Title 26—Internal Revenue--Volume 1
PART 1—INCOME TAXES
§ 1.981-2   Foreign law community income for taxable years beginning before January 1, 1967.
(a) Election for special treatment —(1) In general. For all open taxable years beginning before January 1, 1967, for which an individual citizen of the United States meets the requirements of subparagraphs (A) and (C) of section 981(a)(1) and subparagraph (2) of this paragraph, such citizen and his nonresident alien spouse may make a joint election to have section 981(c)(2) and paragraph (b) of this section apply to their income which is treated as community income under the applicable community property laws of a foreign country or countries. However, if the conditions prescribed by section 981(d)(3) and subparagraph (3) of this paragraph are met, the nonresident alien spouse is not required to join in the election and such citizen may make a separate election to have section 981(c)(2) and paragraph (b) of this section apply to such income for such taxable years. An election under section 981(c)(1) and this section shall apply to every open taxable year of such citizen and his nonresident alien spouse beginning before January 1, 1967, for which all the requirements of subparagraphs (A) and (C) of section 981(a)(1) and subparagraph (2) of this paragraph are met. It is immaterial whether such open taxable year is a taxable year subject to the provisions of the 1954 Code, the 1939 Code, or any other internal revenue law in effect before the 1939 Code. An election under section 981(c)(1) and this section has no effect for any taxable year beginning after December 31, 1966. For the definition of “open taxable year” see section 981(e)(2) and paragraph (a) of § 1.981-3. If the citizen and his nonresident alien spouse have different taxable years, see paragraph (c) of § 1.981-3. If one of the spouses is deceased, see paragraph (d) of § 1.981-3. An election under section 981(c)(1) and this section is binding and may not be revoked.
(2) Requirements to be met. In order for the citizen of the United States to make an election under this section, whether required to be made jointly with his nonresident alien spouse or permitted to be made separately, it is required under section 981(c)(1) that, for each taxable year to which the election applies, the citizen making the election be (i) a citizen of the United States and (ii) married at the close of the taxable year to an individual who is ( a ) a nonresident alien during the entire taxable year and ( b ), in the case of any such taxable years subsequent to the first, the same nonresident alien individual to whom the citizen was married at the close of such first taxable year. The provisions of paragraph (a)(2) of § 1.981-1 apply to determine whether a U.S. citizen making an election under section 981(c)(1) and this section is married at the close of a taxable year to an individual who is a nonresident alien during the entire taxable year.
(3) Cases where joint election is not required. A nonresident alien spouse is not required to join in an election under section 981(c)(1) and this section if the Director of International Operations determines in accordance with paragraph (c)(4) of this section—
(i) That an election under section 981(c)(1) and this section would not affect the liability for Federal income tax of the nonresident alien spouse for any taxable year, whether beginning on, before, or after January 1, 1967, or
(ii) That the effect of the election on the liability of the nonresident alien spouse for Federal income tax for any such taxable year cannot be ascertained and that to deny the election to the U.S. citizen spouse would be inequitable and cause undue hardship to the U.S. citizen.
(4) Manner of electing. The election under section 981(c)(1) and this section shall be made in accordance with the applicable rules set forth in paragraph (c) of this section.
(b) Treatment of community income —(1) In general. Community income, as defined in paragraph (b)(1) of § 1.981-1, for any taxable year beginning before January 1, 1967, to which an election under section 981(c)(1) and this section applies, and the deductions properly allocable to such income, shall be divided between the U.S. citizen and his nonresident alien spouse in accordance with the rules set forth in section 981(c)(2) and subparagraphs (2) and (3) of this paragraph. The income shall be divided in such manner even though the nonresident alien spouse is not required, in accordance with paragraph (a)(3) of this section, to join in the election by the U.S. citizen.
(2) Earned income, business income, partnership income, and income from separate property. All community income for any taxable year to which this paragraph applies which is treated as the income of one of the spouses in accordance with section 981(b)(1), (2), or (3) and paragraph (b)(2), (3), (4), or (5) of § 1.981-1 shall be treated as the income of that spouse for purposes of this paragraph.
(3) Other community income. All community income for any taxable year to which this paragraph applies, other than income described in subparagraph (2) of this paragraph, shall be treated as the income of the spouse who, for such taxable year, has a greater amount of gross income than the other spouse, determined by adding to the amount of gross income which is treated as the gross income of that spouse in accordance with subparagraph (2) of this paragraph the amount of the gross income for the taxable year which is treated as the separate income of that spouse under the community property laws of the foreign country having jurisdiction to determine the legal ownership of the income. If either spouse dies during a taxable year, the taxable year of the surviving spouse shall be treated as ending on the date of such death for the purpose of determining which spouse has the greater amount of gross income for such taxable year. Moreover, if the U.S. citizen and his nonresident alien spouse do not have the same taxable year, as defined in section 441(b) and the regulations thereunder, the periods for which the amounts of gross income are to be compared under this subparagraph are (i) the taxable year of the citizen and (ii) that period falling within the consecutive taxable years of the nonresident alien spouse which coincides with the period covered by such taxable year of the citizen. See paragraph (c) of § 1.981-3.
(c) Time and manner of making election —(1) In general. A citizen of the United States and his nonresident alien spouse or, if subparagraph (4) of this paragraph applies, such citizen alone may make an election under section 981(c)(1) and this section at any time on or after November 13, 1966, for each and every taxable year beginning before January 1, 1967, which on the date of the election, as defined in paragraph (b) of § 1.981-3, is open within the meaning of section 981(e)(2) and paragraph (a) of § 1.981-3. The election shall be made by filing a return, an amended return, or a claim for refund, whichever is proper, for each taxable year to which the election applies and attaching thereto a statement that the election is being made and that the requirements of paragraph (a)(2) of this section are met for each such taxable year. The statement must also show the information required by subparagraph (2) of this paragraph and must, where applicable, be signed by both persons making the election.
(2) Information required. The statement described in subparagraph (1) of this paragraph must show—
(i) The name, address, and account number, if any, of each spouse,
(ii) The name and address of the executor, administrator, or other person making the election for a deceased spouse,
(iii) The taxable years to which the election applies,
(iv) The office of the district director, or the service center, where the return or returns, if any, for such taxable year or years were filed,
(v) The dates on which such return or returns, if any, were filed and on which the tax for such taxable year or years was paid, if the tax has been paid, and
(vi) The name of the foreign country or countries having jurisdiction to determine the ownership of any income being treated in accordance with section 981(c)(2) and paragraph (b) of this section.
(3) Place for filing. Any return, amended return, or claim for refund filed under subparagraph (1) of this paragraph in respect of any taxable year shall be filed with the Director of International Operations, Internal Revenue Service, Washington, DC 20225. (See § 1.6091-3.)
(4) Determination that joint election is not required. A U.S. citizen spouse entitled to make an election under section 981(c)(1) and this section for open taxable years beginning before January 1, 1967, may apply to the Director of International Operations for a determination under section 981(d)(3) that the nonresident alien spouse is not required to join in the election by such citizen. This application shall be made by filing with the Director of International Operations, Internal Revenue Service, Washington, DC 20225, a statement setting forth the same information required by subparagraph (2) of this paragraph and such other information as is required by the Director of International Operations to justify a claim that the requirements of section 981(d)(3) and paragraph (a)(3) of this section are met. The Director of International Operations shall notify the U.S. citizen by letter of his determination with respect to the application. If the determination is that the nonresident alien spouse is not required to join in the election, a copy of the letter of determination shall be attached to each return, amended return, or claim for refund, to be filed pursuant to subparagraph (1) of this paragraph.
§ 1.981-3   Definitions and other special rules.
(a) Open taxable years. (1) For purposes of paragraph (a) of § 1.981-1, and paragraph (a) of § 1.981-2, a taxable year of the U.S. citizen, and the taxable year or years of his nonresident alien spouse ending or beginning within such taxable year of such citizen, shall be treated as open if the period prescribed by section 6501(a) (or section 6501(c)(4) if the period is extended by agreement) for assessing a deficiency against the citizen for his taxable year has not expired before the date of the election, determined under paragraph (b) of this section. Thus, for example, a taxable year of a U.S. citizen beginning before January 1, 1967, is open for purposes of this subparagraph if, before the election under section 981(c)(1) and § 1.981-2, such citizen has never filed a return for such year and a return was required under section 6012 without reference to section 981. For example, if a U.S. citizen spouse on a calendar year basis who has never filed a return for 1960 decides in 1975 that he wishes to make the election under section 981(c)(1) and § 1.981-2 in order to avoid being subject to tax for 1960 on his share of the community income for that year, he may in 1975 elect the benefits of section 981(c)(2) by filing an election in accordance with paragraph (c) of § 1.981-2. In such case, a taxable year or years of the nonresident alien spouse of such citizen ending or beginning within 1960 shall be treated in 1975 as an open taxable year.
(2) Subparagraph (1) of this paragraph shall apply even though the period prescribed by section 6501 for assessing a deficiency against the nonresident alien spouse for his taxable year or years ending or beginning within the taxable year of the U.S. citizen has expired before the election is made.
(3) If either spouse dies during a taxable year to which an election under § 1.981-1 or § 1.981-2 applies, the taxable year of the decedent and the surviving spouse shall be determined under this paragraph without regard to section 981(e)(4), relating to death of spouse during the taxable year. See paragraph (a)(2) of § 1.443-1.
(4) For definition of the term “taxable year”, see section 441(b) and the regulations thereunder.
(b) Date of election. (1) For purposes of § 1.981-1 and this section the date of an election made under section 981(a) and § 1.981-1 is the date on which the return, amended return, or claim for refund required by paragraph (c)(1) of § 1.981-1 is filed.
(2) For purposes of § 1.981-2 and this section the date of an election made under section 981(c)(1) and § 1.981-2 is the date on which the returns, amended returns, or claims for refund, required by paragraph (c)(1) of § 1.981-2 are filed.
(3) For provisions treating timely mailing as timely filing, see section 7502 and the regulations thereunder.
(c) Spouses with different taxable years. If the U.S. citizen and his nonresident alien spouse do not have the same taxable year, as defined in section 441(b) and the regulations thereunder, the election under § 1.981-1 or § 1.981-2 shall apply to each taxable year of such citizen in respect of which the election is made and to that period falling within the consecutive taxable years of the nonresident alien spouse which coincides with the period covered by such taxable year of the citizen.
(d) Election on behalf of deceased spouse. Any election, statement, or request, required to be made under paragraph (c) of § 1.981-1, or paragraph (c) of § 1.981-2, by one of the spouses may, if such spouse is deceased, be made by the executor, administrator, or other person charged with the property of such deceased spouse.
(e) Extension of period of limitations on assessment or refund —(1) Assessment of deficiency. Except as provided in subparagraph (3) of this paragraph, if an election under section 981(a) and § 1.981-1, or under section 981(c)(1) and § 1.981-2, is properly made, the period within which a deficiency may be assessed for any taxable year to which the election applies shall, to the extent the deficiency is attributable to the application of such election, not expire before one year after the date of the election, determined under paragraph (b) of this section.
(2) Refund of tax. Except as provided in subparagraph (3) of this paragraph, if an election under section 981(a) and § 1.981-1, or under section 981(c)(1) and § 1.981-2, is properly made, the period within which a claim for credit or refund of an overpayment for any taxable year to which the election applies may be filed shall, to the extent the overpayment is attributable to the application of the election, not expire before one year after the date of the election, determined under paragraph (b) of this section.
(3) Exception in case of nonelecting alien. Subparagraphs (1) and (2) of this paragraph shall not apply to any taxable year of a nonresident alien spouse who, in accordance with paragraph (a)(3) of § 1.981-2, is not required to join in the election by the U.S. citizen spouse under section 981(c)(1) and § 1.981-2.
(f) Payment of interest for extension period. To the extent that an overpayment or deficiency for any taxable year is attributable to an election made under § 1.981-1 or § 1.981-2, no interest shall be allowed or paid for any period ending with the day before the date which is one year after the date of the election, determined under paragraph (b) of this section.
§ 1.985-0   Outline of regulation.
This section lists the paragraphs contained in §§ 1.985-1 through 1.985-6.
(a) Applicability and effective date.
(b) Dollar functional currency.
(c) Functional currency of a QBU that is not required to use the dollar.
(d) Single functional currency for a foreign corporation.
(e) Translation of nonfunctional currency transactions.
(f) Examples.
(a) Background and scope.
(b) Eligible QBU.
(c) Time and manner for dollar election.
(d) Effect of dollar election.
(a) Scope and effective date.
(b) Statement of method.
(c) Translation into United States dollars.
(d) Computation of DASTM gain or loss.
(e) Effect of DASTM gain or loss on gross income, taxable income, or earnings and profits.
(a) Adoption or election.
(b) Condition for changing functional currencies.
(c) Relationship to certain other sections of the Code.
(a) In general.
(b) Step 1—Taking into account exchange gain or loss on certain section 988 transactions.
(c) Step 2—Determining the new functional currency basis of property and the new functional currency amount of liabilities and any other relevant items.
(d) Step 3A—Additional adjustments that are necessary when a branch changes functional currency.
(e) Step 3B—Additional adjustments that are necessary when a taxpayer changes functional currency.
(f) Examples.
(a) In general.
(b) Certain controlled foreign corporations.
(c) All other foreign corporations.
(d) Pre-1987 section 902 amounts.
(e) Net worth branch.
(f) Profit and loss branch.
§ 1.985-1   Functional currency.
(a) Applicability and effective date —(1) Purpose and scope. These regulations provide guidance with respect to defining the functional currency of a taxpayer and each qualified business unit (QBU), as defined in section 989(a). Generally, a taxpayer and each QBU must make all determinations under subtitle A of the Code (relating to income taxes) in its respective functional currency. This section sets forth rules for determining when the functional currency is the United States dollar (dollar) or a currency other than the dollar. Section 1.985-2 provides an election to use the dollar as the functional currency for certain QBUs that absent the election would have a functional currency that is a hyperinflationary currency, and explains the effect of making the election. Section 1.985-3 sets forth the dollar approximate separate transactions method that certain QBUs must use to compute their income or loss or earnings and profits. Section 1.985-4 provides that the adoption of a functional currency is a method of accounting and sets forth conditions for a change in functional currency. Section 1.985-5 provides adjustments that are required to be made upon a change in functional currency. Finally, § 1.985-6 provides transition rules for a QBU that uses the dollar approximate separate transactions method for its first taxable year beginning after December 31, 1986.
(2) Effective date. These regulations apply to taxable years beginning after December 31, 1986. However, any taxpayer desiring to apply temporary Income Tax Regulations § 1.985-0T through § 1.985-4T in lieu of these regulations to all taxable years beginning after December 31, 1986, and on or before October 20, 1989 may (on a consistent basis) so choose. For the text of the temporary regulations, see 53 FR 20308 (1988).
(b) Dollar functional currency —(1) In general. The dollar shall be the functional currency of a taxpayer or QBU described in paragraph (b)(1)(i) through (v) of this section regardless of the currency used in keeping its books and records (as defined in § 1.989(a)-1(d)). The dollar shall be the functional currency of—
(i) A taxpayer that is not a QBU (e.g., an individual);
(ii) A QBU that conducts its activities primarily in dollars. A QBU conducts its activities primarily in dollars if the currency of the economic environment in which the QBU conducts its activities is primarily the dollar. The facts and circumstances test set forth in paragraph (c)(2) of this section shall apply in making this determination;
(iii) Except as otherwise provided by ruling or administrative pronouncement, a QBU that has the United States, or any possession or territory of the United States where the dollar is the standard currency, as its residence (as defined in section 988(a)(3)(B));
(iv) A QBU that does not keep books and records in the currency of any economic environment in which a significant part of its activities is conducted. Whether a QBU keeps such books and records is determined in accordance with paragraph (c)(3) of this section; or
(v) A QBU that produces income or loss that is, or is treated as, effectively connected with the conduct of a trade or business within the United States.
(2) QBUs operating in a hyperinflationary environment —(i) Taxable years beginning on or before August 24, 1994. For taxable years beginning on or before August 24, 1994, see § 1.985-2 with respect to a QBU that elects to use, or is otherwise required to use, the dollar as its functional currency.
(ii) Taxable years beginning after August 24, 1994 —(A) In general. For taxable years beginning after August 24, 1994, except as otherwise provided in paragraph (b)(2)(ii)(B) of this section, any QBU that otherwise would be required to use a hyperinflationary currency as its functional currency must use the dollar as its functional currency and compute income or loss or earnings and profits under the rules of § 1.985-3.
(B) Exceptions —( 1 ) Certain QBU branches. The functional currency of a QBU that otherwise would be required to use a hyperinflationary currency as its functional currency and that is a branch of a foreign corporation having a non-dollar functional currency that is not hyperinflationary shall be the functional currency of the foreign corporation. Such QBU's income or loss or earnings and profits shall be determined under § 1.985-3 by substituting the functional currency of the foreign corporation for the dollar.
( 2 ) Corporation that is not a controlled foreign corporation. A foreign corporation (or its QBU branch) operating in a hyperinflationary environment is not required to use the dollar as its functional currency pursuant to paragraph (b)(2)(ii)(A) of this section if that foreign corporation is not a controlled foreign corporation as defined in section 957 or 953(c)(1)(B). However, a noncontrolled section 902 corporation, as defined in section 904(d)(2)(E), may elect to use the dollar (or, if appropriate, the currency specified in paragraph (b)(2)(ii)(B)( 1 ) of this section) as its (or its QBU branch's) functional currency under the procedures set forth in § 1.985-2(c)(3).
