section 987 QBU only if the this section apply to taxable years
election applies. An election under first taxable year for which the election beginning one year after the first day of
§ 1.987–8T(d) may not be revoked. would apply is the first taxable year for the first taxable year following
(i) Fresh start taxpayers. A taxpayer to which an election under § 1.987–8T(d) December 7, 2016. Notwithstanding the
which § 1.987–10 applies that is (annual deemed termination election) preceding sentence, if a taxpayer makes
sradovich on DSK3GMQ082PROD with RULES4
required under § 1.987–10(a) to apply applies with respect to the section 987 an election under § 1.987–11(b), then
the fresh start transition method QBU. paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B),
described in § 1.987–10(b) (fresh start (g)(2)(ii) through (g)(3)(i)(D) (c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and
taxpayer) may make the election under [Reserved]. For further guidance, see (g)(3)(i)(E) through (G) of this section
§ 1.987–8T(d) only if the first taxable § 1.987–1(g)(2)(ii) through (g)(3)(i)(D). apply to taxable years to which
year for which the election would apply (E) Election for a CFC to apply section §§ 1.987–1 through 1.987–10 apply as a
to the taxpayer is either the first taxable 987 to a dollar QBU. An election under result of such election.
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/16.svg)
![88870 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations
(i) Expiration date. The applicability section 985 regarding the change in (b) * * *
of this section expires on December 6, functional currency. See §§ 1.985– (4) [Reserved]. For further guidance,
2019. 1(c)(6) and 1.985–5. see § 1.987–3T(b)(4).
■ Par. 5. Section 1.987–2 is amended by (iii) Separation of section 987 QBUs. * * * * *
adding paragraph (c)(9) to read as The separation of a section 987 QBU (c) * * *
follows: (separating QBU) into two or more (2) * * *
section 987 QBUs (separated QBUs) (ii) [Reserved]. For further guidance,
§ 1.987–2 Attribution of items to eligible that, after the separation, are directly
QBUs; definition of a transfer and related
see § 1.987–3T(c)(2)(ii).
owned by the same owner, or that are
rules. indirectly owned by the same partner * * * * *
* * * * * through a single section 987 aggregate (c) * * *
(c) * * * partnership, does not give rise to a (2) * * *
(9) [Reserved]. For further guidance, transfer of the separating QBU’s assets (v) through (d) [Reserved]. For further
see § 1.987–2T(c)(9). or liabilities to the owner under § 1.987– guidance, see § 1.987–3T(c)(2)(v)
* * * * * 2(c). Additionally, transactions that through (d).
occurred between the separating QBUs (e) Examples. * * *
■ Par. 6. Section 1.987–2T is added to
in the taxable year of the separation Example 9 through Example 14
read as follows:
prior to the completion of the separation [Reserved]. For further guidance, see
§ 1.987–2T Attribution of items to eligible do not give rise to transfers for purposes § 1.987–3T(e), Example 9 through
QBUs; definition of a transfer and related
of section 987. For this purpose, a Example 14.
rules (temporary). ■ Par. 8. Section 1.987–3T is added to
separation occurs when the assets and
(a) through (c)(8) [Reserved]. For read as follows:
liabilities that are properly reflected on
further guidance, see § 1.987–2(a)
the books and records of a separating § 1.987–3T Determination of section 987
through (c)(8).
QBU begin to be properly reflected on taxable income or loss of an owner of a
(9) Certain disregarded transactions
the books and records of two or more section 987 QBU (temporary).
not treated as transfers—(i)
separated QBUs. A separation may (a) through (b)(2)(i) [Reserved]. For
Combinations of section 987 QBUs. The
result from any transaction or series of further guidance, see § 1.987–3(a)
combination of two or more separate
transactions in which a separating QBU through (b)(2)(i).
section 987 QBUs (combining QBUs)
becomes two or more separated QBUs. (ii) No translation of basis or amount
that are directly owned by the same
A separation may also result when a realized with respect to a specified
owner, or that are indirectly owned by
section 987 QBU that is subject to a owner functional currency transaction
the same partner through a single
grouping election under § 1.987– treated as a historic asset. If the
section 987 aggregate partnership, into
1(b)(2)(ii)(A) changes its functional acquisition of a historic asset gives rise
one section 987 QBU (combined QBU)
currency. For rules regarding the to a specified owner functional currency
does not give rise to a transfer of any
determination of net unrecognized transaction described in paragraph
combining QBU’s assets or liabilities to
section 987 gain or loss of a separated (b)(4)(ii) of this section, the basis of the
the owner under § 1.987–2(c). In
QBU, see § 1.987–4T(f)(2). historic asset, and any amount realized
addition, transactions between the
(c)(10) through (d) [Reserved]. For
combining QBUs occurring in the on a disposition of the historic asset, is
further guidance see § 1.987–2(c)(10)
taxable year of the combination do not not translated if the amount is
through (d).
result in a transfer of the combining denominated in the owner’s functional
(e) Effective/applicability date. This
QBUs’ assets or liabilities to the owner currency.
section applies to taxable years
under § 1.987–2(c). For this purpose, a (3) [Reserved]. For further guidance,
beginning on or after one year after the
combination occurs when the assets and see § 1.987–3(b)(3).
first day of the first taxable year
liabilities that are properly reflected on (4) Special rule for section 988
following December 7, 2016.
the books and records of two or more transactions—(i) In general. Section 988
Notwithstanding the preceding
combining QBUs begin to be properly and the regulations thereunder apply to
sentence, if a taxpayer makes an
reflected on the books and records of a section 988 transactions of a section 987
election under § 1.987–11(b), then this
combined QBU and the separate QBU. For this purpose, whether a
section applies to taxable years to which
existence of the combining QBUs transaction is a section 988 transaction
§§ 1.987–1 through 1.987–10 apply as a
ceases. A combination may result from is determined by reference to the
result of such election.