(C) Change in functional currency —( 1 ) In general. If a QBU is required to change its functional currency to the dollar under paragraph (b)(2)(ii)(A) of this section, or chooses or is required to change its functional currency to the dollar for any open taxable year (and all subsequent taxable years) under § 1.985-3(a)(2)(ii), the change is considered to be made with the consent of the Commissioner for purposes of § 1.985-4. A QBU changing functional currency must make adjustments described in § 1.985-7 if the year of change (as defined in § 1.481-1(a)(1)) begins after 1987, or the adjustments described in § 1.985-6 if the year of change begins in 1987. No adjustments under section 481 are required solely because of a change in functional currency described in this paragraph (b)(2)(ii)(C).
( 2 ) Effective date. This paragraph (b)(2)(ii)(C) applies to taxable years beginning after April 6, 1998. However, a taxpayer may choose to apply this paragraph (b)(2)(ii)(C) to all open years after December 31, 1986, provided each person, and each QBU branch of a person, that is related (within the meaning of § 1.985-2(d)(3)) also applies to this paragraph (b)(2)(ii)(C).
(D) Hyperinflationary currency. For purposes of sections 985 through 989, the term hyperinflationary currency means the currency of a country in which there is cumulative inflation during the base period of at least 100 percent as determined by reference to the consumer price index of the country listed in the monthly issues of the “International Financial Statistics” or a successor publication of the International Monetary Fund. If a country's currency is not listed in the monthly issues of “International Financial Statistics,” a QBU may use any other reasonable method consistently applied for determining the country's consumer price index. Base period means, with respect to any taxable year, the thirty-six calendar months immediately preceding the first day of the current calendar year. For this purpose, the cumulative inflation rate for the base period is based on compounded inflation rates. Thus, if for 1991, 1992, and 1993, a country's annual inflation rates are 29 percent, 25 percent, and 30 percent, respectively, the cumulative inflation rate for the three-year base period is 110 percent [((1.29 × 1.25 × 1.3)−1.0 × 1.10) × 100 = 110%] and the currency of the country for the QBU's 1994 year is considered hyperinflationary. In making the determination whether a currency is hyperinflationary, the determination for purposes of United States generally accepted accounting principles may be used for income tax purposes provided the determination is based on criteria that is substantially similar to the rules previously set forth in this paragraph (b)(2)(ii)(D), the method of determination is applied consistently from year to year, and the same method is applied to all related persons as defined in § 1.985-3(e)(2)(vi).
(E) Change in functional currency when currency ceases to be hyperinflationary —( 1 ) In general. A QBU that has been required to use the dollar as its functional currency under paragraph (b)(2) of this section, or has elected to use the dollar as its functional currency under paragraph (b)(2)(ii)(B)( 2 ) of this section or § 1.985-2, must change its functional currency as of the first day of the first taxable year that follows three consecutive taxable years in which the currency of its economic environment, determined under paragraph (c)(2) of this section, is not a hyperinflationary currency. The functional currency of the QBU for such year shall be determined in accordance with paragraph (c) of this section. For purposes of § 1.985-4, the change is considered to be made with the consent of the Commissioner. See § 1.985-5 for adjustments that are required upon a change in functional currency.
( 2 ) Effective Date. This paragraph (b)(2)(ii)(E) of this section applies to taxable years beginning after April 6, 1998.
(c) Functional currency of a QBU that is not required to use the dollar —(1) General rule. The functional currency of a QBU that is not required to use the dollar under paragraph (b) of this section shall be the currency of the economic environment in which a significant part of the QBU's activities is conducted, if the QBU keeps, or is presumed under paragraph (c)(3) of this section to keep, its books and records in such currency.
(2) Economic environment. For purposes of section 985 and the regulations thereunder, the economic environment in which a significant part of a QBU's activities is conducted shall be determined by taking into account all the facts and circumstances.
(i) Facts and circumstances. The facts and circumstances that are considered in determining the economic environment in which a significant part of a QBU's activities is conducted include, but are not limited to, the following:
(A) The currency of the country in which the QBU is a resident as determined under section 988(a)(3)(B);
(B) The currencies of the QBU's cash flows;
(C) The currencies in which the QBU generates revenues and incurs expenses;
(D) The currencies in which the QBU borrows and lends;
(E) The currencies of the QBU's sales markets;
(F) The currencies in which pricing and other financial decisions are made;
(G) The duration of the QBU's business operations; and
(H) The significance and/or volume of the QBU's independent activities.
(ii) Rate of inflation. The rate of inflation (regardless of how it is determined) shall not be a factor used to determine a QBU's economic environment.
(iii) Consistency. A taxpayer must consistently apply the facts and circumstances test set forth in this paragraph (c)(2) in evaluating the economic environment of its QBUs, e.g., its branches, that engage in the same or similar trades or businesses.
(3) Books and records presumption. A QBU shall be presumed to keep books and records in the currency of the economic environment in which a significant part of its activities are conducted. The presumption may be overcome only if the QBU can demonstrate to the satisfaction of the district director that a substantial nontax purpose exists for not keeping any books and records in such currency. A taxpayer may not use this presumption affirmatively in determining a QBU's functional currency.
(4) Multiple currencies. If a QBU has more than one currency that satisfies the requirements of paragraph (c)(1) of this section, the QBU may choose any such currency as its functional currency.
(5) Relationship of United States accounting principles. In making the functional currency determination under this paragraph (c), the currency of the QBU for purposes of United States generally accepted accounting principles (GAAP) will ordinarily be accepted as the functional currency of the QBU for income tax purposes, provided that the GAAP determination is based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section.
(6) Effect of changed circumstances. Regardless of any change in circumstances, a QBU may change its functional currency determined under this paragraph (c) only if the QBU complies with § 1.985-4 or the Commissioner's consent is considered to have been granted under § 1.985-2(d)(4) or § 1.985-3(a)(2)(ii). For special rules relating to the conversion to the euro, see § 1.985-8.
(d) Single functional currency for a foreign corporation —(1) General rule. This paragraph (d) applies to a foreign corporation that has two or more QBUs that do not have the same functional currency. The foreign corporation shall be treated as having a single functional currency for the corporation as a whole that is different from the functional currency of one or more of its QBUs. The determination of a foreign corporation's functional currency shall be made by first applying paragraph (d)(1)(i) and then paragraph (d)(l)(ii) of this section.
(i) Step 1. Each QBU of the foreign corporation determines its functional currency in accordance with the rules set forth in paragraphs (b) and (c) of this section and § 1.985-2.
(ii) Step 2. The foreign corporation determines its functional currency applying the principles of paragraphs (b) and (c) of this section to the corporation's activities as a whole. Thus, if a foreign corporation has two branches, the corporation shall determine its functional currency by applying the principles of paragraphs (b) and (c) of this section to the combined activities of the corporation and the branches. For purposes of this paragraph (d)(1), if a QBU of a foreign corporation has the dollar as its functional currency under paragraph (b)(2) of this section, the QBU's activities shall be considered dollar activities of the corporation.
(2) Translation of income or loss of QBUs having different functional currencies than the foreign corporation as a whole. Where the functional currency of a foreign corporation as a whole differs from the functional currency of one or more of its QBUs, each such QBU shall determine the amount of its income or loss or earnings and profits (or deficit in earnings and profits) in its functional currency under the principles of section 987 (relating to branch transactions). The amount of income or loss or earnings and profits (or deficit in earnings and profits) of each QBU in its functional currency shall then be translated into the foreign corporation's functional currency using the appropriate exchange rate as defined in section 989(b)(4) for purposes of determining the corporation's income or loss or earnings and profits (or deficit in earnings and profits).
(e) Translation of nonfunctional currency transactions. Except for a QBU using the dollar approximate separate transactions method described in § 1.985-3, see section 988 and the regulations thereunder for the treatment of nonfunctional currency transactions.
(f) Examples. The provisions of this section are illustrated by the following examples:
(1) Example 1. P, a domestic corporation, operates exclusively through foreign branch X in Country A. X is a QBU within the meaning of section 989(a) and its residence is Country A as determined under section 988 (a)(3)(B). The currency of Country A is the LC. All of X's purchases, sales, and expenses are in the LC. The laws of A require X to keep books and records in the LC. It is determined that the LC is the currency of X under United States generally accepted accounting principles. This determination is based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section. Under these facts, while the functional currency of P is the dollar since its residence is the United States, the functional currency of X is the LC.
(2) Example 2. P, a publicly-held domestic regulated investment company (as defined under section 851), operates exclusively through foreign branch B in Country R. B is a QBU within the meaning of section 989(a) and its residence is Country R as determined under section 988(a)(3)(B). The currency of Country R is the LC. B's principal activities consist of purchasing and selling stock and securities of Country R companies and securities issued by Country R. It is determined that the dollar is the currency of B under United States generally accepted accounting principles. This determination is not based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section. Under these facts, while the functional currency of P is the dollar since its residence is the United States, B may choose the LC as its functional currency because it has significant activities in the LC provided it keeps books and records in the LC. The fact that the dollar is the currency of B under generally accepted accounting principles is irrelevant for purposes of determining B's functional currency because the GAAP determination was not based on factors similar to those set forth in paragraph (c)(2) of this section.
(3) Example 3. P, a domestic bank, operates through foreign branch X in Country R. X is a QBU within the meaning of section 989(a) and its residence is Country R as determined under section 988(a)(3)(B). The currency of Country R is the LC. The laws of R require X to keep books and records in the LC. The branch customarily loans dollars and LCs. In the case of its LC loans, X ordinarily fixes the terms of the loans by reference to a contemporary London Inter-Bank Offered Rate (LIBOR) on dollar deposits. For instance, the interest on the amount of the outstanding LC loan principal might equal LIBOR plus 2 percent and the amount of the outstanding LC loan principal would be adjusted to reflect changes in the dollar value of the LC. X is primarily funded with dollar-denominated funds borrowed from related and unrelated parties. X's only LC activities are paying local taxes, employee wages, and local expenses such as rent and electricity. Under these facts, X's activities are primarily conducted in dollars. Thus, although X keeps its books and records in LCs, X's functional currency is the dollar.
(4) Example 4. S, a foreign corporation organized in Country U, is wholly-owned by P, a domestic corporation. The currency of Country U is the LC. S's sole function is acting as a financing vehicle for P and domestic corporations that are affiliated with P. All borrowing and lending transactions between S and P and its domestic affiliates are in dollars. Furthermore, primarily all of S's other borrowings are dollar-denominated or based on a dollar index. S's only LC activities are paying local taxes, employee wages, and local expenses such as rent and electricity. S keeps its books and records in the LC. Under these facts, S's activities are primarily conducted in dollars. Thus, although S keeps its books and records in LCs, S's functional currency is the dollar.
(5) Example 5. D is a domestic corporation whose primary activity is the extraction of natural gas and oil through foreign branch X in Country Y. X is a QBU within the meaning of section 989(a) and its residence is Country Y as determined under section 988(a)(3)(B). The currency of Country Y is the LC. X bills a significant amount of its natural gas and oil sales in dollars and a significant amount in LCs. X also incurs significant LC and dollar expenses and liabilities. The laws of Country Y require X to keep its books and records in the LC. It is determined that the LC is the currency of X under United States generally accepted accounting principles. This determination is based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section. Absent other factors indicating that X primarily conducts its activities in the dollar, D could choose either the dollar or the LC as X's functional currency because X has significant activities in both the dollar and the LC, provided the books and records requirement is satisfied. If, instead, X's activities were determined to be primarily in the dollar, then X would have to use the dollar as its functional currency.
(6) Example 6. S, a foreign corporation organized in Country U, is wholly-owned by P, a domestic corporation. The currency of U is the LC. S purchases the products it sells from related and unrelated parties, including P. These purchases are made in the LC. In addition, most of S's gross receipts are generated by transactions denominated in the LC. S attempts to determine its LC price for goods sold in such a manner as to obtain an LC equivalent of a certain dollar amount after reduction for all LC costs. However, local market conditions sometimes result in pricing adjustments. Thus, changes in the LC-dollar exchange rate from period to period generally result in corresponding changes in the LC price of S's products. S pays local taxes, employee wages, and other local expenses in the LC. It is determined that the dollar is the currency of S under United States generally accepted accounting principles. This determination is not based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section. Under these facts, S could choose either the dollar or the LC as its functional currency because S has significant activities in both the dollar and the LC, provided that the books and records requirement is satisfied.
(7) Example 7. S, a foreign corporation organized in Country X, is wholly-owned by P, a domestic corporation. S conducts all of its operations through two branches. Branch A is located in Country F and branch B is located in Country G. S, A, and B are QBUs within the meaning of section 989(a). Branch A's and branch B's residences are Country F and Country G respectively as determined under section 988(a)(3)(B). The currency of Country F is the FC and the currency of Country G is the LC. The functional currencies of S, A, and B are determined in a two step procedure.
Step 1: The functional currency of branches A and B. Branch A and branch B both conduct all activities in their respective local currencies. The FC is the currency of branch A and the LC is the currency of branch B under United States generally accepted accounting principles. This determination is based on facts and circumstances substantially similar to those set forth in paragraph (c)(2) of this section. Under these facts, the functional currency of branch A is the FC and the functional currency of branch B is the LC.
Step 2: The functional currency of S. S's functional currency is determined by disregarding the fact that A and B are branches. When A's activities and B's activities are viewed as a whole, S determines that it only conducts significant activities in the LC. Therefore, S's functional currency is the LC. See Examples 9, 10, and 11 for how the earnings and profits of a foreign corporation, which has branches with different functional currencies, are determined.
(8) Example 8. Assume the same facts as in Example 7, except that S does not exist and P conducts all of its operations through branch A and branch B. In this instance P's functional currency in Step 2 is the dollar, regardless of the fact that its branches' activities viewed as a whole are in the LC, because P is a taxpayer whose residence is the United States under section 988(a)(3)(B)(i). Therefore, while the functional currency of branch A is the FC and the functional currency of branch B is the LC, the functional currency of P is the dollar because its residence is the United States.
(9)-(11) [Reserved]
(12) Example 12. F, a foreign corporation, has gain from the disposition of a United States real property interest (as defined in section 897(c)). The gain is taken into account as if F were engaged in a trade or business within the United States during the taxable year and as if such gain were effectively connected with such trade or business. F's disposition activity shall be treated as a separate QBU with a dollar functional currency because such activity produced income that is treated as effectively connected with a trade or business within the United States. Therefore, F must compute its gain from the disposition by giving the United States real property interest an historic dollar basis.
§ 1.985-2   Election to use the United States dollar as the functional currency of a QBU.
(a) Background and scope —(1) In general. This section permits an eligible QBU to elect to use the dollar as its functional currency for taxable years beginning on or before August 24, 1994. An election to use a dollar functional currency is not permitted for a QBU other than an eligible QBU. Paragraph (b) of this section defines an eligible QBU. Paragraph (c) of this section describes the time and manner for making the dollar election and paragraph (d) of this section describes the effect of making the election. For the definition of a QBU, see section 989(a). See § 1.985-1(b)(2)(ii) for rules requiring a QBU to use the dollar as its functional currency in taxable years beginning after August 24, 1994.
(2) Exception. Pursuant to § 1.985-1(b)(2)(ii)(B)( 2 ), the rules of paragraph (c)(3) of this section shall apply with respect to the procedure required to be followed by a noncontrolled section 902 corporation as defined in section 904(d)(2)(E) to elect the dollar as its (or its QBU branch's) functional currency and the application of § 1.985-3.
(b) Eligible QBU —(1) In general. The term “eligible QBU” means a QBU that could have used a hyperinflationary currency as its functional currency absent the dollar election. See § 1.985-1 for how a QBU determines its functional currency absent the dollar election.
(2) Hyperinflationary currency. See § 1.985-1(b)(2)(ii)(D) for the definition of hyperinflationary currency.
(c) Time and manner for dollar election —(1) QBUs that are branches of United States persons —(i) Rule. If an eligible QBU is a branch of a United States person, the dollar election shall be made by attaching a completed Form 8819 to the United States person's timely filed (taking extensions into account) tax return for the first taxable year for which the election is to be effective.
(ii) Procedure prior to the issuance of Form 8819. In the absence of Form 8819, the election shall be made in accordance with § 1.985-2T(c)(1). Failure to file an amended return within the time period prescribed in § 1.985-2T(c)(1) shall not invalidate the dollar election if it is established to the satisfaction of the district director that reasonable cause existed for such failure. A subsequent election for 1988 will not prejudice the taxpayer with respect to such reasonable cause determination. Nevertheless, each United States person making an election under the § 1.985-2T(c)(1) must file a Form 8819 in the time and manner provided in the Form's instructions.
(2) Eligible QBUs that are controlled foreign corporations or branches of controlled foreign corporations —(i) Rule. If an eligible QBU is a controlled foreign corporation (as described in section 957), or a branch of a controlled foreign corporation, the election may be made either by the foreign corporation or by the controlling United States shareholders on behalf of the foreign corporation by—
(A) Filing a completed Form 8819 in the time and manner provided in the Form's instructions, and
(B) Providing the written notice required by paragraph (c)(2)(ii) of this section at the time and in the manner prescribed therein.
(ii) Notice. Prior to filing Form 8819, the controlling United States shareholders (or the foreign corporation, if the dollar election is made by the corporation) shall provide written notice that the dollar election will be made to all United States persons known to be shareholders who own (within the meaning of section 958(a)) stock of the foreign corporation. Such notice shall also include all information required in Form 8819.