any transaction or series of transactions (f) Expiration date. The applicability functional currency of the section 987
in which the combining QBUs become of this section expires on December 6, QBU. (But see paragraph (b)(4)(ii) of this
a combined QBU. For rules regarding 2019. section, providing that specified owner
the determination of net unrecognized functional currency transactions are not
■ Par. 7. Section 1.987–3 is amended by
section 987 gain or loss of a combined treated as section 988 transactions.)
adding paragraphs (b)(2)(ii), (b)(4),
QBU, see § 1.987–4T(f)(1). However, except as provided in
(c)(2)(ii) and (v), and (d), and Example
(ii) Change in functional currency paragraph (b)(4)(iii)(A) of this section,
9 through Example 14 at the end of
from a combination. If, following a section 988 gain or loss is determined
paragraph (e) to read as follows:
combination of section 987 QBUs in, and by reference to, the functional
described in paragraph (c)(9)(i) of this § 1.987–3 Determination of section 987 currency of the owner of the section 987
section, the combined section 987 QBU taxable income or loss of an owner of a QBU rather than the functional currency
sradovich on DSK3GMQ082PROD with RULES4
has a different functional currency than section 987 QBU. of the section 987 QBU. Accordingly, in
one or more of the combining section * * * * * determining section 988 gain or loss of
987 QBUs, any such combining section (b) * * * a section 987 QBU with respect to a
987 QBU is treated as changing its (2) * * * section 988 transaction of the section
functional currency and the owner of (ii) [Reserved]. For further guidance, 987 QBU, the amounts required under
the combined section 987 QBU must see § 1.987–3T(b)(2)(ii). section 988 and the regulations
comply with the regulations under * * * * * thereunder to be translated on the
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/17.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88871
applicable booking date or payment date 1.988–2(e)(7) for rules relating to 1T(c)(1)(ii)(B) regarding the use of a spot
with respect to the section 988 transactions denominated in, or rate convention.
transaction are translated into the determined by reference to, a (iii) through (iv) [Reserved]. For
owner’s functional currency at the rate hyperinflationary currency. further guidance, see § 1.987–3(c)(2)(iii)
required under section 988 and the (C) Election to use a foreign currency through (iv).
regulations thereunder. mark-to-market method of accounting. (v) Translation of income to account
(ii) Specified owner functional A taxpayer may elect under this for certain foreign income tax claimed
currency transactions not treated as paragraph (b)(4)(iii)(C) to apply the as a credit. The owner of a section 987
section 988 transactions. Transactions foreign currency mark-to-market method QBU claiming a credit under section
of a section 987 QBU described in of accounting described in this 901 for foreign income taxes, other than
sections 988(c)(1)(B)(i), 988(c)(1)(B)(ii), paragraph for all qualified short-term foreign income taxes deemed paid
and 988(c)(1)(C) (including the section 988 transactions described in under section 902 or section 960, that
acquisition of nonfunctional currency as paragraph (b)(4)(iii)(B) of this section, are properly reflected on the books and
described in § 1.988–1(a)(1)), other than and any related hedges, that are records of the section 987 QBU (the
transactions described in paragraph properly attributable to a section 987 creditable tax amount) must determine
(b)(4)(iii)(A) of this section, that are QBU on or after the effective date of the section 987 taxable income or loss
denominated in (or determined by election and that are not otherwise attributable to the section 987 QBU by
reference to) the owner’s functional accounted for under a mark-to-market reducing the amount of section 987
currency (specified owner functional method of accounting under section 475 taxable income or loss that otherwise
currency transactions) are not treated as or section 1256. Under the foreign would be determined under this section
section 988 transactions. Thus, no currency mark-to-market method of by an amount equal to the creditable tax
currency gain or loss is recognized by a accounting, the timing of section 988 amount, translated into U.S. dollars
section 987 QBU under section 988 with gain or loss on section 988 transactions using the yearly average exchange rate
respect to such transactions. is determined under the principles of for the taxable year in which the
(iii) Determination of section 988 gain section 1256(a)(1). Thus, only section creditable tax is accrued, and by
or loss for qualified short-term section 988 gain or loss is taken into account increasing the resulting amount by an
988 transactions—(A) Determination by under the foreign currency mark-to- amount equal to the creditable tax
reference to the section 987 QBU’s amount, translated using the same
market method of accounting.
functional currency for certain exchange rate that is used to translate
Appropriate adjustments must be made
transactions subject to a mark-to-market the creditable taxes into U.S. dollars
to prevent the section 988 gain or loss
method of accounting. Section 988 gain under section 986(a). See Example 14 of
from being taken into account again
or loss with respect to section 988 paragraph (e) of this section,, for an
under section 988 or another provision
transactions described in paragraph illustration of this rule.
of the Code or regulations. A section 988
(b)(4)(iii)(B) of this section that are (d) Election to translate all items at
transaction subject to this election is not
accounted for under a mark-to-market the yearly average exchange rate.
subject to the ‘‘netting rule’’ of section
method of accounting for Federal Notwithstanding § 1.987–3(c), a
988(b) and § 1.988–2(b)(8), under which
income tax purposes or under the taxpayer that has made the annual
foreign currency mark-to-market method exchange gain or loss is limited to
overall gain or loss realized in a deemed termination election described
of accounting described in paragraph in § 1.987–8T(d) may elect under this
(b)(4)(iii)(C) of this section, and any transaction, in taxable years prior to the
taxable year in which section 988 gain paragraph (d) to translate all items of
hedges entered into to manage risk with income, gain, deduction, and loss with
respect to such transactions within the or loss would be recognized with
respect to such section 988 transaction respect to a section 987 QBU
meaning of § 1.1221–2(c)(4) (related determined under § 1.987–3(b) in the
hedges), must be determined in, and by but for this election.
(iv) Examples. Examples 10 through functional currency of the section 987
reference to, the functional currency of QBU into the owner’s functional
the section 987 QBU (rather than the 13 of paragraph (e) of this section
illustrate the application of this currency, if necessary, at the yearly
functional currency of its owner). average exchange rate for the taxable
(B) Qualified short-term section 988 paragraph (b)(4).
(c)(1) through (c)(2)(i) [Reserved]. For year. Example 9 of paragraph (e) of this
transaction. A qualified short-term section illustrates the application of this
section 988 transaction is a section 988 further guidance, see § 1.987–3(c)(1)
through (c)(2)(i). election.
transaction that occurs in the ordinary (e) Example 1 through Example 8
course of a section 987 QBU’s business (ii) Amount realized with respect to
[Reserved]. For further guidance, see
and has an original term of one year or historic assets that are section 988
§ 1.987–3(e), Example 1 through
less on the date the transaction is transactions. If the acquisition of a
Example 8.
entered into by the section 987 QBU. historic asset gave rise to a section 988
The holding of currency that is transaction described in paragraph Example 9. The facts are the same as in
nonfunctional currency (within the (b)(4)(i) of this section, then in Example 7, except that U.S. Corp properly
elects under paragraph (d) of this section to
meaning of section 988(c)(1)(C)(ii)) to computing the total gain or loss on a translate all items of income, gain, deduction,
the section 987 QBU in the ordinary disposition of the historic asset (some or and loss with respect to Business A at the
course of a section 987 QBU’s trade or all of which total gain or loss may be yearly average exchange rate. Accordingly,
business also is treated as a qualified section 988 gain or loss described in Business A’s Ö2,000 gain on the sale of the
short-term section 988 transaction. Any section 988(b) and paragraph (b)(4)(i) of land is translated at the yearly average
sradovich on DSK3GMQ082PROD with RULES4
transaction that is denominated in, or this section), the amount realized exchange rate for 2021 of Ö1 = $1.05, and the
determined by reference to, a (determined, if necessary, under amount of gain reported by U.S. Corp on the
sale of the land is $2,100.
hyperinflationary currency, including § 1.987–3(b)(2)(i)) is translated into the Example 10. Business A acquires £100 on
the holding of hyperinflationary owner’s functional currency using the August 27, 2021, for Ö120 and sells the
currency, is not considered a qualified spot rate on the date such item is pounds on November 17, 2021, for Ö125. The
short-term section 988 transaction. See properly taken into account, subject to dollar-pound spot rate (without the use of a
§§ 1.988–2(b)(15), 1.988–2(d)(5), and the limitation under § 1.987– spot rate convention) is £1 = $1 on August
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/18.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88873
Translation
Amount in Ö Amount in $
rate
Revenue ....................................................................................................................................... Ö100 Ö1 = $1.50 $150.00
General Expenses ....................................................................................................................... (30) Ö1 = $1.50 (45.00)
Depreciation ................................................................................................................................. (10) Ö1 = $1.00 (10.00)
Tentative section 987 taxable income ......................................................................................... Ö60 ........................ $95.00
Adjustments under paragraph (c)(2)(v) of this section:
Decrease by Ö15 tax translated at yearly average exchange rate (Ö1 = $1.50) ................ ........................ ........................ ($22.50)
Increase by Ö15 tax translated at spot rate on payment date (Ö1 = $1.60) ....................... ........................ ........................ 24.00
Section 987 taxable income ........................................................................................................ ........................ ........................ $96.50
(f) Effective/applicability date. This regulations under section 987 apply, as Example 1. Combination of two section 987
section applies to taxable years determined under § 1.987–4(c), and by QBUs that have the same owner. (i) Facts.
beginning on or after one year after the treating the combining QBUs as having DC1, a domestic corporation, owns Entity A,
a DE. Entity A conducts a business in France
first day of the first taxable year combined immediately prior to the that constitutes a section 987 QBU (French
following December 7, 2016. beginning of the taxable year of QBU) that has the euro as its functional
Notwithstanding the preceding combination. currency. French QBU has a net accumulated
sentence, if a taxpayer makes an (2) Separations. The net unrecognized unrecognized section 987 loss from all prior
election under § 1.987–11(b), then this section 987 gain or loss of a separated
taxable years to which the regulations under
section applies to taxable years to which section 987 apply of $100. DC1 also owns
QBU (as defined in § 1.987–2T(c)(9)(iii)) Entity B, a DE. Entity B conducts a business
§§ 1.987–1 through 1.987–10 apply as a
for a taxable year is determined under in Germany that constitutes a section 987
result of such election.
§ 1.987–4(b) by taking into account the QBU (German QBU) that has the euro as its
(g) Expiration date. The applicability
separated QBU’s share of the net functional currency. German QBU has a net
of this section expires on December 6, accumulated unrecognized section 987 gain
2019. accumulated unrecognized section 987
gain or loss of the separating QBU (as from all prior taxable years to which the
■ Par. 9. Section 1.987–4 is amended by regulations under section 987 apply of $110.
defined in § 1.987–2T(c)(9)(iii)) for all During the taxable year, Entity A and Entity
adding paragraphs (c)(2) and (f) to read
prior taxable years to which the B merge under local law. As a result, the
as follows:
regulations under section 987 apply, as books and records of French QBU and
§ 1.987–4 Determination of net determined under § 1.987–4(c), and by German QBU are combined into a new single
unrecognized section 987 gain or loss of a treating the separating QBU as having set of books and records. The combined
section 987 QBU. separated immediately prior to the entity has the euro as its functional currency.