(iii) Reasonable cause exception. Failure of the controlling United States shareholders (or the foreign corporation, if the dollar election is made by the corporation) to timely file Form 8819 or provide written notice to a United States person required to be notified by paragraph (c)(2)(ii) of this section shall not invalidate the dollar election, if it is established to the satisfaction of the district director that reasonable cause existed for such failure.
(iv) Procedure prior to the issuance of Form 8819. In the absence of Form 8819, an eligible QBU described in paragraph (c)(2)(i) of this section shall make the dollar election in accordance with § 1.985-2T(c)(2). Nevertheless, the person or persons that made such election must file a Form 8819 in the time and manner provided in the Form's instructions.
(3) Eligible QBUs that are noncontrolled foreign corporations or branches of noncontrolled foreign corporations —(i) Rule. If an eligible QBU is a noncontrolled foreign corporation (a foreign corporation not described in section 957), or a branch of a noncontrolled foreign corporation, the dollar election must be made by the corporation or the majority domestic corporate shareholders on behalf of the corporation by applying the rules provided in paragraph (c)(2)(i)(A) and (B), (ii), (iii), and (iv) of this section substituting “majority domestic corporate shareholders” for “controlling United States shareholders” wherever it appears therein. The term “majority domestic corporate shareholders” means those domestic corporate shareholders (as described in section 902(a)) who, in the aggregate, own (within the meaning of section 958(a)) greater than 50 percent of the total combined voting stock of all classes of stock of the noncontrolled foreign corporation entitled to vote that is owned (within the meaning of section 958(a)) by all the domestic corporate shareholders.
(ii) Procedure prior to the issuance of Form 8819. In the absence of Form 8819, an eligible QBU described in paragraph (c)(3)(i) of this section shall make the dollar election in accordance with § 1.985-2T(c)(3). Nevertheless, the person or persons that made such election must file a Form 8819 in the time and manner provided in the Form's instructions.
(4) Others. Any other person making a dollar election under this section shall elect by filing Form 8819 and fulfilling any other notice requirements that may be required by the Commissioner.
(d) Effect of dollar election —(1) General rule. If a dollar election is made (or considered made under paragraph (d)(3) of this section) by or on behalf of an eligible QBU, the QBU shall be deemed to have the dollar as its functional currency. Each United States person that owns (within the meaning of section 958(a)) stock of a foreign corporation which has the dollar as its functional currency under § 1.985-2 must make all of its federal income tax calculations with respect to the foreign corporation using the dollar as the corporation's functional currency (regardless of when ownership was acquired or whether the United States person received the written notice required by paragraph (c)(2)(i)(B) of this section).
(2) Computation —(i) In general. Except as provided in paragraph (d)(2)(ii) of this section, any eligible QBU that pursuant to this § 1.985-2 has a dollar functional currency must compute income or loss or earnings and profits (or deficit in earnings and profits) in dollars using the dollar approximate separate transactions method described in § 1.985-3.
(ii) Alternative method. An eligible QBU that has a dollar functional currency pursuant to this § 1.985-2 may use a method other than the dollar approximate separate transactions method described in § 1.985-3 only if the QBU demonstrates to the satisfaction of the Commissioner that it can properly employ such method. Generally, the QBU must show that it could compute foreign currency gain or loss under the principles of section 988 with respect to each of its section 988 transactions. If subsequently the QBU can no longer demonstrate to the satisfaction of the district director that it can properly employ such an alternative method, then the QBU will be deemed to have changed its method of accounting to the dollar approximate separate transactions method described in § 1.985-3. This change in accounting will be treated as having been made with the consent of the Commissioner. No adjustments under either § 1.985-5T (or any succeeding final regulation) or section 481(a) shall be required solely because of the change. Rather the QBU shall begin accounting for its operations under § 1.985-3 based on its dollar books and records as of the time of the change.
(3) Conformity —(i) General rule. If a dollar election is made under this § 1.985-2 for an eligible QBU (“electing QBU”), then the dollar shall be the functional currency of any related person (regardless of when such person became related to the electing QBU) that is an eligible QBU, or any branch of any such related person that is an eligible QBU. For purposes of the preceding sentence, the term “related person” means any person with a relationship defined in section 267 (b) to the electing QBU (or to the United States or foreign person of which the electing QBU is a part). In determining whether two or more corporations are members of the same controlled group under section 267(b)(3), a person is considered to own stock owned directly by such person, stock owned with the application of section 1563(e)(1), and stock owned with the application of section 267(c).
(ii) Branches of United States and foreign persons. If a dollar election is made for a QBU branch of any person, each eligible QBU branch of such person shall have the dollar as its functional currency.
(4) Required adjustments. If an eligible QBU's functional currency changes due to a dollar election, or due to the conformity requirements of paragraph (d)(3) of this section, such change shall be deemed for purposes of § 1.9B5-4 to be consented to by the Commissioner. No adjustments under section 481(a) shall be required solely because of the change. However, the QBU must make those adjustments required by § 1.985-5T (or any succeeding final regulation).
(5) Taxable year conformity required. Generally, the adjustments required by paragraph (d)(4) of this section shall be made for a related person's taxable year—
(i) That includes the date in which the electing QBU made the dollar election if the person was related to such electing QBU at any time during the QBU's taxable year that includes such date, or
(ii) During which the person first becomes related to any electing QBU, in all other cases.
(6) Availability of election. A dollar election may be made by or on behalf of a QBU, or considered made under the conformity rule of paragraph (d)(3), in any year in which the QBU is an eligible QBU. If a dollar election is not made by or on behalf of a QBU for its first taxable year beginning after December 31, 1986 in which it is an eligible QBU, then any dollar election made by or on behalf of the QBU, or considered made under the conformity rules of paragraph (d)(3) of this section, that results in a change in the QBU's functional currency shall be treated as having been made with the consent of the Commissioner. In such a case, however, the taxpayer must make those adjustments required by § 1.985-5T (or any succeeding final regulation).
(7) Effect of changed circumstances. Regardless of any change in circumstances ( e.g., a currency ceases to qualify as hyperinflationary), a QBU whose functional currency is the dollar under this section may change its functional currency only if the QBU complies with § 1.985-4.
(8) Examples. The provisions of this section are illustrated by the following examples.
§ 1.985-3   United States dollar approximate separate transactions method.
(a) Scope and effective date —(1) Scope. This section describes the United States dollar (dollar) approximate separate transactions method of accounting (DASTM). For all purposes of subtitle A, this method of accounting must be used to compute the gross income, taxable income or loss, or earnings and profits (or deficit in earnings and profits) of a QBU (as defined in section 989(a)) that has the dollar as its functional currency pursuant to § 1.985-1(b)(2).
(2) Effective date —(i) In general. This section is effective for taxable years beginning after August 24, 1994.
(ii) DASTM prior-year election. A taxpayer may elect to apply this section to any open taxable year beginning after December 31, 1986 (whether or not DASTM has been previously elected for some or all of those years). In order to make this election, the taxpayer must apply § 1.985-3 to that year and all subsequent years. In addition, each person that is related (within the meaning of § 1.985-3(e)(2)(vi)) to the taxpayer on the last day of any taxable year for which the election is effective and that would have been eligible to elect DASTM must also apply these rules to that year and all subsequent years. A taxpayer that has not previously elected to apply DASTM to its prior taxable years may make the DASTM election for the pertinent years by filing amended returns and complying with the applicable election procedures of § 1.985-2. Form 8819 shall be attached to the return for the first year for which the election is to be effective. A taxpayer that has elected DASTM for prior taxable years and applied the rules under § 1.985-3 (as contained in the April 1, 1994 edition of 26 CFR part 1 (1.908 to 1.1000)) may amend its returns to apply the rules of this § 1.985-3. In either case, the DASTM election for prior taxable years shall be deemed to be made with the consent of the Commissioner.
(b) Statement of method. Under DASTM, income or loss or earnings and profits (or a deficit in earnings and profits) of a QBU for its taxable year shall be determined in dollars by—
(1) Preparing an income or loss statement from the QBU's books and records (within the meaning of § 1.989(a)-1(d)) as recorded in the QBU's hyperinflationary currency (as defined in § 1.985-1(b)(2)(ii)(D));
(2) Making the adjustments necessary to conform such statement to United States generally accepted accounting principles and tax accounting principles (including reversing monetary correction adjustments required by local accounting principles);
(3) Translating the amounts of hyperinflationary currency as shown on such adjusted statement into dollars in accordance with paragraph (c) of this section; and
(4) Adjusting the resulting dollar income or loss or earnings and profits (or deficit in earnings and profits) and, where necessary, particular items of gross income, deductible expense or other amounts, in accordance with paragraph (e) of this section to reflect the amount of DASTM gain or loss as determined under paragraph (d) of this section.
(c) Translation into United States dollars —(1) In general. Except as otherwise provided in this paragraph (c), the amounts shown on the income or loss statement, as adjusted under paragraph (b)(2) of this section, shall be translated into dollars at the exchange rate (as defined in paragraph (c)(6) of this section) for the translation period (as defined in paragraph (c)(7) of this section) to which they relate. However, if the QBU previously changed its functional currency to the dollar, and the rules of § 1.985-5 (or, if applicable, § 1.985-5T, as contained in the April 1, 1993 edition of 26 CFR part 1 (1.908 to 1.1000)) applied in translating its balance sheet amounts into dollars, then the spot exchange rate applied under those rules shall be used to translate any amount that would otherwise be translated at a rate determined by reference to a translation period prior to the change in functional currency. For example, depreciation with respect to an asset acquired while the QBU had a nondollar functional currency shall be translated into dollars at the spot rate on the last day of the taxable year before the year of change to a dollar functional currency, rather than at the rate for the period in which the asset was acquired.
(2) Cost of goods sold. The dollar value of cost of goods sold shall equal the sum of the dollar values of beginning inventory and purchases less the dollar value of closing inventory as these amounts are determined under paragraph (c)(3) of this section.
(3) Beginning inventory, purchases, and closing inventory —(i) Beginning inventory. Amounts representing beginning inventory shall be translated so as to obtain the same amount of dollars which represented such items in the closing inventory balance for the preceding taxable year.
(ii) Purchases. Amounts representing items purchased or otherwise first included in inventory during the taxable year shall be translated at the exchange rate for the translation period in which the cost of such items was incurred.
(iii) Closing inventory —(A) In general. Amounts representing items included in the closing inventory balance shall be translated at the exchange rate for the translation period in which the cost of such items was incurred. However, if amounts representing items included in the closing inventory balance are either valued at market or written down to market value, they shall be translated at the exchange rate existing on the last day of the taxable year. For purposes of determining lower of cost or market, items of inventory included in the closing inventory balance shall be translated into dollars at the exchange rate for the translation period in which the cost of such items was incurred and compared with market as determined in the QBU's hyperinflationary currency translated into dollars at the exchange rate existing on the last day of the taxable year.
(B) Determination of translation period. The method used to determine the translation period of amounts representing items of closing inventory for purposes of paragraph (c)(3)(iii)(A) of this section may be based upon reasonable approximations and averages, including rates of turnover, provided that the method is used consistently from year to year.
(4) Depreciation, depletion, and amortization. Amounts representing allowances for depreciation, depletion, or amortization shall be translated at the exchange rate for the translation period in which the cost of the underlying asset was incurred, except as provided in paragraph (c)(1) of this section.
(5) Prepaid expenses or income. Amounts representing expense or income paid or received in a prior taxable year shall be translated at the exchange rate for the translation period during which they were paid or received.
(6) Exchange rate. The exchange rate for a translation period may be determined under any reasonable method, provided that the method is consistently applied to all translation periods and conforms to the taxpayer's method of financial accounting. Reasonable methods include the average of beginning and ending exchange rates for the translation period and the spot rate on the last day of the translation period. Once chosen, a method for determining an exchange rate can be changed only with the consent of the district director.
(7) Translation period —(i) In general. Except as provided in paragraphs (c)(3)(iii)(B) and (c)(7)(ii) of this section, a translation period shall be each month within a QBU's taxable year.
(ii) Exception. A taxpayer may divide its taxable year into translation periods of equal length (with not more than one short period annually) that are less than one month. Once such a translation period is established, it may not be changed without the consent of the district director.
(8) Dollar transactions —(i) In general. Except as provided in paragraph (c)(8)(ii) of this section, no DASTM gain or loss is realized with respect to dollar transactions since the dollar is the functional currency of the QBU. Thus, the amount of any payment or receipt of dollars shall be reflected in the income or loss statement by the amount of such dollars. Also, the income or loss attributable to any transaction in which the amount that a QBU is entitled to receive (or is required to pay) by reason of such transaction is denominated in terms of the dollar, or is determined by reference to the value of the dollar, must be computed transaction by transaction. For example, if a foreign corporation lends 20 LC when 20 LC = $20 and is entitled to receive the LC equivalent of $20 at maturity plus a market rate of interest in dollars (or its LC equivalent), the loan is a dollar transaction. Similarly, this paragraph applies to any transaction that is determined to be a dollar transaction under section 988.
(ii) Non-dollar functional currency. If pursuant to § 1.985-1(b)(2)(ii)(B)( 1 ), a QBU is required to use a functional currency other than the dollar, then that currency shall be substituted for the dollar in applying paragraph (c)(8)(i) of this section.
(9) Third currency transactions. A taxpayer may use any reasonable method of accounting for transactions described in sections 988(c)(1)(B) and (C) that are denominated in, or determined by reference to, a currency other than the QBU's hyperinflationary currency or the dollar (third currency transactions) so long as such method is consistent with its method of financial accounting.
(10) Examples. The provisions of this paragraph (c) are illustrated by the following examples:
1 Where multiple months are indicated, the exchange rate applies for all months.
2 See paragraph (ii) of this Example.
(d) Computation of DASTM gain or loss —(1) Rule. DASTM gain or loss of a QBU equals—
(i) The net worth of the QBU (as determined under paragraph (d)(2) of this section) at the end of the taxable year minus the net worth of the QBU at the end of the preceding taxable year; plus
(ii) The dollar amount of the items described in paragraph (d)(3) of this section and minus the dollar amount of the items described in paragraph (d)(4) of this section; minus
(iii) The amount of dollar income or earnings and profits (or plus the amount of any dollar loss or deficit in earnings and profits) as determined for the taxable year pursuant to paragraphs (b)(1) through (b)(3) of this section.
(2) Net worth. Net worth of a QBU at the end of any taxable year equals the aggregate dollar amount representing assets on the QBU's balance sheet at the end of the taxable year less the aggregate dollar amount representing liabilities on the balance sheet. Notwithstanding any other provision in this paragraph (d)(2), the district director may adjust the amount of any asset or liability if a purpose for acquiring (or disposing of) the asset or incurring (or discharging) the liability is to manipulate the composition of the balance sheet for any period during the taxable year in order to avoid tax. The taxpayer shall determine net worth by—
(i) Preparing a balance sheet as of the end of the taxable year from the QBU's books and records (within the meaning of § 1.989(a)-1(d)) as recorded in the QBU's hyperinflationary currency;
(ii) Making adjustments necessary to conform such balance sheet to United States generally accepted accounting principles and tax accounting principles (including reversing monetary correction adjustments required by local accounting principles); and
(iii) Translating the asset and liability amounts shown on the balance sheet into United States dollars in accordance with paragraph (d)(5) of this section.
(3) Positive adjustments —(i) In general. The items described in this paragraph (d)(3) are dividend distributions for the taxable year and any items that decrease net worth for the taxable year but that generally do not affect income or loss or earnings and profits (or a deficit in earnings and profits). Such items include a transfer to the home office of a QBU branch and a return of capital.
(ii) Translation. Except as provided by ruling or administrative pronouncement, items described in paragraph (d)(3)(i) of this section shall be translated into dollars as follows:
(A) If the item giving rise to the adjustment would be translated under paragraph (d)(5) of this section at the exchange rate for the last translation period of the taxable year if it were shown on the QBU's year-end balance sheet, such item shall be translated at the exchange rate on the date the item is transferred.
(B) If the item giving rise to the adjustment would be translated under paragraph (d)(5) of this section at the exchange rate for the translation period in which the cost of the item was incurred if it were shown on the QBU's year-end balance sheet, such item shall be translated at the same historical rate.
(iii) Effective date. Paragraph (d)(3)(ii) of this section is applicable for any transfer, dividend, or distribution that is a return of capital that is made after March 8, 2005, and that gives rise to an adjustment under this paragraph (d)(3).
(4) Negative adjustments. The items described in this paragraph (d)(4) are items that increase net worth for the taxable year but that generally do not affect income or loss or earnings and profits (or a deficit in earnings and profits). Such items include a capital contribution or a transfer from a home office to a QBU branch. Except as otherwise provided by ruling or administrative pronouncement, if the contribution or transfer is not in dollars, the amount of a capital contribution or transfer shall be translated into dollars at the exchange rate on the date made.
(5) Translation of balance sheet. Asset and liability amounts shown on the balance sheet in hyperinflationary currency (adjusted pursuant to paragraph (d)(2)(ii) of this section) shall be translated into dollars as provided in this paragraph (d)(5). However, if the QBU previously changed its functional currency to the dollar and the rules of § 1.985-5 (or, if applicable, § 1.985-5T, as contained in the April 1, 1993 edition of 26 CFR part 1 (1.908 to 1.1000)) applied in translating its balance sheet amounts into dollars, then the spot exchange rate applied under those rules shall be used to translate any amount that would otherwise be translated at a rate determined by reference to a translation period prior to the change in functional currency. For example, the basis of real property acquired while the QBU had a nondollar functional currency shall be translated into dollars at the spot rate on the last day of the taxable year before the year of change to a dollar functional currency, rather than at the rate for the period in which the cost was incurred.