* * * * * beginning of the taxable year of (ii) Analysis. Pursuant to § 1.987–
2T(c)(9)(i), French QBU and German QBU are
(c) * * * separation. A separated QBU’s share of
combining QBUs, and their combination does
(2) [Reserved]. For further guidance, the separating QBU’s net accumulated not give rise to a transfer that is taken into
see § 1.987–4T(c)(2). unrecognized section 987 gain or loss account in determining the amount of a
* * * * * for all such prior taxable years is remittance (as defined in § 1.987–5(c)). For
(f) [Reserved]. For further guidance, determined by apportioning the purposes of computing net unrecognized
see § 1.987–4T(f). separating QBU’s net accumulated section 987 gain or loss under § 1.987–4 for
unrecognized section 987 gain or loss the year of the combination, the combination
* * * * *
for all such prior taxable years to each is deemed to have occurred on the last day
■ Par. 10. Section 1.987–4T is added to of the owner’s prior taxable year, such that
read as follows: separated QBU in proportion to the the owner functional currency net value of
aggregate adjusted basis of the gross the combined section 987 QBU at the end of
§ 1.987–4T Determination of net assets properly reflected on the books that taxable year described under § 1.987–
unrecognized section 987 gain or loss of a and records of each separated QBU 4(d)(1)(B) takes into account items reflected
section 987 QBU (temporary). immediately after the separation. For on the balance sheets of both French QBU
(a) through (c)(1) [Reserved]. For purposes of determining the owner and German QBU at that time. Additionally,
further guidance, see § 1.987–4(a) functional currency net value of the any transactions between French QBU and
through (c)(1). German QBU occurring during the year of the
separated QBUs on the last day of the merger will not result in transfers to or from
(2) Coordination with § 1.987–12T. taxable year preceding the taxable year
For purposes of paragraph (c)(1) of this a section 987 QBU. Pursuant to paragraph
of separation under § 1.987–5(d)(1)(B) (f)(1) of this section, the combined QBU will
section, amounts taken into account and (e), the balance sheets of the have a net accumulated unrecognized section
under § 1.987–5 are determined without separated QBUs on that day will be 987 gain from all prior taxable years of $10
regard to § 1.987–12T. deemed to reflect the assets and (the $100 loss from French QBU plus the
(d) through (e) [Reserved]. For further $110 gain from German QBU).
liabilities reflected on the balance sheet
guidance, see § 1.987–4(d) through (e). Example 2. Separation of two section 987
(f) Combinations and separations—(1) of the separating QBU on that day,
QBUs that have the same owner. (i) Facts.
Combinations. The net unrecognized apportioned between the separated DC1, a domestic corporation, owns Entity A,
section 987 gain or loss of a combined QBUs in a reasonable manner that takes a DE. Entity A conducts a business in the
sradovich on DSK3GMQ082PROD with RULES4
QBU (as defined in § 1.987–2T(c)(9)(i)) into account the assets and liabilities Netherlands that constitutes a section 987
for a taxable year is determined under reflected on the balance sheets of the QBU (Dutch QBU) that has the euro as its
separated QBUs immediately after the functional currency. The business of Dutch
§ 1.987–4(b) by taking into account the QBU consists of manufacturing and selling
net accumulated unrecognized section separation.
bicycles and scooters and is recorded on a
987 gain or loss of each combining QBU (3) Examples. The following examples single set of books and records. On the last
(as defined in § 1.987–2T(c)(9)(i)) for all illustrate the rules of paragraphs (f)(1) day of Year 1, the adjusted basis of the gross
prior taxable years to which the and (2) of this section. assets of Dutch QBU is Ö1,000. In Year 2, the
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/20.svg)
![88874 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations
net accumulated unrecognized section 987 to a dollar QBU (as defined in § 1.987– determination date, the partnership sold
loss of Dutch QBU from all prior taxable 1T(b)(6)(i)) for which the CFC owner has all of its assets for cash equal to the fair
years is $200. During Year 2, Entity A elected under § 1.987–1T(b)(6)(iii) to market value of such assets (taking into
separates the bicycle and scooter business
apply section 987 is determined by account section 7701(g)), satisfied all of
such that each business begins to have its
own books and records and to meet the reference to the residence of the CFC its liabilities (other than those described
definition of a section 987 QBU under owner. This paragraph (b)(4) applies to in § 1.752–7), paid an unrelated third
§ 1.987–1(b)(2) (hereafter, ‘‘bicycle QBU’’ and any CFC that has made the election party to assume all of its § 1.752–7
‘‘scooter QBU’’). There are no transfers under § 1.987–1T(b)(6)(iii), including a liabilities in a fully taxable transaction,
between DC1 and Dutch QBU before the CFC described in § 1.987–1(b)(1)(ii). and then liquidated.
separation. After the separation, the aggregate (c) [Reserved]. For further guidance, (ii) Determination date.—(A) In
adjusted basis of bicycle QBU’s assets is Ö600 see § 1.987–6(c). general. Except as provided in
and the aggregate adjusted basis of scooter (d) Effective/applicability date. This paragraph (b)(2)(ii)(B) of this section,
QBU’s assets is Ö400. Each section 987 QBU section applies to taxable years the determination date is the date of the
continues to have the euro as its functional
beginning on or after one year after the most recent event described in § 1.704–
currency.