(i) Closing inventory. Amounts representing items of inventory included in the closing inventory balance shall be translated in accordance with paragraph (c)(3)(iii) of this section.
(ii) Bad debt reserves. Amounts representing bad debt reserves shall be translated at the exchange rate for the last translation period for the taxable year.
(iii) Prepaid income or expense. Amounts representing expenses or income paid or received in a prior taxable year shall be translated in accordance with paragraph (c)(5) of this section.
(iv) Hyperinflationary currency. Amounts of the hyperinflationary currency and hyperinflationary demand deposit balances shall be translated at the exchange rate for the last translation period of the taxable year.
(v) Certain assets —(A) In general. Amounts representing plant, real property, equipment, goodwill, and patents and other intangibles shall be translated at the exchange rate for the translation period in which the cost of the asset was incurred.
(B) Adjustment to certain assets. Amounts representing depreciation, depletion, and amortization reserves shall be translated in accordance with paragraph (c)(4) of this section.
(vi) Hyperinflationary debt obligations. Except as provided in paragraph (d)(5)(vii) of this section, amounts representing a hyperinflationary debt obligation (including accounts receivable and payable) shall be translated at the exchange rate for the last translation period for the taxable year.
(vii) Accrued foreign income taxes. Amounts representing an accrued but unpaid foreign income tax shall be translated at the exchange rate on the last day of the last translation period of the taxable year of accrual.
(viii) Certain hyperinflationary financial instruments. Amounts representing any item described in section 988(c)(1)(B)(iii) (relating to forward contracts, futures contracts, options, or similar financial instruments) denominated in or determined by reference to the hyperinflationary currency shall be translated at the exchange rate for the last translation period for the taxable year.
(ix) Other assets and liabilities. Amounts representing assets and liabilities, other than those described in paragraphs (d)(5)(i) through (viii) of this section, shall be translated at the exchange rate for the translation period in which the cost of the asset or the amount of the liability was incurred.
(6) Dollar transactions. Notwithstanding any other provisions of this paragraph (d), where the amount representing an item shown on the balance sheet reflects a dollar transaction (described in paragraph (c)(8) of this section), the transaction shall be taken into account in accordance with that paragraph.
(7) Third currency transactions. A taxpayer may use any reasonable method of accounting for transactions described in section 988(c)(1)(B) and (C) that are denominated in, or determined by reference to, a currency other than the QBU's hyperinflationary currency or the dollar (third currency transactions), so long as such method is consistent with its method of financial accounting.
(8) Character. The amount of DASTM gain or loss determined under paragraph (d)(1) of this section shall be ordinary income or loss.
(9) Example. The provisions of this paragraph (d) are illustrated by the following example:
1 S ages its accounts receivable and groups them into two categories—those outstanding for 30 days and those outstanding for 60 days.
2 Translated the same as closing inventory under paragraph (c)(3)(iii).
3 The cost of S's plant was incurred in several translation periods. Therefore, the dollar cost and dollar depreciation reflect several translation rates.
4 S has a variety of equipment. Therefore, S's dollar basis represents the sum of the hyperinflationary cost of each, translated according to the exchange rate for the translation period incurred.
1 The exchange rates on the date of the April and December dividends were 33.5h:$1 and 39.5h:$1, respectively.
(e) Effect of DASTM gain or loss on gross income, taxable income, or earnings and profits —(1) In general. For all purposes of subtitle A, the amount of DASTM gain or loss of a QBU determined under paragraph (d) of this section is taken into account by the QBU for purposes of determining the amount of its gross income, taxable income or loss, earnings and profits (or deficit in earnings and profits), and, where necessary, particular items of income, expense or other amounts. DASTM gain or loss is allocated under one of two methods. Certain small QBUs may elect the small QBU DASTM allocation described in paragraph (e)(2) of this section. All other QBUs must use the 9-step procedure described in paragraph (e)(3) of this section.
(2) Small QBU DASTM allocation —(i) Election threshold. A taxpayer may elect to use the small QBU DASTM allocation described in paragraph (e)(2)(iv) of this section with respect to a QBU that has an adjusted basis in assets (translated as provided in paragraph (d)(5) of this section) of $10 million or less at the end of any taxable year. In calculating the $10 million threshold, a QBU shall be treated as owning all of the assets of each related QBU (as defined in paragraph (e)(2)(vi) of this section) having its residence (as defined in section 988(a)(3)(B)) in the QBU's country of residence (related same- country QBU). For this purpose, appropriate adjustment shall be made to eliminate the double counting of assets created in transactions between related QBUs resident in the same country. For example, assume QBU-1, resident in country X, sells inventory to related QBU-2, also resident in country X, in exchange for an account receivable. For purposes of determining the assets of QBU-1 under this paragraph (e)(2)(i), the taxpayer shall take into account either the inventory shown on the books of QBU-2 or QBU-1's receivable from QBU-2 (but not both).
(ii) Consent to election. The election of the small QBU DASTM allocation or subsequent application of the rules of paragraph (e)(3) of this section due to an increase in the adjusted basis of the QBU's assets shall be deemed to have been made with the consent of the Commissioner. Once the election under paragraph (e)(2)(iii) of this section is made, it shall apply for all years in which the adjusted basis of the assets of the QBU (and any related same-country QBU) is $10 million or less, unless revoked with the Commissioner's consent. If the adjusted basis of the assets of the QBU (and any related same- country QBU) exceeds $10 million at the end of any taxable year, the rules of paragraph (e)(3) of this section shall apply to that QBU (and any related same-country QBU) for such year and each subsequent year unless such QBU again qualifies, and applies for and obtains the Commissioner's consent, to use the small QBU DASTM allocation. However, if a QBU acquires assets with a principal purpose of avoiding the application of paragraph (e)(2)(iv) of this section, the Commissioner may disregard the acquisition of such assets.
(iii) Manner of making election —(A) QBUs that are branches of United States persons. For the first year in which this election is effective, in the case of a QBU branch of a United States person, a statement shall be attached to the United States person's timely filed Federal income tax return (taking extensions into account). The statement shall identify the QBU (or QBUs) for which the election is being made by describing its business and its country of residence, state the adjusted basis of the assets of the QBU (and any related same-country QBUs) to which the election applies, and include a statement that the election is being made pursuant to § 1.985-3(e)(2).
(B) Other QBUs. In the case of a QBU other than one described in paragraph (e)(2)(iii)(A) of this section, an election must be made in the manner prescribed in § 1.964-1. The statement filed with the Internal Revenue Service as required under § 1.964-1 must include the information required under paragraph (e)(2)(iii)(A) of this section.
(iv) Effect of election. If a taxpayer elects under this paragraph (e)(2) to use the small QBU DASTM allocation, DASTM gain or loss, as determined under paragraph (d) of this section, of a small QBU shall be allocated ratably to all items of the QBU's gross income (determined prior to adjustment for DASTM gain or loss). Therefore, for purposes of the foreign tax credit, DASTM gain or loss shall be allocated on the basis of the relative amounts of gross income in each separate category as defined in § 1.904-5(a)(4)(v). In the case of a controlled foreign corporation (within the meaning of section 957 or 953(c)(1)(B)), for purposes of section 952, DASTM gain or loss shall be allocated to subpart F income in a separate category in the same ratio that the gross subpart F income in that category for the taxable year bears to its total gross income in that category for the taxable year.
(v) Conformity. If a person (or a QBU of such person) makes an election under this paragraph (e)(2) to use the small QBU DASTM allocation, then each QBU of any related person (as defined in paragraph (e)(2)(vi) of this section) that satisfies the threshold requirement of paragraph (e)(2)(i) of this section (after application of the aggregation rule of paragraph (e)(2)(i) of this section) shall be deemed to have made the election.
(vi) Related person. The term related person means any person with a relationship to the QBU (or to the United States or foreign person of which the electing QBU is a part) that is defined in section 267(b) or section 707(b).
(3) DASTM 9-step procedure —(i) Step 1—prepare balance sheets. The taxpayer shall prepare an opening and a closing balance sheet for the QBU for each balance sheet period during the taxable year. The balance sheet period is the most frequent period for which balance sheet data are reasonably available (but in no event less frequently than quarterly). The balance sheet period may not be changed without the consent of the district director. The balance sheets must be prepared under the principles of paragraph (d)(2) of this section.
(ii) Step 2—identify certain assets and liabilities. The taxpayer shall identify each item on the balance sheet that is described in section 988(c)(1)(B) or (C) and that would have been translated under paragraph (d)(5) of this section into dollars at the exchange rate for the last translation period for the taxable year (or the exchange rate on the last day of the last translation period of the taxable year in the case of an accrued foreign income tax liability).
(iii) Step 3—characterize the assets. The taxpayer shall characterize and group the assets identified in paragraph (e)(3)(ii) of this section (Step 2) according to the source and the type of income that they generate, have generated, or may reasonably be expected to generate by applying the principles of § 1.861-9T(g)(3) or its successor regulation (relating to characterization of assets for purposes of interest expense allocation). If a purpose for a taxpayer's business practices is to manipulate asset characterization or groupings, the district director may allocate or apportion DASTM gain or loss attributable to the assets. Thus, if a taxpayer that previously did not separately state interest on accounts receivable begins to impose an interest charge and a purpose for the change was to manipulate tax characterizations or groupings, then the district director may require that none of the DASTM gain or loss attributable to those receivables be allocated or apportioned to interest income.
(iv) Step 4—determine DASTM gain or loss attributable to certain assets —(A) General rule. The taxpayer shall determine the dollar amount of DASTM gain or loss attributable to assets in each group identified in paragraph (e)(3)(iii) of this section (Step 3) as follows:
(B) Weighting to prevent distortion. If averaging the adjusted basis of assets in a group at the beginning and end of a balance sheet period results in an allocation of DASTM gain or loss that does not clearly reflect income, as might be the case in the event of a purchase or disposition of an asset that is not in the normal course of business, the taxpayer must use a weighting method that reflects the time the assets are held by the QBU during the translation period.
(C) Example. The provisions of this paragraph (e)(3)(iv) are illustrated by the following example:
(v) Step 5—adjust dollar gross income by DASTM gain or loss from assets. The taxpayer shall adjust the dollar amount of the QBU's gross income (computed under paragraphs (b)(1) through (b)(3) of this section) generated by each group of assets characterized in paragraph (e)(3)(iii) of this section (Step 3) by the amount of DASTM gain or loss attributable to those assets computed under paragraph (e)(3)(iv) of this section (Step 4). Thus, if a group of assets, such as accounts receivable, generates both a category of income described in section 904(d)(1)(I) (relating to general limitation income) that is not foreign base company income as defined in section 954 and a DASTM loss under paragraph (e)(3)(iv) of this section (Step 4), the amount of the DASTM loss would reduce the amount of the QBU's gross income in that category. Similarly, if a group of assets, such as short-term bank deposits, generates both foreign personal holding company income that is passive income (described in sections 954(c)(1)(A) and 904(d)(1)(A)) and a DASTM loss under paragraph (e)(3)(iv) of this section (Step 4), the amount of the DASTM loss would reduce the amount of the QBU's foreign personal holding company income and passive income. See section 904(f) and the regulations thereunder in the case where that section would apply and DASTM loss attributable to a group of assets exceeds the income generated by such assets.
(vi) Step 6—determine DASTM gain or loss attributable to liabilities —(A) General rule. The taxpayer shall determine the dollar amount of DASTM gain or loss attributable to liabilities identified in paragraph (e)(3)(ii) of this section (Step 2), and described in paragraph (e)(3)(vi)(B) of this section as follows:
(B) Separate calculation. The calculation shall be made separately for interest-bearing liabilities described in paragraph (e)(3)(vii) of this section (Step 7) and for each of the classes of non-interest-bearing liabilities described in paragraph (e)(3)(viii) of this section (Step 8).
(C) Weighting to prevent distortion. Where a distortion would result from averaging the amount of liabilities at the beginning and end of a balance sheet period, as might be the case where a taxpayer incurs or retires a substantial liability, the taxpayer must use a different method that more clearly reflects the average amount of liabilities weighted to reflect the time the liability was outstanding during the balance sheet period.
(vii) Step 7—adjust dollar income and expense by DASTM gain or loss from interest-bearing liabilities —(A) In general. The taxpayer shall apply the amount of DASTM gain on interest-bearing liabilities computed under paragraph (e)(3)(vi) of this section (Step 6) to reduce interest expense generated by such liabilities ( e.g., prior to the application of § 1.861-9T or its successor regulation). To the extent DASTM gain on such liabilities exceeds interest expense, it shall be sourced or otherwise classified in the same manner that interest expense is allocated and apportioned under § 1.861-9T or its successor regulation. The amount of DASTM loss on interest-bearing liabilities computed under paragraph (e)(3)(vi) of this section (Step 6) shall be allocated and apportioned in the same manner that interest expense is allocated and apportioned under § 1.861-9T or its successor regulation (without regard to the exceptions to fungibility in § 1.861-10T or its successor regulation). For purposes of this section, an interest-bearing liability is a liability that requires payment of periodic interest (whether fixed or variable), has original issue discount, or would have interest imputed under subtitle A.
(B) Allocation of DASTM gain or loss from interest-bearing liabilities that generate related person interest expense. DASTM gain or loss from interest-bearing liabilities that generate related person interest expense (as provided in section 954(b)(5)) shall be allocated for purposes of subtitle A (including sections 904 and 952) in the same manner that the related person interest expense of that debt is required to be allocated under the rules of section 954(b)(5) and § 1.904-5(c)(2).
(C) Modified gross income method. In applying the modified gross income method described in § 1.861-9T(j) or its successor regulation, gross income shall be adjusted for any DASTM gain or loss from assets as provided in paragraph (e)(3)(v) of this section (Step 5) and any DASTM gain or loss with respect to short-term, non-interest-bearing trade payables as provided in paragraph (e)(3)(viii)(A) of this section.
(viii) Step 8—adjust dollar income and expense by DASTM gain or loss from non-interest bearing liabilities —(A) Short-term, non-interest-bearing trade payables. The taxpayer shall allocate DASTM gain or loss on short-term non-interest-bearing trade payables for purposes of subtitle A (including sections 904 and 952) to the same category or type of gross income as the cost or expense to which the trade payable relates. For this purpose, a short-term, non-interest-bearing trade payable is a non-interest-bearing liability with a term of 183 days or less that is incurred to purchase property or services to be used by the obligor in an active trade or business.
(B) Excise tax payables. The taxpayer shall allocate DASTM gain or loss on excise tax payables for purposes of subtitle A (including sections 904 and 952) to the same category or type of gross income as would be derived from the activity to which the excise tax relates.
(C) Other non-interest-bearing liabilities —( 1 ) In general. Except as provided in paragraphs (e)(3)(viii)(A), (e)(3)(viii)(B), and (e)(3)(viii)(C)( 2 ) of this section, DASTM gain or loss on non-interest-bearing liabilities shall be allocated under paragraph (e)(3)(ix) of this section (Step 9).
( 2 ) Tracing if substantial distortion of income. DASTM gains and losses on liabilities described in paragraph (e)(3)(viii)(C)( 1 ) of this section may be attributed to the same section 904(d) separate category or subpart F category as the transaction to which the liability relates if the taxpayer demonstrates to the satisfaction of the district director, or it is determined by the district director, that application of paragraph (e)(3)(viii)(C)( 1 ) of this section results in a substantial distortion of income.
(ix) Step 9—allocate residual DASTM gain or loss. If there is a difference between the net DASTM gain or loss determined under paragraphs (e)(3)(i) through (viii) of this section (Steps 1 through 8) and the DASTM gain or loss determined under paragraph (d) of this section, the amount of the difference must be allocated for purposes of subtitle A (including sections 904 and 952) to the QBU's gross income (computed under paragraphs (b)(1) through (3) of this section, as adjusted under paragraphs (e)(3)(i) through (viii) of this section (Steps 1 through 8)) on the basis of the relative amounts of each category or type of gross income.
§ 1.985-4   Method of accounting.
(a) Adoption of election. The adoption of, or the election to use, a functional currency shall be treated as a method of accounting. The functional currency shall be used for the year of adoption (or election) and for all subsequent taxable years unless permission to change is granted, or considered to be granted under § 1.985-2 or § 1.985-8, by the Commissioner.
(b) Condition for changing functional currencies. Generally, permission to change functional currencies shall not be granted unless significant changes in the facts and circumstances of the QBU's economic environment occur. If the determination of the functional currency of the QBU for purposes of United States generally accepted accounting principles (GAAP) is based on facts and circumstances substantially similar to those set forth in § 1.985-1(c)(2), then ordinarily the Commissioner will grant a taxpayer's request to change its functional currency (or the functional currency of its branch that is a QBU) to a new functional currency only if the taxpayer (or its QBU) also changes to the new functional currency for purposes of GAAP. However, permission to change will not necessarily be granted merely because the new functional currency will conform to the taxpayer's GAAP functional currency.
(c) Relationship to certain other sections of the Code. Nothing in this section shall be construed to override the provisions of any other sections of the Code of regulations that require the use of consistent accounting methods. Such provisions must be independently satisfied separate and apart from the identification of a functional currency. For instance, while separate geographical divisions of a taxpayer's trade or business may have different functional currencies, such geographical divisions may nevertheless be required to consistently use other methods of accounting.
§ 1.985-5   Adjustments required upon change in functional currency.
(a) In general. This section applies in the case of a taxpayer or qualified business unit (QBU) (including a section 987 QBU (as defined in § 1.987-1(b)(3)) changing from one functional currency (old functional currency) to another functional currency (new functional currency). A taxpayer or QBU subject to the rules of this section shall make the adjustments set forth in the 3-step procedure described in paragraphs (b) through (e) of this section. Except as otherwise provided in this section, the adjustments shall be made on the last day of the last taxable year ending before the year of change (as defined in § 1.481-1(a)(1)). Gain or loss required to be recognized under paragraphs (b), (d)(2), (e)(2), and (e)(4)(iii) of this section is not subject to section 481 and, therefore, the full amount of the gain or loss must be included in income on the last day of the last taxable year ending before the year of change.
(b) Step 1—Taking into account exchange gain or loss on certain section 988 transactions. The taxpayer or QBU shall recognize or otherwise take into account for all purposes of the Internal Revenue Code the amount of any unrealized exchange gain or loss attributable to a section 988 transaction (as defined in section 988(c)(1)(A) through (C)) that, after applying section 988(d), is denominated in terms of or determined by reference to the new functional currency. The amount of such gain or loss shall be determined without regard to the limitations of section 988(b) (that is, whether any gain or loss would be realized on the transaction as a whole). The character and source of such gain or loss shall be determined under section 988.
(c) Step 2—Determining the new functional currency basis of property and the new functional currency amount of liabilities and any other relevant items. Except as otherwise provided in this section, the new functional currency adjusted basis of property and the new functional currency amount of liabilities and any other relevant items (for example, items described in section 988(c)(1)(B)(iii)) shall equal the product of the old functional currency adjusted basis or liability and the new functional currency/old functional currency spot rate on the last day of the last taxable year ending before the year of change.
(d) Step 3A—Additional adjustments that are necessary when a QBU changes functional currency —(1) QBU changing to a functional currency other than the owner's functional currency —(i) Rule. If a QBU changes its functional currency, and after the change the QBU is a section 987 QBU that is subject to §§ 1.987-1 through 1.987-15 pursuant to § 1.987-1(b)(1), then the adjustments described in either paragraph (d)(1)(ii) or (d)(1)(iii) of this section shall be taken into account for purposes of section 987.
(ii) QBU and the owner had different functional currencies prior to the change. If the QBU and the owner of the QBU had different functional currencies prior to the change and as a result the QBU was a section 987 QBU prior to the change, then the adjustments described in paragraphs (d)(1)(ii)(A) and (d)(1)(ii)(B) of this section shall be taken into account.
(A) Determining new historic rates. The historic rate (as defined in § 1.987-1(c)(3)) for the year of change and subsequent taxable years with respect to a historic item (as defined in § 1.987-1(e)) reflected on the balance sheet of the section 987 QBU immediately prior to the year of change shall be equal to the historic rate prior to the year of change (that is, a rate that translates the section 987 QBU's old functional currency into the owner's functional currency) divided by the spot rate (as defined in § 1.987-1(c)(1)) for translating an amount denominated in the section 987 QBU's old functional currency into the section 987 QBU's new functional currency on the last day of the last taxable year ending before the year of change. For example, if a taxpayer with a U.S. dollar (USD) functional currency owns a section 987 QBU that changes from a British pound (GBP) functional currency to a euro (EUR) functional currency, the historic rate for translating a specific historic item of this section 987 QBU from GBP to USD is 1.50, and the spot rate for translating GBP to EUR on the last day of the last taxable year before the change is 1.30, then the new historic rate for translating this historic item from EUR to USD is 1.15 (1.50/1.30).
(B) Determining the owner functional currency net value of the QBU on the last day of the last taxable year ending before the year of change under § 1.987-4(d)(1)(i)(B). For purposes of determining the owner functional currency net value of the section 987 QBU on the last day of the last taxable year ending before the year of change under § 1.987-4(d)(1)(i)(B) and § 1.987-4(e), the section 987 QBU's marked items (as defined in § 1.987-1(d)) shall be translated from the section 987 QBU's old functional currency into the owner's functional currency using the spot rate on the last day of the last taxable year ending before the year of change.
(iii) QBU and the taxpayer had the same functional currency prior to the change. If a QBU that has the same functional currency as a taxpayer changes its functional currency to a new functional currency that is different than the functional currency of the taxpayer, and as a result the taxpayer becomes an owner of a section 987 QBU (see § 1.987-1), the taxpayer and section 987 QBU will become subject to section 987 for the year of change and subsequent years.
(2) QBU changing to the owner's functional currency. If a section 987 QBU changes its functional currency to the functional currency of its owner, the section 987 QBU shall be treated as if it terminated on the last day of the last taxable year ending before the year of change. See §§ 1.987-5, 1.987-8, 1.987-12, and 1.987-13 for the effect of a termination of a section 987 QBU that is subject to §§ 1.987-1 through 1.987-15.
(e) Step 3B—Additional adjustments that are necessary when a taxpayer/owner changes functional currency —(1) Corporations. The amount of a corporation's new functional currency earnings and profits and the amount of its new functional currency paid-in capital shall equal the old functional currency amounts of such items multiplied by the spot rate for translating an amount denominated in the corporation's old functional currency into the corporation's new functional currency on the last day of the last taxable year ending before the year of change.
(2) Collateral consequences to a United States shareholder of a corporation changing to the United States dollar as its functional currency. A United States shareholder (within the meaning of section 951(b) or section 953(c)(1)(A)) of a controlled foreign corporation (within the meaning of section 957 or section 953(c)(1)(B)) changing its functional currency to the dollar shall recognize foreign currency gain or loss computed under section 986(c) as if all previously taxed earnings and profits, if any, (including amounts attributable to pre-1987 taxable years that were translated from dollars into functional currency in the foreign corporation's first post-1986 taxable year) were distributed immediately prior to the change.
(3) Taxpayers that are not corporations. [Reserved]
(4) Adjustments to a section 987 QBU's balance sheet and unrecognized section 987 gain or loss when an owner changes functional currency —(i) Owner changing to a functional currency other than the section 987 QBU's functional currency. If an owner of a section 987 QBU, subject to §§ 1.987-1 through 1.987-15 pursuant to § 1.987-1(b)(1), changes to a functional currency other than the functional currency of the section 987 QBU, the adjustments described in paragraphs (e)(4)(i)(A) through (C) of this section are taken into account for purposes of section 987.
(A) Determining new historic rates. The historic rate (as defined in § 1.987-1(c)(3)) for the year of change and subsequent taxable years with respect to a historic item (as defined in § 1.987-1(e)) reflected on the balance sheet of the section 987 QBU immediately before the year of change is equal to the historic rate before the year of change (that is, a rate that translates the section 987 QBU's functional currency into the owner's old functional currency) divided by the spot rate for translating an amount denominated in the owner's new functional currency into the owner's old functional currency on the last day of the last taxable year ending before the year of change. For example, if a taxpayer that owns a section 987 QBU with a British pound functional currency changes from a U.S. dollar functional currency to a euro functional currency, and the historic rate for translating a specific item of the section 987 QBU from GBP to USD is 1.50 and the spot rate for translating EUR to USD on the last day of the last taxable year before the change is 1.10, then the new historic rate for translating this historic item from GBP to EUR is 1.36 (1.50/1.10).
(B) Determining the owner functional currency net value of the section 987 QBU on the last day of the last taxable year ending before the year of change under § 1.987-4(d)(1)(i)(B). For purposes of determining the change in the owner functional currency net value of the section 987 QBU on the last day of the last taxable year preceding the year of change under § 1.987-4(d)(1)(i)(B) and (e), the section 987 QBU's marked items are translated into the owner's new functional currency at the spot rate on the last day of the last taxable year ending before the year of change.
(C) Translation of unrecognized section 987 gain or loss. Any net accumulated unrecognized section 987 gain or loss determined under § 1.987-4(c), cumulative suspended section 987 loss determined under § 1.987-11(b), or deferred section 987 gain or loss determined under § 1.987-12 is translated from the owner's old functional currency into the owner's new functional currency using the spot rate for translating an amount denominated in the owner's old functional currency into the owner's new functional currency on the last day of the last taxable year ending before the year of change.
(ii) Taxpayer with the same functional currency as its QBU changing to a different functional currency. If a taxpayer with the same functional currency as its QBU changes to a new functional currency and as a result the taxpayer becomes an owner of a section 987 QBU ( see § 1.987-1), the taxpayer and the section 987 QBU become subject to section 987 for the year of change and subsequent taxable years.
(iii) Owner changing to the same functional currency as the section 987 QBU. If an owner changes its functional currency to the functional currency of its section 987 QBU, the section 987 QBU is treated as if it terminated on the last day of the last taxable year ending before the year of change. See §§ 1.987-5, 1.987-8, 1.987-12, and 1.987-13 for the consequences of a termination of a section 987 QBU that is subject to §§ 1.987-1 through 1.987-15.
(f) Example. The provisions of this section are illustrated by the following example:
(1) Facts. FC, a foreign corporation, is wholly owned by DC, a domestic corporation. The Commissioner granted permission to change FC's functional currency from the British pound to the euro beginning January 1, year 2. The EUR/GBP exchange rate on December 31, year 1, is €1:£0.50.
(2) Analysis —(i) Determining new functional currency basis of property and liabilities. The following table shows how FC must convert the items on its balance sheet from the British pound to the euro on December 31, year 1.
Table 1 to Paragraph (f)(2)(i) Conversion of FC's Balance Sheet Items
(ii) Exchange gain or loss on section 988 transactions. Under paragraph (b) of this section, FC will recognize a £50,000 loss (£50,000 current value minus £100,000 historical basis) on the Euro Bond resulting from the change in functional currency because, after the change, the Euro Bond will no longer be an asset denominated in a non-functional currency. The amount of FC's retained earnings on its December 31, year 1, balance sheet reflects the £50,000 loss on the Euro Bond.
(g) Applicability date. Generally, this section applies to taxable years beginning after December 31, 2024. However, if pursuant to § 1.987-15(b), a taxpayer chooses to apply §§ 1.987-1 through 1.987-15 to a taxable year before the first taxable year described in § 1.987-15(a)(1), then this section applies to that taxable year and subsequent years.
§ 1.985-6   Transition rules for a QBU that uses the dollar approximate separate transactions method for its first taxable year beginning in 1987.
(a) In general. This section sets forth transition rules for a QBU that used the dollar approximate separate transactions method of accounting set forth in § 1.985-3 or § 1.985-3T (as contained in the April 1, 1989 edition of 26 CFR part 1 (1.908 to 1.1000)) for its first taxable year beginning in 1987 (DASTM QBU). A DASTM QBU must determine the dollar and hyperinflationary currency basis of its assets and the dollar and hyperinflationary currency amount of its liabilities that were acquired or incurred in taxable years beginning before January 1, 1987. In addition, a DASTM QBU must determine its net worth, including its retained earnings, at the end of the QBU's last taxable year beginning before January 1, 1987. This section provides rules for controlled foreign corporations (as defined in section 957 or section 953(c)(1)(B)), other foreign corporations, and branches of United States persons that must make these determinations.
(b) Certain controlled foreign corporations. If a DASTM QBU was a controlled foreign corporation for its last taxable year beginning before January 1, 1987, and it had a significant event as described in § 1.964-1(c)(6) in a taxable year beginning before January 1, 1987, then the rules of this paragraph (b) shall apply.
(1) Basis in assets and amount of liabilities. The hyperinflationary currency adjusted basis of the QBU's assets and the hyperinflationary currency amount of the QBU's liabilities acquired or incurred by the QBU in a taxable year beginning before January 1, 1987, shall be the basis or the amount as determined under § 1.964-1(e) prior to translation under § 1.964-1(e)(4). The dollar adjusted basis of such assets and the dollar amount of such liabilities shall be the adjusted basis or the amount as determined under the rules of § 1.964-1(e) after translation under § 1.964-1(e)(4).
(2) Retained earnings. The dollar amount of the QBU's retained earnings at the end of its last taxable year beginning before January 1, 1987, shall be the dollar amount determined under § 1.964-1(e)(3).
(c) All other foreign corporations. If a foreign corporation is a DASTM QBU that is not described in paragraph (b) of this section, then the hyperinflationary currency and dollar adjusted basis in the QBU's assets acquired in taxable years beginning before January 1, 1987, the hyperinflationary currency and dollar amount of the QBU's liabilities acquired or incurred in taxable years beginning before January 1, 1987, and the dollar amount of the QBU's net worth, including its retained earnings, at the end of its last taxable year beginning before January 1, 1987, shall be determined by applying the principles of § 1.985-3T or § 1.985-3. Thus, for example, the dollar basis of plant and equipment shall be determined using the appropriate historical exchange rate.
(d) Pre-1987 section 902 amounts —(1) Translation of pre-1987 section 902 accumulated profits and taxes into United States dollars. The foreign income taxes and accumulated profits or deficits in accumulated profits of a foreign corporation that were maintained in foreign currency for purposes of section 902 and that are attributable to taxable years of the foreign corporation beginning before January 1, 1987, shall be translated into dollars at the spot exchange rate on the first day of its first taxable year beginning after December 31, 1986. Once translated into dollars, these accumulated profits and taxes shall (absent a change in functional currency) remain in dollars for all federal income tax purposes.
(2) Carryforward of accumulated deficits in accumulated profits from pre-1987 taxable years to post-1986 taxable years. For purposes of sections 902 and 960, the post-1986 undistributed earnings of a foreign corporation that is subject to the rules of this section shall be reduced by the dollar amount of the corporation's deficit in accumulated profits, if any, determined under section 902 and the regulations thereunder, that was accumulated at the end of the corporation's last taxable year beginning before January 1, 1987. The dollar amount of the accumulated deficit shall be determined by multiplying the foreign currency amount of such deficit by the spot exchange rate on the last day of the corporation's last taxable year beginning before January 1, 1987, and shall be taken into account on the first day of the corporation's first taxable year beginning after December 31, 1986. Post-1986 undistributed earnings may not be reduced by the dollar amount of a pre-1987 deficit in retained earnings determined under § 1.964-1(e).
(e) Net worth branch. If a DASTM QBU is a branch of a United States person and the QBU used a net worth method of accounting for its last taxable year beginning before January 1, 1987, then the rules of this paragraph (e) shall apply. A net worth method of accounting is any method of accounting under which the taxpayer calculates the taxable income of a QBU based on the net change in the dollar value of the QBU's equity (assets minus liabilities) during the course of a taxable year, taking into account any contributions or remittances made during the year. See, e.g., Rev. Rul. 75-106, 1975-1 C.B. 31. (See § 601.601(d)(2)(ii)( b ) of this chapter).
(1) Basis in assets and amount of liabilities —(i) Hyperinflationary amounts. For the first taxable year beginning in 1987, the hyperinflationary currency adjusted basis of a QBU's assets or the hyperinflationary currency amounts of its liabilities acquired or incurred in a taxable year beginning before January 1, 1987 is the hyperinflationary currency basis or amount at the date when acquired or incurred, as adjusted according to United States generally accepted accounting and tax accounting principles. If a hyperinflationary currency basis or amount was not determined at such date, the dollar basis or amount, as adjusted according to United States generally accepted accounting and tax accounting principles, shall be translated into hyperinflationary currency at the spot exchange rate on the date when the asset or liability was acquired or incurred.
(ii) Dollar amounts. For the first taxable year beginning in 1987, the dollar adjusted basis of the QBU's assets and the amounts of its liabilities shall be those amounts reflected on the QBU's dollar books and records at the end of the taxpayer's last taxable year beginning before January 1, 1987, after adjusting the books and records according to United States generally accepted accounting and tax accounting principles.
(2) Ending net worth. The dollar amount of the QBU's net worth at the end of its last taxable year beginning before January 1, 1987 shall equal the QBU's net worth at that date as determined under paragraph (e)(1)(ii) of this section.
(f) Profit and loss branch. If a DASTM QBU is a branch of a United States person and the QBU used a profit and loss method of accounting for its last taxable year beginning before January 1, 1987, then the United States person shall first apply the transition rules of § 1.987-5 in order to determine the beginning amount and dollar basis of the branch's EQ pool, the hyperinflationary currency basis of the branch's assets, and the hyperinflationary currency amounts of its liabilities. A profit and loss method of accounting is any method of accounting under which the taxpayer calculates the profits of a QBU by computing the QBU's profits in its functional currency and translating the net result into dollars. See e.g., Rev. Rul. 75-107, 1975-1 C.B. 32. (See § 601.601(d)(2)(ii)( b ) of this chapter). The QBU and the taxpayer must then make the adjustments required by § 1.985-5, e.g., the QBU must take into account unrealized exchange gain or loss on dollar-denominated section 988 transactions, the taxpayer must account for the deemed termination of the branch, and the taxpayer must translate the QBU's balance sheet items from hyperinflationary currency into dollars at the spot rate.
§ 1.985-7   Adjustments required in connection with a change to DASTM.