(ii) Analysis. Pursuant to § 1.987– first day of the first taxable year 1(b)(2)(iv)(f)(5) or § 1.704–
2T(c)(9)(iii), bicycle QBU and scooter QBU following December 7, 2016. 1(b)(2)(iv)(s)(1) (a revaluation event),
are separated QBUs, and the separation of Notwithstanding the preceding irrespective of whether the capital
Dutch QBU, a separating QBU, does not give sentence, if a taxpayer makes an accounts of the partners are adjusted
rise to a transfer taken into account in election under § 1.987–11(b), then this under § 1.704–1(b)(2)(iv)(f), or, if there
determining the amount of a remittance (as section applies to taxable years to which has been no revaluation event, the date
defined in § 1.987–5(c)). For purposes of §§ 1.987–1 through 1.987–10 apply as a of the formation of the partnership.
computing net unrecognized section 987 gain result of such election. (B) Allocations not in accordance
or loss under § 1.987–4 for Year 2, the (e) Expiration date. The applicability with liquidation value percentage. If a
separation will be deemed to have occurred
of this section expires on December 6, partnership agreement provides for the
on the last day of the owner’s prior taxable
year, Year 1. Pursuant to paragraph (f)(2) of 2019. allocation of any item of income, gain,
this section, bicycle QBU will have a net ■ Par. 13. Section 1.987–7 is amended deduction, or loss from partnership
accumulated unrecognized section 987 loss by adding paragraph (b) to read as property to a partner other than in
of $120 (Ö600/Ö1,000 × $200), and scooter follows: accordance with the partner’s
QBU will have a net accumulated liquidation value percentage, the
unrecognized section 987 loss of $80 (Ö400/ § 1.987–7 Section 987 aggregate determination date is the last day of the
Ö1,000 × $200). partnerships.
partner’s taxable year, or, if the partner’s
(g) [Reserved]. For further guidance, * * * * * section 987 QBU owned indirectly
see § 1.987–4(g). (b) [Reserved]. For further guidance, through a section 987 aggregate
(h) Effective/applicability date. This see § 1.987–7T(b). partnership terminates during the
section applies to taxable years * * * * * partner’s taxable year, the date such
beginning on or after one year after the ■ Par. 14. Section 1.987–7T is added to section 987 QBU is terminated.
first day of the first taxable year read as follows: (3) Example. The following example
following December 7, 2016. illustrates the rule of this paragraph (b).
§ 1.987–7T Section 987 aggregate
Notwithstanding the preceding Example. (i) Facts. DC, a domestic
partnerships (temporary).
sentence, if a taxpayer makes an corporation, owns all of the stock of FS, a
election under § 1.987–11(b), then this (a) [Reserved]. For further guidance, controlled foreign corporation (as defined in
section applies to taxable years to which see § 1.987–7(a). section 957(a)) with the U.S. dollar as its
(b) Liquidation value percentage functional currency. FS owns a capital and
§§ 1.987–1 through 1.987–10 apply as a
methodology—(1) In general. In any profits interest in FPRS, a foreign
result of such election.
(i) Expiration date. The applicability taxable year, a partner’s share of each partnership. The remaining capital and
asset, including its basis in each asset, profits interest in FPRS is owned by DC.
of this section expires on December 6, FPRS is a section 987 aggregate partnership
2019. and the amount of each liability
reflected under § 1.987–2(b) on the with the euro as its functional currency. The
■ Par. 11. Section 1.987–6 is amended balance sheet of FPRS reflects one asset
books and records of an eligible QBU (Asset A) with a basis of Ö60x and a fair
by adding paragraph (b)(4) to read as
owned indirectly through a section 987 market value of Ö100x, another asset (Asset
follows:
aggregate partnership is proportional to B) with a basis of Ö100x and a fair market
§ 1.987–6 Character and source of section the partner’s liquidation value value of Ö200x, and a liability (Liability) of
987 gain or loss. percentage with respect to the aggregate Ö50x. At the end of year 1, the liquidation
* * * * * partnership for that taxable year, as value percentage, as determined under
determined under paragraph (b)(2) of paragraph (b)(2) of this section, of DC with
(b) * * *
this section. respect to FPRS is 75 percent, and the
(4) [Reserved]. For further guidance, liquidation value percentage of FS with
see § 1.987–6T(b)(4). (2) Liquidation value percentage—(i) respect to FPRS is 25 percent.
* * * * * In general. For purposes of this (ii) Result. Under § 1.987–1(b)(4), DC and
paragraph (b), a partner’s liquidation FS are each treated as indirectly owning an
■ Par. 12. Section 1.987–6T is added to
value percentage is the ratio (expressed eligible QBU with a balance sheet that
read as follows:
as a percentage) of the liquidation value reflects their respective shares of any assets
§ 1.987–6T Character and source of of the partner’s interest in the and liabilities of FPRS. Under paragraph
sradovich on DSK3GMQ082PROD with RULES4
section 987 gain or loss (temporary) partnership to the aggregate liquidation (b)(1) of this section, DC and FS’s shares of
value of all of the partners’ interests in FPRS’s assets and liabilities are determined
(a) through (b)(3) [Reserved]. For
in accordance with DC and FS’s respective
further guidance, see § 1.987–6(a) the partnership. The liquidation value liquidation value percentages. Accordingly,
through (b)(3). of a partner’s interest in a partnership is because DC has a liquidation value
(4) Source of section 987 gain or loss the amount of cash the partner would percentage of 75 percent with respect to
with respect to a dollar QBU. The source receive with respect to the interest if, FPRS, Ö75x of Asset A (with a Ö45x basis),
of section 987 gain or loss with respect immediately following the applicable Ö150x of Asset B (with a Ö75x basis), and
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/21.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88875
Ö37.50x of Liability will be attributed to the § 1.987–12 Deferral of section 987 gain or 987 aggregate partnership refer to any
DC–FPRS QBU. Additionally, because FS has loss. partnership for which the acquisition or
a liquidation value percentage of 25 percent (a) through (h) [Reserved]. For further disposition of a partnership interest
with respect to FPRS, Ö25x of Asset A (with guidance, see § 1.987–12T(a) through could give rise to foreign currency gain
a Ö15x basis), Ö50x of Asset B (with a Ö25x (h).
basis), and Ö12.50x of Liability will be
or loss realized under section 987(3).
attributed to the FS–FPRS QBU. ■ Par. 18. Section 1.987–12T is added to Additionally, references to recognition
read as follows: of section 987 gain or loss under
(c) [Reserved]. For further guidance, § 1.987–5 encompass any determination
see § 1.987–7(c). § 1.987–12T Deferral of section 987 gain or and recognition of gain or loss under
(d) Effective/applicability date. This loss (temporary).
section 987(3) that would occur but for
section applies to taxable years (a) In general—(1) Overview. This this section. Accordingly, the principles
beginning on or after one year after the section provides rules that defer the of this section apply to a QBU subject
first day of the first taxable year recognition of section 987 gain or loss to section 987 regardless of whether the
following December 7, 2016. that, but for this section, would be QBU otherwise is subject to §§ 1.987–1
Notwithstanding the preceding recognized in connection with certain through 1.987–11. An owner of a QBU
sentence, if a taxpayer makes an QBU terminations and certain other that is not subject to § 1.987–5 must
election under § 1.987–11(b), then this transactions involving partnerships. adapt the rules set forth in this section
section applies to taxable years to which This paragraph (a) provides an overview as necessary to recognize section 987
§§ 1.987–1 through 1.987–10 apply as a of this section and describes the gains or losses that are subject to this
result of such election. section’s scope of application, including section consistent with the principles of
(e) Expiration date. The applicability with respect to QBUs subject to section this section.
of this section expires on December 6, 987 but to which §§ 1.987–1 through (3) Exceptions—(i) Annual deemed
2019. 1.987–11 generally do not apply. termination elections. This section does
■ Par. 15. Section 1.987–8 is amended Paragraph (b) of this section describes not apply to section 987 gain or loss of
by adding paragraph (d) to read as the extent to which section 987 gain or a section 987 QBU with respect to
follows: loss is recognized under § 1.987–5 or which the annual deemed termination
similar principles in the taxable year of election described in § 1.987–8T(d) is in
§ 1.987–8 Termination of a section 987 a deferral event (as defined in paragraph effect.
QBU. (b)(2) of this section) with respect to a (ii) De minimis exception. This
* * * * * QBU. Paragraph (c) of this section section does not apply to a section 987
(d) [Reserved]. For further guidance, describes the extent to which section QBU for a taxable year if the net
see § 1.987–8T(d). 987 gain or loss that, as a result of unrecognized section 987 gain or loss of
* * * * * paragraph (b), is not recognized under the section 987 QBU that, as a result of
■ Par. 16. Section 1.987–8T is added to § 1.987–5 or similar principles is this section, would not be recognized
read as follows recognized upon the occurrence of under § 1.987–5 in the taxable year does
subsequent events. Paragraph (d) of this not exceed $5 million.
§ 1.987–8T Termination of a section 987 section describes the extent to which (b) Gain and loss recognition in
QBU (temporary). section 987 loss is recognized under connection with a deferral event—(1) In
(a) through (c) [Reserved]. For further § 1.987–5 or similar principles in the general. Notwithstanding § 1.987–5, the
guidance, see § 1.987–8(a) through (c). taxable year of an outbound loss event owner of a section 987 QBU with
(d) Annual deemed termination (as defined in paragraph (d)(2) of this respect to which a deferral event occurs
election. A taxpayer, including a section) with respect to a QBU. (a deferral QBU) includes in taxable
taxpayer described in § 1.987–1(b)(1)(ii) Paragraph (e) of this section provides income section 987 gain or loss in
to which §§ 1.987–1 through 1.987–11 rules for determining the source and connection with the deferral event only
generally do not apply, may elect under character of gains and losses that, as a to the extent provided in paragraphs
this paragraph (d) to deem all of the result of this section, are not recognized (b)(3) and (c) of this section. However,
section 987 QBUs of which it is an under § 1.987–5 or similar principles in if the deferral event also constitutes an
owner to terminate on the last day of the taxable year of a deferral event or outbound loss event described in
each taxable year for which the election outbound loss event. Paragraph (f) of paragraph (d) of this section, the amount
is in effect. See § 1.987–8(e) regarding this section defines controlled group of loss recognized by the owner may be
the effect of such a deemed termination. and qualified successor for purposes of further limited under that paragraph.