(a) In general. If a QBU begins to use the dollar approximate separate transactions method of accounting set forth in § 1.985-3 (DASTM) in a taxable year beginning after April 6, 1998, adjustments shall be made as provided by this section. For the rules with respect to foreign corporations, see paragraph (b) of this section. For the rules with respect to adjustments to the income of United States shareholders of controlled foreign corporations, see paragraph (c) of this section. For the rules with respect to adjustments relating to QBU branches, see paragraph (d) of this section. For the effective date of this section, see paragraph (e). For purposes of applying this section, the look-back period shall be the period beginning with the first taxable year after the transition date and ending on the last day prior to the taxable year of change. The term transition date means the later of the last day of the last taxable year ending before the base period as defined in § 1.985-1(b)(2)(ii)(D) or the last day of the taxable year in which the QBU last applied DASTM. The taxable year of change shall mean the taxable year of change as defined in § 1.481-1(a)(1). The application of this paragraph may be illustrated by the following examples:
(b) Adjustments to foreign corporations —(1) In general. In the case of a foreign corporation, the corporation shall make the adjustments set forth in paragraphs (b)(2) through (4) of this section. The adjustments shall be made on the first day of the taxable year of change.
(2) Treatment of certain section 988 transactions —(i) Exchange gain or loss from section 988 transactions unrealized as of the transition date. A foreign corporation shall adjust earnings and profits by the amount of any unrealized exchange gain or loss that was attributable to a section 988 transaction (as defined in sections 988(c)(1)(A), (B), and (C)) that was denominated in terms of (or determined by reference to) the dollar and was held by the corporation on the transition date. Such gain or loss shall be computed as if recognized on the transition date and shall be reduced by any gain and increased by any loss recognized by the corporation with respect to such transaction during the look-back period. The amount of such gain or loss shall be determined without regard to the limitations of section 988(b) (i.e., whether any gain or loss would be realized on the transaction as a whole). The character and source of such gain or loss shall be determined under section 988. Proper adjustments shall be made to account for gain or loss taken into account by reason of this paragraph (b)(2). See § 1.985-5(f) Example 1, footnote 1.
(ii) Treatment of a section 988 transaction entered into and terminated during the look-back period. A foreign corporation shall reduce earnings and profits by the amount of any gain, and increase earnings and profits by the amount of any loss, that was recognized with respect to any dollar denominated section 988 transactions entered into and terminated during the look-back period.
(3) Opening balance sheet. The opening balance sheet of a foreign corporation for the taxable year of change shall be determined as if the corporation had changed its functional currency to the dollar by applying § 1.985-5(c) on the transition date and had translated its assets and liabilities acquired and incurred during the look-back period under § 1.985-3.
(4) Earnings and profits adjustments —(i) Pre-1987 accumulated profits. The foreign income taxes and accumulated profits or deficits in accumulated profits of a foreign corporation that are attributable to taxable years beginning before January 1, 1987, as stated on the transition date, and that were maintained for purposes of section 902 in the old functional currency, shall be translated into dollars at the spot rate in effect on the transition date. The applicable accumulated profits shall be reduced on a last-in, first-out basis by the aggregate dollar amount (translated from functional currency in accordance with the rules of section 989(b)) attributable to earnings and profits that were distributed (or treated as distributed) during the look-back period to the extent such amounts distributed exceed the earnings and profits calculated under (b)(4)(ii) or (b)(4)(iii), as applicable. See § 1.902-1(b)(2)(ii). Once translated into dollars, these pre-1987 taxes and accumulated profits or deficits in accumulated profits shall (absent a change in functional currency) remain in dollars for all federal income tax purposes.
(ii) Post-1986 undistributed earnings of a CFC. In the case of a controlled foreign corporation (within the meaning of section 957 or section 953(c)(1)(B))(CFC) or a foreign corporation subject to the rules of § 1.904-6(a)(2), the corporation's post-1986 undistributed earnings in each separate category as defined in § 1.904-5(a)(1) as of the first day of the taxable year of change (and prior to adjustment under paragraph (c)(1) of this section) shall equal the sum of—
(A) The corporation's post-1986 undistributed earnings and profits (or deficit in earnings and profits) in each separate category as defined in § 1.904-5(a)(1) as stated on the transition date translated into dollars at the spot rate in effect on the transition date; and
(B) The sum of the earnings and profits (or deficit in earnings and profits) in each separate category determined under § 1.985-3 for each post-transition date taxable year prior to the taxable year of change.
Such amount shall be reduced by the aggregate dollar amount (translated from functional currency in accordance with the rules of section 989(b)) attributable to earnings and profits that were distributed (or treated as distributed) during the look-back period out of post-1986 earnings and profits in such separate category. For purposes of applying this paragraph (b)(4)(ii)(B), the opening balance sheet for calculating earnings and profits under § 1.985-3 for the first post-transition year shall be translated into dollars pursuant to § 1.985-5(c).
(iii) Post-1986 undistributed earnings of other foreign corporations. In the case of a foreign corporation that is not a CFC or subject to the rules of § 1.904-6(a)(2), the corporation's post-1986 undistributed earnings shall equal the sum of—
(A) The corporation's post-1986 undistributed earnings (or deficit) on the transition date translated into dollars at the spot rate in effect on the transition date; and
(B) The sum of the earnings and profits (or deficit in earnings and profits) determined under § 1.985-3 for each post-transition date taxable year (or such later year determined under section 902(c)(3)(A)) prior to the taxable year of change.
Such amount shall be reduced by the aggregate dollar amount (translated from functional currency in accordance with the rules of section 989(b)) that was distributed (or treated as distributed) during the look-back period out of post-1986 earnings and profits. For purposes of applying this paragraph (b)(4)(iii)(B), the opening balance sheet for calculating earnings and profits under § 1.985-3 for the first post-transition year shall be translated into dollars pursuant to § 1.985-5(c).
(c) United States shareholders of controlled foreign corporations —(1) In general. A United States shareholder (within the meaning of section 951(b) or section 953(c)(1)(B)) of a CFC that changes to DASTM shall make the adjustments set forth in paragraphs (c) (2) through (5) of this section on the first day of the taxable year of change. Adjustments under this section shall be taken into account by the shareholder (or such shareholder s successor in interest) ratably over four taxable years beginning with the taxable year of change. Similar rules shall apply in determining adjustments to income of United States persons who have made an election under section 1295 to treat a passive foreign investment company as a qualified electing fund.
(2) Treatment under subpart F of income recognized on section 988 transactions. The character of amounts taken into account under paragraph (b)(2) of this section for purposes of sections 951 through 964, shall be determined on the transition date and to the extent characterized as subpart F income shall be taken into account in accordance with the rules of paragraph (c)(1) of this section. Such amounts shall retain their character for all federal income tax purposes (including sections 902, 959, 960, 961, 1248, and 6038).
(3) Recognition of foreign currency gain or loss on previously taxed earnings and profits on the transition date. Gain or loss is recognized under section 986(c) as if all previously taxed earnings and profits as determined on the transition date, if any, were distributed on such date. Such gain or loss shall be reduced by any foreign currency gain and increased by any foreign currency loss that was recognized under section 986(c) with respect to distributions of previously taxed earnings and profits during the look-back period. Such amount shall be characterized in accordance with section 986(c) and taken into account in accordance with the rules of paragraph (c)(1) of this section.
(4) Subpart F income adjustment. Subpart F income in a separate category shall be determined under § 1.985-3 for each look-back year. For this purpose, the opening DASTM balance sheet shall be determined under § 1.985-5. The sum of the difference (positive or negative) between the amount computed pursuant to § 1.985-3 and amount that was included in income for each year shall be taken into account in the taxable year of change pursuant to paragraph (c)(1) of this section. Such amounts shall retain their character for all federal income tax purposes (including sections 902, 959, 960, 961, 1248, and 6038). For rules applicable if an adjustment under this section results in a loss for the taxable year in a separate category, see section 904(f) and the regulations thereunder. The amount of previously taxed earnings and profits as determined under section 959(c)(2) shall be adjusted (positively or negatively) by the amount taken into account under this paragraph (c)(4) as of the first day of the taxable year of change.
(5) Foreign tax credit. A United States shareholder of a CFC shall compute an amount of foreign taxes deemed paid under section 960 with respect to any positive adjustments determined under paragraph (c) of this section. The amount of foreign tax deemed paid shall be computed with reference to the full amount of the adjustment and to the post-1986 undistributed earnings determined under paragraph (b)(4) (i) and (ii) of this section and the post-1986 foreign income taxes of the CFC on the first day of the taxable year of change (i.e., without taking into account earnings and taxes for the taxable year of change). For purposes of section 960, the associated taxes in each separate category shall be allocated pro rata among, and deemed paid in, the shareholder's taxable years in which the income is taken into account. (No adjustment to foreign taxes deemed paid in prior years is required solely by reason of a negative adjustment to income under paragraph (c)(1) of this section).
(d) QBU branches —(1) In general. In the case of a QBU branch, the taxpayer shall make the adjustments set forth in paragraphs (d)(2) through (d)(4) of this section. Adjustments under this section shall be taken into account by the taxpayer ratably over four taxable years beginning with the taxable year of change.
(2) Treatment of certain section 988 transactions —(i) Exchange gain or loss from section 988 transactions unrealized as of the transition date. A QBU branch shall adjust income by the amount of any unrealized exchange gain or loss that was attributable to a section 988 transaction (as defined in sections 988(c)(1) (A), (B), and (C)) that was denominated in terms of (or determined by reference to) the dollar and was held by the QBU branch on the transition date. Such gain or loss shall be computed as if recognized on the transition date and shall be reduced by any gain and increased by any loss recognized by the QBU branch with respect to such transaction during the look-back period. The amount of such gain or loss shall be determined without regard to the limitations of section 988(b) (i.e., whether any gain or loss would be realized on the transaction as a whole). The character and source of such gain or loss shall be determined under section 988. Proper adjustments shall be made to account for gain or loss taken into account by reason of this paragraph (d)(2). See § 1.985-5(f) Example 1, footnote 1.
(ii) Treatment of a section 988 transaction entered into and terminated during the look-back period. A QBU branch shall reduce income by the amount of any gain, and increase income by the amount of any loss, that was recognized with respect to any dollar denominated section 988 transactions entered into and terminated during the look-back period.
(3) Deemed termination income adjustment. The taxpayer shall realize gain or loss attributable to the QBU branch's equity pool (as stated on the transition date) under the principles of section 987, computed as if the branch terminated on the transition date. Such amount shall be reduced by section 987 gain and increased by section 987 loss that was recognized by such taxpayer with respect to remittances during the look-back period.
(4) Branch income adjustment. Branch income in a separate category shall be determined under § 1.985-3 for each look-back year. For this purpose, the opening DASTM balance sheet shall be determined under § 1.985-5. The sum of the difference (positive or negative) between the amount computed pursuant to § 1.985-3 and amount taken into account for each year shall be taken into account in the taxable year of change pursuant to paragraph (d)(1) of this section. Such amounts shall retain their character for all federal income tax purposes.
(5) Opening balance sheet. The opening balance sheet of a QBU branch for the taxable year of change shall be determined as if the branch had changed its functional currency to the dollar by applying § 1.985-5(c) on the transition date and had translated its assets and liabilities acquired and incurred during the look-back period under § 1.985-3.
(e) Effective date. This section is effective for taxable years beginning after April 6, 1998. However, a taxpayer may choose to apply this section to all open taxable years beginning after December 31, 1986, provided each person, and each QBU branch of a person, that is related (within the meaning of § 1.985-2(d)(3)) to the taxpayer also applies this section.
§ 1.985-8   Special rules applicable to the European Monetary Union (conversion to euro).
(a) Definitions —(1) Legacy currency. A legacy currency is the former currency of a Member State of the European Community which is substituted for the euro in accordance with the Treaty establishing the European Community signed February 7, 1992. The term legacy currency shall also include the European Currency Unit.
(2) Conversion rate. The conversion rate is the rate at which the euro is substituted for a legacy currency.
(b) Operative rules —(1) Initial adoption. A QBU (as defined in § 1.989(a)-1(b)) whose first taxable year begins after the euro has been substituted for a legacy currency may not adopt a legacy currency as its functional currency.
(2) QBU with a legacy currency as its functional currency —(i) Required change. A QBU with a legacy currency as its functional currency is required to change its functional currency to the euro beginning the first day of the first taxable year—
(A) That begins on or after the day that the euro is substituted for that legacy currency (in accordance with the Treaty on European Union); and
(B) In which the QBU begins to maintain its books and records (as described in § 1.989(a)-1(d)) in the euro.
(ii) Notwithstanding paragraph (b)(2)(i) of this section, a QBU with a legacy currency as its functional currency is required to change its functional currency to the euro no later than the last taxable year beginning on or before the first day such legacy currency is no longer valid legal tender.
(3) QBU with a non-legacy currency as its functional currency —(i) In general. A QBU with a non-legacy currency as its functional currency may change its functional currency to the euro pursuant to this § 1.985-8 if—
(A) Under the rules set forth in § 1.985-1(c), the euro is the currency of the economic environment in which a significant part of the QBU's activities are conducted;
(B) After conversion, the QBU maintains its books and records (as described in § 1.989(a)-1(d)) in the euro; and
(C) The QBU is not required to use the dollar as its functional currency under § 1.985-1(b).
(ii) Time period for change. A QBU with a non-legacy currency as its functional currency may change its functional currency to the euro under this section only if it does so within the period set forth in paragraph (b)(2) of this section as if the functional currency of the QBU was a legacy currency.
(4) Consent of Commissioner. A change made pursuant to paragraph (b) of this section shall be deemed to be made with the consent of the Commissioner for purposes of § 1.985-4. A QBU changing its functional currency to the euro pursuant to paragraph (b)(2) of this section must make adjustments as provided in paragraph (c) of this section. A QBU changing its functional currency to the euro pursuant to paragraph (b)(3) must make adjustments as provided in § 1.985-5.
(5) Statement to file upon change. With respect to a QBU that changes its functional currency to the euro under paragraph (b) of this section, an affected taxpayer shall attach to its return for the taxable year of change a statement that includes the following: “TAXPAYER CERTIFIES THAT A QBU OF THE TAXPAYER HAS CHANGED ITS FUNCTIONAL CURRENCY TO THE EURO PURSUANT TO TREAS. REG. § 1.985-8.” For purposes of this paragraph (b)(5), an affected taxpayer shall be in the case where the QBU is: a QBU of an individual U.S. resident (as a result of the activities of such individual), the individual; a QBU branch of a U.S. corporation, the corporation; a controlled foreign corporation (as described in section 957)(or QBU branch thereof), each United States shareholder (as described in section 951(b)); a partnership, each partner separately; a noncontrolled section 902 corporation (as described in section 904(d)(2)(E)) (or branch thereof), each domestic shareholder as described in § 1.902-1(a)(1); or a trust or estate, the fiduciary of such trust or estate.
(c) Adjustments required when a QBU changes its functional currency from a legacy currency to the euro pursuant to paragraph (b)(2) of this section —(1) In general. A QBU that changes its functional currency from a legacy currency to the euro pursuant to paragraph (b)(2) of this section must make the adjustments described in paragraphs (c)(2) through (5) of this section. Section 1.985-5 shall not apply.
(2) Determining the euro basis of property and the euro amount of liabilities and other relevant items. The euro basis in property and the euro amount of liabilities and other relevant items shall equal the product of the legacy functional currency adjusted basis or amount of liabilities multiplied by the applicable conversion rate.
(3) Taking into account exchange gain or loss on legacy currency section 988 transactions —(i) In general. Except as provided in paragraphs (c)(3)(iii) and (iv) of this section, a legacy currency denominated section 988 transaction (determined after applying section 988(d)) outstanding on the last day of the taxable year immediately prior to the year of change shall continue to be treated as a section 988 transaction after the change and the principles of section 988 shall apply.
(ii) Examples. The application of this paragraph (c)(3) may be illustrated by the following examples:
(ii) On January 1, 1999, the euro will replace the deutschmark as the national currency of Germany pursuant to the Treaty on European Union signed February 7, 1992. Assume that on January 1, 1999, X changes its functional currency to the euro pursuant to this section. Assume that the euro/deutschmark conversion rate is set by the European Council at €1 = DM2. Assume further that the euro/guilder conversion rate is set at €1 = fl2.25. In 1999, X will accrue one month of interest equal to €44.44 (fl100/2.25). On January 31, 1999, pursuant to the note, X will receive interest denominated in euros of €533.33 (fl1200/2.25). Pursuant to this paragraph (c)(3), X will realize an exchange loss in the 1999 taxable year with respect to accrued interest computed under the principles of § 1.988-2(b)(3). For this purpose, the exchange rate used under § 1.988-2(b)(3)(i) is the guilder/euro conversion rate and the exchange rate used under § 1.988-2(b)(3)(ii) is the deutschmark/euro conversion rate. Thus, with respect to the interest accrued in 1998, X will realize exchange loss of €25.13 under § 1.988-2(b)(3) as follows: [€488.89 (fl1100/2.25) − €514.02 (DM1028.04/2) = −€25.13]. With respect to the one month of interest accrued in 1999, X will realize no exchange gain or loss since the exchange rate when the interest accrued and the spot rate on the payment date are the same.
(iii) X will realize exchange loss of €666.67 on repayment of the loan principal computed in the same manner as in Example 1 [€5333.33 (fl12,000/2.25) − €6000 fl12,000/1)/2)]. The losses with respect to accrued interest and principal are characterized and sourced under the rules of section 988.
(iii) Special rule for legacy nonfunctional currency. The QBU shall realize or otherwise take into account for all purposes of the Internal Revenue Code the amount of any unrealized exchange gain or loss attributable to nonfunctional currency (as described in section 988(c)(1)(C)(ii)) that is denominated in a legacy currency as if the currency were disposed of on the last day of the taxable year immediately prior to the year of change. The character and source of the gain or loss are determined under section 988.