The owner of a section 987 QBU that is this section. Paragraph (g) of this section (2) Deferral event—(i) In general. A
deemed to terminate under this provides an anti-abuse rule. Paragraph deferral event with respect to a section
paragraph is treated as having (h) of this section provides examples 987 QBU means any transaction or
transferred all of the assets and illustrating the rules described in this series of transactions that satisfy the
liabilities attributable to such section section. conditions described in paragraphs
987 QBU to a new section 987 QBU on (2) Scope. This section applies to any (b)(2)(ii) and (b)(2)(iii) of this section.
the first day of the following taxable foreign currency gain or loss realized (ii) Transactions. The transaction or
year. under section 987(3), including foreign series of transactions include either:
(e) through (f) [Reserved]. For further currency gain or loss of an entity (A) A termination of the section 987
guidance, see § 1.987–8(e) through (f). described in § 1.987–1(b)(1)(ii). QBU other than any of the following
(g) Effective/applicability date. This References in this section to section 987 terminations: a termination described in
sradovich on DSK3GMQ082PROD with RULES4
section applies to taxable years gain or loss refer to any foreign currency § 1.987–8(b)(3), a termination described
beginning on or after December 7, 2016. gain or loss realized under section in § 1.987–8(c), or a termination
(h) Expiration date. The applicability 987(3), references to a section 987 QBU described solely in § 1.987–8(b)(1); or
of this section expires on December 6, refer to any eligible QBU (as defined in (B) A disposition of part of an interest
2019. § 1.987–1(b)(3)(i), but without regard to in a section 987 aggregate partnership or
■ Par. 17. Section 1.987–12 is added to § 1.987–1(b)(3)(ii)) that is subject to DE through which the section 987 QBU
read as follows: section 987, and references to a section is owned or any contribution by another
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/22.svg)
![Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations 88879
after the Entity A sale, are reflected on the loss of a deferral QBU owner with § 1.988–2 Recognition and computation of
books and records of successor QBUs are respect to a deferral QBU described in exchange gain or loss.
treated as though they were not transferred paragraph (i)(1) of this section must be * * * * *
and therefore as remaining on the books and
adjusted to equal the amount of (b) * * *
records of DC1’s Business A section 987 QBU
notwithstanding the Entity A sale. outstanding deferred section 987 gain or (16) [Reserved].
Accordingly, DC1’s remittance amount under loss that the deferral QBU owner would * * * * *
§ 1.987–5 is $0, and DC1 recognizes no have had with respect to the deferral (i) [Reserved].
section 987 gain or loss with respect to QBU on the transition date if, ■ Par. 20. Section 1.988–1 is amended
Business A. immediately before the deferral event, by adding paragraph (a)(3) to read as
Example 5. Partial recognition of deferred the deferral QBU had transitioned to the
gain or loss. (i) Facts. DC1 owns all of the follows:
method prescribed by §§ 1.987–1
interests in Entity A, a DE that conducts
through 1.987–10 pursuant to the fresh § 1.988–1 Certain definitions and special
Business A in Country X. During Year 1, DC1 rules.
contributes all of its interests in Entity A to start transition method.
DC2 in an exchange to which section 351 (3) Adjustments in the case of an * * * * *
applies. At the time of the contribution, outbound loss event. The basis of any (a) * * *
Business A has net accumulated stock described in paragraph (d)(4) of (3) [Reserved]. For further guidance,
unrecognized section 987 gain of $100x. this section that was received in see § 1.988–1T(a)(3).
After the contribution, Entity A continues to connection with the transfer (or deemed
conduct business in Country X (Business B).
* * * * *
transfer) of assets of an outbound loss ■ Par. 21. Section 1.988–1T is added to
In Year 3, as a result of a net transfer of
property from Business B to DC2, DC2’s
QBU described in paragraph (i)(1) of read as follows:
remittance proportion with respect to this section and that is held on the
Business B, as determined under § 1.987–5, transition date must be adjusted to equal § 1.988–1T Certain definitions and special
is 0.25. the basis that such stock would have rules (temporary).
(ii) Analysis. (A) For the reasons described had on the transition date if, (a)(1) through (a)(2) [Reserved]. For
in Example 1, the contribution of Entity A by immediately prior to the outbound loss further guidance, see § 1.988–1(a)(1)
DC1 to DC2 results in a termination of event, the outbound loss QBU had through (2).
Business A and a deferral event with respect transitioned to the method prescribed (3) Specified owner functional
to Business A, a deferral QBU; DC1 is a
deferral QBU owner within the meaning of
by §§ 1.987–1 through 1.987–10 currency transactions of a section 987
paragraph (c)(1)(ii) of this section; Business pursuant to the fresh start transition QBU not treated as section 988
B is a successor QBU with respect to method. If no such stock was received, transactions. Specified owner
Business A; DC2 is a successor QBU owner; the amount of any outbound section 987 functional currency transactions, as
and the $100x of net accumulated loss with respect to the outbound loss defined in § 1.987–3T(b)(4)(ii), held by a
unrecognized section 987 gain with respect QBU that may be recognized on or after section 987 QBU are not treated as
to Business A becomes deferred section 987 the transition date pursuant to section 988 transactions. Thus, no
gain as a result of the deferral event. paragraph (d)(5) of this section must be currency gain or loss shall be recognized
(B) Under paragraph (c)(1) of this section,
DC1 recognizes deferred section 987 gain
adjusted to equal the amount of such by a section 987 QBU under section 988
with respect to Business A in accordance loss that would be outstanding and that with respect to such transactions.
with paragraphs (c)(2) through (4) of this may be recognized pursuant to that (4) through (i) [Reserved]. For further
section. Under paragraph (c)(2)(i) of this paragraph if, immediately before the guidance, see § 1.988–1(a)(4) through (i).
section, DC1 recognizes deferred section 987 outbound loss event, the outbound loss (j) Effective/applicability date. This
gain in Year 3 as a result of the remittance QBU had transitioned to the method section applies to taxable years
from Business B to DC2. Under paragraph prescribed by §§ 1.987–1 through 1.987– beginning on or after one year after the
(c)(2)(ii) of this section, the amount of 10 pursuant to the fresh start transition first day of the first taxable year
deferred section 987 gain that DC1 recognizes
is $25x, which is DC1’s outstanding deferred
method. following December 7, 2016.
section 987 gain or loss ($100x) with respect (j) Effective/applicability date—(1) In Notwithstanding the preceding
to Business A multiplied by the remittance general. Except as described in sentence, if a taxpayer makes an
proportion (0.25) of DC2 with respect to paragraph (j)(2) of this section, this election under § 1.987–11(b), then this
Business B for the taxable year as determined section applies to any deferral event or section applies to taxable years to which
under § 1.987–5(b). outbound loss event that occurs on or §§ 1.987–1 through 1.987–10 apply as a
(i) Coordination with fresh start after January 6, 2017. result of such election.
transition method—(1) In general. If a (2) Exception. This section applies to (k) Expiration date. The applicability
taxpayer is a deferral QBU owner, or is any deferral event or outbound loss of this section expires on December 6,
or was the owner of an outbound loss event that occurs on or after December 2019.