(iv) Legacy currency denominated accounts receivable and payable —(A) In general. A QBU may elect to realize or otherwise take into account for all purposes of the Internal Revenue Code the amount of any unrealized exchange gain or loss attributable to a legacy currency denominated item described in section 988(c)(1)(B)(ii) as if the item were terminated on the last day of the taxable year ending prior to the year of change.
(B) Time and manner of election. With respect to a QBU that makes an election described in paragraph (c)(3)(iv)(A) of this section, an affected taxpayer (as described in paragraph (b)(5) of this section) shall attach a statement to its tax return for the taxable year ending immediately prior to the year of change which includes the following: “TAXPAYER CERTIFIES THAT A QBU OF THE TAXPAYER HAS ELECTED TO REALIZE CURRENCY GAIN OR LOSS ON LEGACY CURRENCY DENOMINATED ACCOUNTS RECEIVABLE AND PAYABLE UPON CHANGE OF FUNCTIONAL CURRENCY TO THE EURO.” A QBU making the election must do so for all legacy currency denominated items described in section 988(c)(1)(B)(ii).
(4) Adjustments when a branch changes its functional currency to the euro —(i) Branch changing from a legacy currency to the euro in a taxable year during which taxpayer's functional currency is other than the euro. If a branch changes its functional currency from a legacy currency to the euro for a taxable year during which the taxpayer's functional currency is other than the euro, the branch's euro equity pool shall equal the product of the legacy currency amount of the equity pool multiplied by the applicable conversion rate. No adjustment to the basis pool is required.
(ii) Branch changing from a legacy currency to the euro in a taxable year during which taxpayer's functional currency is the euro. If a branch changes its functional currency from a legacy currency to the euro for a taxable year during which the taxpayer's functional currency is the euro, the taxpayer shall realize gain or loss attributable to the branch's equity pool under the principles of section 987, computed as if the branch terminated on the last day prior to the year of change. Adjustments under this paragraph (c)(4)(ii) shall be taken into account by the taxpayer ratably over four taxable years beginning with the taxable year of change.
(5) Adjustments to a branch's accounts when a taxpayer changes to the euro —(i) Taxpayer changing from a legacy currency to the euro in a taxable year during which a branch's functional currency is other than the euro. If a taxpayer changes its functional currency to the euro for a taxable year during which the functional currency of a branch of the taxpayer is other than the euro, the basis pool shall equal the product of the legacy currency amount of the basis pool multiplied by the applicable conversion rate. No adjustment to the equity pool is required.
(ii) Taxpayer changing from a legacy currency to the euro in a taxable year during which a branch's functional currency is the euro. If a taxpayer changes its functional currency from a legacy currency to the euro for a taxable year during which the functional currency of a branch of the taxpayer is the euro, the taxpayer shall take into account gain or loss as determined under paragraph (c)(4)(ii) of this section.
(6) Additional adjustments that are necessary when a corporation changes its functional currency to the euro. The amount of a corporation's euro currency earnings and profits and the amount of its euro paid-in capital shall equal the product of the legacy currency amounts of these items multiplied by the applicable conversion rate. The foreign income taxes and accumulated profits or deficits in accumulated profits of a foreign corporation that were maintained in foreign currency for purposes of section 902 and that are attributable to taxable years of the foreign corporation beginning before January 1, 1987, also shall be translated into the euro at the conversion rate.
(d) Treatment of legacy currency section 988 transactions with respect to a QBU that has the euro as its functional currency —(1) In general. This § 1.985-8(d) applies to a QBU that has the euro as its functional currency and that holds a section 988 transaction denominated in, or determined by reference to, a currency that is substituted by the euro. For example, this paragraph (d) will apply to a German QBU with the euro as its functional currency if the QBU is holding Country X currency or other section 988 transactions denominated in such currency on the day in the year 2005 when the euro is substituted for the Country X currency.
(2) Principles of paragraph (c)(3) of this section shall apply. With respect to a QBU described in paragraph (d) of this section, the principles of paragraph (c)(3) of this section shall apply. For example, if a German QBU with the euro as its functional currency is holding a Country X currency denominated debt instrument on the day in the year 2005 when the euro is substituted for the Country X currency, the instrument shall continue to be treated as a section 988 transaction pursuant to the principles of paragraph (c)(3)(i) of this section. However, if such QBU holds Country X currency, the QBU shall take into account any unrealized exchange gain or loss pursuant to the principles of paragraph (c)(3)(iii) of this section as if the currency was disposed of on the day prior to the day the euro is substituted for the Country X currency. Similarly, if the QBU makes an election under the principles of paragraph (c)(3)(iv) of this section, the QBU shall take into account for all purposes of the Internal Revenue Code the amount of any unrealized exchange gain or loss attributable to a legacy currency denominated item described in section 988(c)(1)(B)(ii) as if the item were terminated on the day prior to the day the euro is substituted for the Country X currency.
(e) Effective date. This section applies to tax years ending after July 29, 1998.
§ 1.986(a)-1   Translation of foreign income taxes for purposes of the foreign tax credit.
(a) Translation of foreign income taxes taken into account when accrued —(1) In general. For purposes of this section, the term section 901 taxpayer means the “taxpayer” described in § 1.901-2(f)(1) and so includes a partnership or a specified 10-percent owned foreign corporation (as defined in section 245A(b)) that has legal liability under foreign law for foreign income tax. Except as provided in paragraph (a)(2) of this section, in the case of a section 901 taxpayer that takes foreign income taxes (as defined in section 986(a)(4) (including taxes described in section 903)) into account when accrued, the amount of any foreign income taxes denominated in foreign currency that has been paid or accrued, including additional tax liability denominated in foreign currency, foreign income taxes withheld in foreign currency, or estimated foreign income taxes paid in foreign currency, are translated into dollars using the weighted average exchange rate (as defined in § 1.989(b)-1) (the “average exchange rate”) for the section 901 taxpayer's U.S. taxable year (as defined in § 1.960-1(b)(37)) to which such foreign income taxes relate. See section 986(a)(1)(A). See section 988 and §§ 1.988-1(a)(2)(ii) and 1.988-2(c) for rules for determining whether and the extent to which there is a foreign currency gain or loss when an accrued functional currency amount of foreign income tax denominated in nonfunctional currency differs from the functional currency amount paid.
(2) Exceptions —(i) Foreign income taxes not paid within 24 months. Any foreign income taxes denominated in foreign currency that are paid more than 24 months after the close of the section 901 taxpayer's U.S. taxable year to which they relate are translated into dollars using the spot rate on the date of payment of the foreign income taxes. See section 986(a)(1)(B)(i) and (a)(2)(A). For purposes of this section and § 1.905-3, the term spot rate has the meaning provided in § 1.988-1(d). To the extent any accrued foreign income taxes denominated in foreign currency remain unpaid more than 24 months after the close of the taxable year to which they relate, see § 1.905-3 and paragraph (c) of this section for the required adjustments.
(ii) Foreign income taxes paid before taxable year begins. Any foreign income taxes denominated in foreign currency that are paid before the beginning of the section 901 taxpayer's U.S. taxable year to which such taxes relate are translated into dollars using the spot rate on the date of payment of the foreign income taxes. See section 986(a)(1)(B)(ii) and (a)(2)(A).
(iii) Inflationary currency. Any foreign income taxes denominated in a foreign currency that is an inflationary currency in the section 901 taxpayer's U.S. taxable year to which the foreign income taxes relate, or in any subsequent taxable year up to and including the taxable year in which the taxes are paid, are translated into dollars using the spot rate on the date of payment of such taxes. For purposes of section 986(a)(1)(C) and this paragraph (a)(2)(iii), the term inflationary currency means the currency of a country in which there is cumulative inflation during the base period of at least 30 percent, as determined under the principles of § 1.985-1(b)(2)(ii)(D), where the base period, with respect to any taxable year, is the 36 months ending on the last day of such taxable year (in lieu of the base period described in § 1.985-1(b)(2)(ii)(D), which ends on the last day of the preceding calendar year). Accrued but unpaid foreign income taxes denominated in a foreign currency that is an inflationary currency in the taxable year accrued are translated into dollars at the spot rate on the last day of the section 901 taxpayer's U.S. taxable year to which such taxes relate (provisional year-end rate). However, a U.S. taxpayer that claims a foreign tax credit under section 901 may choose to translate accrued but unpaid foreign income taxes (including foreign income taxes deemed paid under section 960) denominated in a foreign currency that is an inflationary currency into dollars at the spot rate on the date of payment, in lieu of the provisional year-end rate, if such taxes are paid prior to the due date (with extensions) of the original Federal income tax return for the taxable year for which the credit is claimed and such return is timely filed. In all other cases, see § 1.905-3 and paragraph (c) of this section for required adjustments upon payment of accrued foreign income taxes denominated in an inflationary currency.
(iv) Election to translate foreign income taxes using the spot rate as of date of payment —(A) Eligibility to make election. An individual or corporate taxpayer (including a specified 10-percent owned foreign corporation) that is otherwise required to translate foreign income taxes that are denominated in foreign currency using the average exchange rate may elect to translate foreign income taxes described in this paragraph (a)(2)(iv) into dollars using the spot rate on the date of payment of the foreign income taxes, provided that the liability for such taxes is denominated in nonfunctional currency. For purposes of section 986(a)(1)(D) and this paragraph (a)(2)(iv), whether the currency in which a tax liability attributable to a qualified business unit (within the meaning of section 989(a)) (QBU) is denominated is a nonfunctional currency is determined by reference to the functional currency of the individual or corporate taxpayer and not that of the QBU of the taxpayer. Accrued but unpaid foreign income taxes subject to the election under this paragraph (a)(2)(iv) are translated at the provisional year-end rate. However, a taxpayer that claims a foreign tax credit under section 901 may choose to translate accrued but unpaid foreign income taxes (including foreign taxes deemed paid under section 960 with respect to a specified 10-percent owned foreign corporation that has made an election under this paragraph (a)(2)(iv)) into dollars at the spot rate on the date of payment, in lieu of the provisional year-end rate, if such taxes are paid prior to the due date (with extensions) of the original return for the taxable year for which the credit is claimed and such return is timely filed. In all other cases, see § 1.905-3 and paragraph (c) of this section for required adjustments upon payment of accrued foreign income taxes that are translated into dollars at the spot rate on the date of payment.
(B) Scope of election. In general, an individual taxpayer may make an election under this paragraph (a)(2)(iv) for all foreign income taxes denominated in nonfunctional currency, or only for those foreign income taxes that are denominated in nonfunctional currency and that are attributable to the individual's non-QBU activities and all QBUs with dollar functional currencies. A corporate taxpayer may make an election under this paragraph (a)(2)(iv) for all foreign income taxes that are denominated in nonfunctional currency, or only for those foreign income taxes that are denominated in nonfunctional currency and that are attributable to all QBUs (including the corporate taxpayer) with dollar functional currencies. Therefore, an election under this paragraph (a)(2)(iv) may not be made for foreign income taxes that are denominated in a nonfunctional currency of the taxpayer and attributable to QBUs with non-dollar functional currencies, except as part of an election to translate all taxes denominated in nonfunctional currency at the spot rate on the date of payment. For purposes of this paragraph (a)(2)(iv)(B), foreign income tax is attributable to a QBU if the tax is properly recorded on the books and records of the QBU in accordance with sections 985 through 989. An election under this paragraph (a)(2)(iv) by a domestic corporation (or an individual that has made an election under section 962) does not apply to any taxes paid or accrued by foreign corporations with respect to which the individual or corporation is a United States shareholder. However, an election may be made on behalf of a foreign corporation to translate either all of the foreign corporation's foreign income taxes denominated in nonfunctional currency, or only the foreign income taxes denominated in nonfunctional currency that are attributable to the foreign corporation's QBUs with dollar functional currencies, using the spot rate on the date of payment. Such an election is made using the procedures under § 1.964-1(c)(3) that apply to permit controlling domestic shareholders to make or change a tax accounting election on behalf of a foreign corporation.
(C) Time and manner of election. The election under this paragraph (a)(2)(iv) must be made by attaching a statement to the taxpayer's timely filed Federal income tax or information return (including extensions) for the first taxable year to which the election applies. The statement must identify whether the election under this paragraph (a)(2)(iv) is made for all foreign income taxes denominated in nonfunctional currency or only for those foreign income taxes that are denominated in nonfunctional currency and that are either attributable to the taxpayer's QBUs with dollar functional currencies or, in the case of an individual, attributable to non-QBU activities. Once made, the election under this paragraph (a)(2)(iv) applies for the taxable year for which made and all subsequent taxable years unless revoked with the consent of the Commissioner.
(D) Example —( 1 ) Facts. USP, a domestic corporation that uses the calendar year as its taxable year, owns a partnership interest in PS, a non-hybrid partnership organized in Country X. USP also owns an equity interest in HPS, a Country X corporation that has filed an entity classification election under § 301.7701-3 of this chapter to be treated as a partnership for Federal income tax purposes. USP also owns 100% of CFC, a Country Y controlled foreign corporation that uses the U.S. dollar as its functional currency. PS and HPS each use a fiscal year ending November 30 as its taxable year both for Federal income tax purposes and for Country X tax purposes, and their functional currency is the Euro. HPS is the section 901 taxpayer of foreign income taxes denominated in Euros that it pays to Country X and properly records on its books and records. USP takes its distributive share of the HPS taxes into account under sections 702(a)(6) and 901(b)(5) and §§ 1.702-1(a)(6) and 1.704-1(b)(4)(viii) in computing its foreign tax credit. USP is the section 901 taxpayer of Euro-denominated foreign income taxes it pays to Country X with respect to its distributive share of the income of PS, and also pays Country X taxes withheld in Euros from distributions from HPS to USP and properly records these taxes on its books and records. Pursuant to § 1.985-1(b)(1)(iii), USP's functional currency is the dollar. USP timely elects under § 1.986(a)-1(a)(2)(iv) to use the spot rate on the date of payment to translate into dollars its foreign income taxes denominated in nonfunctional currency that are attributable to all QBUs with dollar functional currencies.
( 2 ) Result. The Euro taxes paid by USP with respect to its distributive share of income from PS and the Euro taxes withheld from distributions from HPS are nonfunctional currency taxes attributable to USP, a QBU with a dollar functional currency. Accordingly, these taxes are translated into dollars at the spot rate on the date the taxes are paid. USP's distributive share of the Euro taxes paid by HPS are attributable to HPS, a Euro functional currency QBU of USP. Because these taxes are not attributable to a dollar QBU of USP, they are not covered by USP's election and so are translated into dollars at the average exchange rate for HPS's U.S. taxable year ending on November 30. See § 1.986(a)-1(a)(1). Foreign income taxes paid by CFC are not covered by USP's election; however, if USP so chooses it may make a separate election on behalf of CFC to use the spot rate on the date of payment to translate either all of CFC's nonfunctional currency taxes, or only those taxes that are attributable to CFC's dollar QBUs (which includes CFC). If instead USP had elected to use the spot rate on the date of payment to translate all of its foreign income taxes denominated in nonfunctional currency, rather than only those taxes attributable to QBUs with dollar functional currencies, then the spot rate on the date of payment would apply to translate all of the Euro taxes paid or accrued by USP, including its distributive share of taxes paid by HPS. However, this election would still not apply to taxes paid or accrued by CFC. See § 1.986(a)-1(a)(2)(iv)(B).
(v) Regulated investment companies. In the case of a regulated investment company (as defined in section 851) which takes into account income on an accrual basis, foreign income taxes paid or accrued with respect to such income are translated into dollars using the spot rate on the date the income accrues. See section 986(a)(1)(E).
(b) Translation of foreign income taxes taken into account when paid. In the case of a section 901 taxpayer that takes foreign income taxes into account when paid, the amount of any foreign income tax liability denominated in foreign currency, including additional income tax liability denominated in foreign currency or estimated foreign income taxes paid in foreign currency, are translated into dollars using the spot rate on the date of payment of such taxes. See section 986(a)(2)(A). Foreign income taxes withheld in foreign currency are translated into dollars using the spot rate on the date on which such taxes were withheld.
(c) Refunds or other reductions of foreign income tax liability. In the case of a section 901 taxpayer that takes foreign income taxes into account when accrued, a reduction in the amount of previously-accrued foreign income taxes that is attributable to a refund of foreign income taxes, a credit allowed in lieu of a refund, or a reduction in or other downward adjustment to an accrued amount, including an adjustment on account of accrued foreign income taxes that were not paid by the date 24 months after the close of the U.S. taxable year to which such taxes relate, is translated into dollars using the exchange rate that was used to translate such amount when claimed as a credit or added to PTEP group taxes (as defined in § 1.960-3(d)(1)). In the case of foreign income taxes taken into account when accrued but translated into dollars on the date of payment, see § 1.905-3(b) for required adjustments to reflect a foreign tax redetermination (as defined in § 1.905-3(a)) attributable to a reduction in the amount of previously-accrued foreign income taxes that is attributable to a difference in exchange rates between the date or taxable year of accrual and the date of payment. In the case of a section 901 taxpayer that takes foreign income taxes into account when paid, a refund or other reduction in or downward adjustment to the amount of foreign income taxes is translated into dollars using the exchange rate that was used to translate such amount when claimed as a credit. If a refund or other reduction of foreign income taxes relates to foreign income taxes paid or accrued on more than one date, then the refund or other reduction is deemed to be derived from, and reduces, the payments of foreign income taxes in order, starting with the most recent payment of foreign income taxes first, to the extent thereof.