QBU, and the taxpayer is required under 7, 2016, if such deferral event or ■ Par. 22. Section 1.988–2 is amended
§ 1.987–10(a) to apply the fresh start outbound loss event is undertaken with by revising paragraph (b)(16) and adding
transition method described in § 1.987– a principal purpose of recognizing paragraph (i) to read as follows:
10(b) to the deferral QBU or outbound section 987 loss.
§ 1.988–2 Recognition and computation of
loss QBU, or would have been so (k) Expiration date. The applicability
exchange gain or loss.
required if the taxpayer had owned the of this section expires December 6,
deferral QBU or outbound loss QBU on 2019. * * * * *
the transition date (as defined in (b) * * *
■ Par. 19. Section 1.988–0 is amended
sradovich on DSK3GMQ082PROD with RULES4
§ 1.987–11(c)), the adjustments (16) [Reserved]. For further guidance,
by revising the entry for § 1.988–2(b)(16) see § 1.988–2T(b)(16).
described in paragraphs (i)(2) and (i)(3) and adding an entry for § 1.988–2(i) to
of this section, as applicable, must be read as follows: * * * * *
made on the transition date. (i) [Reserved]. For further guidance,
(2) Adjustment to deferred section 987 § 1.988–0 Taxation of gain or loss from a see § 1.988–2T(i).
gain or loss. The amount of any section 988 transaction; Table of contents. ■ Par. 23. Section 1.988–2T is added to
outstanding deferred section 987 gain or * * * * * read as follows:
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/26.svg)
![88880 Federal Register / Vol. 81, No. 236 / Thursday, December 8, 2016 / Rules and Regulations
§ 1.988–2T Recognition and computation principal purpose the avoidance of first day of the first taxable year
of exchange gain or loss (temporary). Federal income tax. following December 7, 2016.
(a) through (b)(15) [Reserved]. For (B) Recognition of deferred loss. Any Notwithstanding the preceding
further guidance, see § 1.988–2(a) exchange loss that is deferred under sentence, if a taxpayer makes an
through (b)(15). paragraph (b)(16)(ii)(A) of this section is election under § 1.987–11(b), then
(16) Deferral of loss on certain deferred until the end of the term of the paragraph (i) of this section applies to
related-party debt instruments.—(i) loan, determined immediately prior to taxable years to which §§ 1.987–1
Treatment of creditor. For rules the transaction. through 1.987–10 apply as a result of
(17) through (h) [Reserved]. For such election.
applicable to a corporation included in
further guidance, see § 1.988–2(b)(17)
a controlled group that is a creditor (k) Expiration date. The applicability
through (h).
under a debt instrument see § 1.267(f)– (i) Special rules for section 988 of this section expires on December 6,
1(e). transactions of a section 987 QBU. For 2019.
(ii) Treatment of debtor—(A) In rules regarding section 988 transactions John Dalrymple,
general. Exchange loss realized under of a section 987 QBU, see § 1.987–
§ 1.988–2(b)(4) or (b)(6) is deferred if— Deputy Commissioner for Services and
3T(b)(4) for section 987 QBUs in general Enforcement.
(1) The loss is realized by a debtor and § 1.987–1T(b)(6) for dollar QBUs.
with respect to a loan from a person that Approved: November 14, 2016.
(j) Effective/applicability date.
has a relationship to the debtor Paragraph (b)(16) of this section applies Mark J. Mazur,
described in section 267(b) or section to any exchange loss realized on or after Assistant Secretary of the Treasury (Tax
707(b); and December 7, 2016. Paragraph (i) of this Policy).
(2) The transaction resulting in the section applies to taxable years [FR Doc. 2016–28380 Filed 12–7–16; 8:45 am]
realization of exchange loss has as a beginning on or after one year after the BILLING CODE 4830–01–P
sradovich on DSK3GMQ082PROD with RULES4
VerDate Sep<11>2014 18:12 Dec 07, 2016 Jkt 214001 PO 00000 Frm 00028 Fmt 4701 Sfmt 9990 E:\FR\FM\08DER4.SGM 08DER4](https://thefederalregister.org/doc/81_FR_89090/page/27.svg)
Document Created: 2016-12-08 00:27:15
Document Modified: 2016-12-08 00:27:15
| Category | Regulatory Information | |
| Collection | Federal Register | |
| sudoc Class | AE 2.7: GS 4.107: AE 2.106: | |
| Publisher | Office of the Federal Register, National Archives and Records Administration | |
| Section | Rules and Regulations | |
| Action | Final and temporary regulations. | |
| Dates | Effective date. These regulations are effective on December 7, 2016. | |
| Contact | Steven D. Jensen at (202) 317-6938 (not a toll-free number). | |
| FR Citation | 81 FR 88854 | |
| RIN Number | 1545-BL12 | |
| CFR Associated | Income Taxes and Reporting and Recordkeeping Requirements |
2025 Federal Register | Disclaimer | Privacy Policy
USC | CFR | eCFR