(d) Allocation of refunds of foreign income taxes. Refunds of foreign income taxes are allocated to the same separate category as the foreign income taxes to which the refunded taxes relate. Refunds are related to foreign income taxes in a separate category if the foreign income tax that was refunded was imposed with respect to that separate category. See § 1.904-6 concerning the allocation of foreign income taxes to separate categories of income.
(e) Basis of foreign currency refunded —(1) Nonfunctional currency tax liability and dollar functional currency. If the functional currency of the QBU that paid the tax and received the refund is the dollar or the person receiving the refund is not a QBU, then the recipient's basis in the foreign currency refunded is the dollar value of the refund determined under paragraph (c) of this section by using the exchange rate that was used to translate such amount into dollars when claimed as a credit or added to PTEP group taxes.
(2) Nonfunctional currency tax liability and non-dollar functional currency. If the functional currency of the QBU receiving the refund is not the dollar and is different from the currency in which the foreign income taxes were paid, then the recipient's basis in the refunded foreign currency is equal to the functional currency value of the nonfunctional currency refund, translated into functional currency at the appropriate exchange rate between the functional currency and the nonfunctional currency. Such exchange rate is determined under the principles of paragraph (c) of this section, substituting the words “functional currency” for the word “dollar” and using the exchange rate that was used to translate such amount into the QBU's functional currency when claimed as a credit or added to PTEP group taxes (as defined in § 1.960-3(d)(1)). If a QBU receives a refund of nonfunctional currency tax that is denominated in a currency that was the functional currency of the QBU when the refunded tax was claimed as a credit or added to PTEP group taxes, the QBU's basis in the nonfunctional currency received in the refund is determined by using the exchange rate used under § 1.985-5(c) when the QBU's functional currency changed. See § 1.905-3(b)(1)(ii)(C) ( Example 3 ).
(3) Functional currency tax liabilities. If the functional currency of the QBU receiving the refund is the currency in which the refund was made, then the recipient's basis in the currency received is the amount of the functional currency received. If the QBU receives a refund of functional currency tax that was denominated in a nonfunctional currency of the QBU when the tax was claimed as a credit or added to PTEP group taxes, the QBU will recognize the section 988 gain or loss that would have been recognized under § 1.985-5(b) if the refund had been received immediately before the QBU's functional currency changed.
(4) Foreign currency gain or loss. For rules for determining subsequent foreign currency gain or loss on the disposition of nonfunctional currency, the basis of which is determined under this paragraph (e), see section 988(c)(1)(C).
(f) Applicability dates. This section applies to taxable years ending on or after December 16, 2019, and to taxable years of foreign corporations which end with or within a taxable year of a United States shareholder ending on or after December 16, 2019.
§ 1.986(c)-1   Coordination with section 965.
(a) Amount of foreign currency gain or loss. Foreign currency gain or loss with respect to distributions of section 965(a) previously taxed earnings and profits (as defined in § 1.965-1(f)(39)) is determined based on movements in the exchange rate between December 31, 2017, and the time such distributions are made.
(b) Section 965(a) previously taxed earnings and profits. Any gain or loss recognized under section 986(c) with respect to distributions of section 965(a) previously taxed earnings and profits is reduced in the same proportion as the reduction by a section 965(c) deduction amount (as defined in § 1.965-1(f)(42)) of the section 965(a) inclusion amount (as defined in § 1.965-1(f)(38)) that gave rise to such section 965(a) previously taxed earnings and profits.
(c) Section 965(b) previously taxed earnings and profits. Section 986(c) does not apply with respect to distributions of section 965(b) previously taxed earnings and profits (as defined in § 1.965-1(f)(40)).
(d) Applicability dates. The section applies beginning the last taxable year of a foreign corporation that begins before January 1, 2018, and with respect to a United States person, for the taxable year in which or with which such taxable year of the foreign corporation ends.
§ 1.987-0   Table of contents.
This section lists the headings for §§ 1.987-1 through 1.987-15.
(a) In general.
(b) Scope of section 987 and certain rules relating to QBUs.
(1) Persons subject to section 987.
(i) In general.
(ii) Inapplicability to certain entities.
(2) Application of the section 987 regulations to earnings and profits.
(i) In general.
(ii) Timing.
(3) Definition of a section 987 QBU.
(i) In general.
(ii) Section 987 QBU grouping election.
(4) Definition of an eligible QBU.
(i) In general.
(ii) Qualified business unit.
(5) Definition of an owner.
(i) Direct ownership.
(ii) [Reserved]
(6) [Reserved]
(7) Examples illustrating paragraph (b) of this section.
(i) Example 1: Owner owns an eligible QBU and a DE holding company.
(ii) Example 2: Owner owns eligible QBUs through DEs.
(iii) Example 3: Section 987 grouping election.
(c) Exchange rates.
(1) Spot rate.
(i) In general.
(ii) Election to use a spot rate convention.
(2) Yearly average exchange rate.
(3) Historic rate.
(i) In general.
(ii) Date placed in service for depreciable or amortizable property.
(iii) Changed functional currency.
(d) Marked item.
(1) In general.
(2) Current rate election.
(e) Historic item.
(f) Example: Identification of marked and historic items.
(1) Facts.
(2) Analysis.
(g) Elections.
(1) Persons making the election.
(i) United States persons.
(ii) CFCs.
(iii) Consolidated groups.
(iv) Partnerships.
(2) Consistency rules.
(i) Consolidated groups.
(ii) CFCs and foreign partnerships.
(iii) Section 381(a) transactions.
(3) Manner of making or revoking elections.
(i) Statement must be attached to a return.
(ii) Election requirements.
(iii) Elections made under the 2016 and 2019 section 987 regulations.
(4) No change in method of accounting.
(5) Principles of § 1.964-1(c)(3) applicable to section 987 elections.
(h) Definitions.
(a) In general.
(b) Attribution of items to an eligible QBU.
(1) General rules.
(2) Exceptions for non-portfolio stock, interests in partnerships, and certain acquisition indebtedness.
(i) In general.
(ii) Separate account assets.
(3) Adjustments to items reflected on the books and records.
(i) General rule.
(ii) Factors indicating no tax avoidance.
(iii) Factors indicating tax avoidance.
(iv) Section 988 transactions.
(c) Transfers to and from section 987 QBUs.
(1) In general.
(2) Disregarded transactions.
(i) General rule.
(ii) Definition of a disregarded transaction.
(iii) Items derived from disregarded transactions ignored.
(3) through (6) [Reserved]
(7) Application of general tax law principles.
(8) Interaction with § 1.988-1(a)(10).
(9) Certain disregarded transactions not treated as transfers.
(i) Combinations of section 987 QBUs.
(ii) Change in functional currency from a combination.
(iii) Separation of section 987 QBUs.
(iv) Special rules for successor suspended loss QBUs.
(10) Examples.
(i) Example 1: Loan to a section 987 QBU.
(ii) Example 2: Transfer between section 987 QBUs.
(iii) Example 3: Sale of property between two section 987 QBUs.
(iv) through (ix) [Reserved]
(x) Example 10: Contribution of a section 987 QBU's assets to a corporation.
(xi) Example 11: Circular transfers.
(xii) Example 12: Transfers without substance.
(xiii) Example 13: Offsetting positions in section 987 QBUs
(xiv) Example 14: Offsetting positions with respect to a section 987 QBU and a section 988 transaction.
(xv) Example 15: Offsetting positions with respect to a section 987 QBU and a section 988 transaction.
(xvi) Example 16: Borrowing by section 987 QBU followed by immediate distribution to owner.
(xvii) Example 17: Payment of interest by section 987 QBU on obligation of owner.
(xviii) Example 18: Sale of the interests in a DE.
(d) Translation of items transferred to a section 987 QBU.
(1) Marked items.
(2) Historic items.
(e) Cross-reference.
(a) In general.
(b) Determination of each item of income, gain, deduction, or loss in the section 987 QBU's functional currency.
(1) In general.
(2) Translation of items of income, gain, deduction, or loss that are denominated in a nonfunctional currency.
(3) [Reserved]
(4) Section 988 transactions.
(i) In general.
(ii) Section 988 mark-to-market election.
(c) Translation of items of income, gain, deduction, or loss of a section 987 QBU into the owner's functional currency.
(1) In general.
(2) Exceptions.
(i) Recovery of basis with respect to historic assets.
(ii) through (iii) [Reserved]
(iv) Cost of goods sold computation.
(v) Translation of income to account for certain foreign income tax claimed as a credit.
(3) Adjustments to COGS required under the simplified inventory method.
(i) In general.
(ii) Adjustment for cost recovery deductions included in inventoriable costs.
(iii) Adjustment for beginning inventory for non-LIFO inventory.
(iv) Adjustment for year of LIFO liquidation.
(d) [Reserved]
(e) Examples.
(1) Example 1: Item of income denominated in nonfunctional currency.
(2) Example 2: Asset sold for nonfunctional currency.
(3) Example 3: Historic inventory method.
(i) Facts.
(ii) Analysis.
(4) Example 4: Simplified inventory method.
(i) Facts.
(ii) Analysis.
(5) Example 5: Depreciation expense that is not an inventoriable cost.
(6) Example 6: Translation of depreciation expense that is an inventoriable cost (historic inventory method).
(7) Example 7: Sale of land.
(8) Example 8: Current rate election.
(9) through (12) [Reserved]
(13) Example 13: Section 988 transaction.
(i) Facts.
(ii) Analysis.
(14) Example 14: Payment of foreign income tax.
(i) Facts.
(ii) Analysis.
(a) In general.
(b) Calculation of net unrecognized section 987 gain or loss.
(c) Net accumulated unrecognized section 987 gain or loss for all prior taxable years.
(1) In general.
(2) Additional adjustments for certain taxable years beginning on or before December 31, 2024.
(d) Calculation of unrecognized section 987 gain or loss for a taxable year.
(1) Step 1: Determine the change in the owner functional currency net value of the section 987 QBU for the taxable year.
(i) In general.
(ii) Year section 987 QBU is terminated.
(iii) First taxable year of a section 987 QBU.
(iv) First year in which an election is in effect or ceases to be in effect.
(2) Step 2: Increase the amount determined in step 1 by the amount of assets transferred from the section 987 QBU to the owner.
(i) In general.
(ii) Assets transferred from the section 987 QBU to the owner during the taxable year.
(3) Step 3: Decrease the amount determined in steps 1 and 2 by the amount of assets transferred from the owner to the section 987 QBU.
(i) In general.
(ii) Assets transferred from the owner to the section 987 QBU during the taxable year.
(4) Step 4: Decrease the amount determined in steps 1 through 3 by the amount of liabilities transferred from the section 987 QBU to the owner.
(i) In general.
(ii) Liabilities transferred from the owner to the section 987 QBU during the taxable year.
(5) Step 5: Increase the amount determined in steps 1 through 4 by the amount of liabilities transferred from the owner to the section 987 QBU.
(6) Step 6: Decrease or increase the amount determined in steps 1 through 5 by the section 987 taxable income or loss, respectively, of the section 987 QBU for the taxable year.
(7) Step 7: Increase the amount determined in steps 1 through 6 by certain expenses or losses that are not deductible in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year.
(8) Step 8: Decrease the amount determined in steps 1 through 7 by the amount of certain income or gain that is not included in taxable income in computing the section 987 taxable income or loss of the section 987 QBU for the taxable year.
(9) Step 9: Increase or decrease the amount determined in steps 1 through 8 by any income or gain, or any deduction or loss, respectively, that does not impact the adjusted balance sheet.
(10) Step 10: Decrease or increase the amount determined in steps 1 through 9 by any increase or decrease, respectively, to the section 987 QBU's net assets that is not previously taken into account under steps 2 through 9.
(i) In general.
(ii) Determining the residual increase or decrease to net assets.
(iii) Modifications for taxable years to which a current rate election or an annual recognition election applies.
(e) Determination of the owner functional currency net value of a section 987 QBU.
(1) In general.
(i) Marked item.
(ii) Historic item.
(2) Current rate election.
(i) In general.
(ii) QBU net value.
(iii) Alternative calculation of QBU net value.
(f) Combinations and separations.
(1) Combinations.
(2) Separations.
(3) Examples.
(i) Example 1: Combination of two section 987 QBUs that have the same owner.
(ii) Example 2: Separation of two section 987 QBUs that have the same owner.
(g) Examples.
(1) Example 1: Determination of net unrecognized section 987 gain or loss.
(i) Facts.
(ii) Analysis.
(2) Example 2: Determination of net unrecognized section 987 gain or loss if a current rate election in effect.
(i) Facts.
(ii) Analysis.
(iii) Alternative computation of QBU net value.
(3) Example 3: Determination of net unrecognized section 987 gain or loss when a current rate election is revoked.
(i) Facts.
(ii) Analysis.
(a) Recognition of section 987 gain or loss by the owner of a section 987 QBU.
(b) Remittance proportion.
(1) In general.
(2) Annual recognition election.
(c) Remittance.
(1) Definition.
(2) Alternative calculation.
(i) Step 1: Determine the change in QBU net value.
(ii) Step 2: Adjust the amount determined in step 1 for income or loss of the section 987 QBU.
(iii) Step 3: Multiply the amount determined in step 2 by negative one.
(3) Day when a remittance is determined.
(4) Termination.
(d) Aggregate of all amounts transferred from the section 987 QBU to the owner for the taxable year.
(e) Aggregate of all amounts transferred from the owner to the section 987 QBU for the taxable year.
(f) Determination of owner's adjusted basis in transferred assets and amount of transferred liabilities.
(1) In general.
(2) Marked items.
(3) Historic items.
(g) Example—Calculation of section 987 gain or loss recognized.
(1) Facts.
(i) In general.
(ii) Year 1 balance sheet.
(iii) Transfers and income in year 2.
(iv) Year 2 balance sheet.
(2) Analysis.
(i) Computation of amount of remittance.
(ii) Alternative computation of remittance amount.
(iii) Computation of section 987 QBU gross assets plus remittance.
(iv) Computation of remittance proportion.
(v) Computation of section 987 gain or loss.
(3) Annual recognition election.
(a) Ordinary income or loss.
(b) Character and source of section 987 gain or loss.
(1) Timing of source and character determination.
(2) Method for determining the character and source section 987 gain or loss.
(i) Initial assignment
(ii) Reassignment of section 987 gain or loss.
(iii) Special rule for the application of the GILTI high-tax exclusion to section 987 gain or loss.
(3) Allocation and apportionment of foreign income tax to section 987 items under section 861.
(i) The foreign gross income is an item of foreign currency gain or loss.
(ii) The same event or events give rise to both the foreign gross income and the section 987 gain or loss.
(c) Examples.
(1) Example 1: Initial assignment and reassignment of section 987 gain or loss.
(i) Facts.
(ii) Analysis.
(2) Example 2: Effect of GILTI high-tax exclusion.
(i) Facts.
(ii) Analysis.
(3) Example 3: Section 987 gain or loss treated as attributable to section 988 transactions.
(i) Facts.
(ii) Analysis.
(4) Example 4: Section 987 gain or loss assigned to passive foreign personal holding company income.
(i) Facts.
(ii) Analysis.
(a) Overview.
(b) Section 987 regulations generally do not apply to partnerships.
(c) Provisions of the section 987 regulations that apply to partnerships.
(1) In general.
(i) Eligible QBU.
(ii) Partnership.
(2) Applicable provisions.
(i) In general.
(ii) Annual recognition election.
(iii) Section 988 mark-to-market election.
(3) Modifications to applicable provisions.
(i) In general.
(ii) Controlled group.
(4) Terminating QBUs.
(d) Suspended section 987 loss.
(1) In general.
(i) Rules of § 1.987-11(c) and (d)(2) do not apply.
(ii) Suspension of section 987 loss.
(2) Exceptions.
(i) Method under which historic items do not give rise to section 987 gain or loss.
(ii) Annual recognition election.
(iii) De minimis rule.
(3) Recognition of suspended section 987 loss.
(i) In general.
(ii) Partnership that is not engaged in a trade or business.
(iii) Application of the loss-to-the-extent-of-gain rule.
(e) Adjustments to the basis of a partner's interest in the partnership.
(f) S corporations treated as partnerships.
(g) Examples.
(1) Example 1: Aggregate approach to section 987.
(i) Facts.
(ii) Analysis.
(2) Example 2: Entity approach to section 987.
(i) Facts.
(ii) Analysis.
(a) Scope.
(b) In general.
(1) Trade or business ceases.
(2) Substantially all assets transferred.
(3) Owner no longer a CFC.
(4) Owner ceases to exist.
(5) Section 987 QBU ceases to be an eligible QBU with a functional currency different from its owner.
(6) Change in form of ownership.
(c) Transactions described in section 381(a).
(1) Liquidations.
(2) Reorganizations.
(d) [Reserved]
(e) Effect of terminations.
(f) Examples.
(1) Example 1: Cessation of operations.
(i) Facts.
(ii) Analysis.
(2) Example 2: Transfer of a section 987 QBU to a member of a consolidated group.
(i) Facts.
(ii) Analysis.
(3) Example 3: Cessation of controlled foreign corporation status.
(i) Facts.
(ii) Analysis.
(4) Example 4: Section 332 liquidation.
(i) Facts.
(ii) Analysis.
(5) [Reserved]
(6) Example 6: Deemed transfers to a CFC upon a check-the-box election.
(i) Facts.
(ii) Analysis.
(7) Example 7: Sale of a section 987 QBU to a member of a consolidated group.
(i) Facts.
(ii) Analysis.
(a) In general.
(b) Supplemental information.
(c) Retention of records.
(d) Information on a dedicated section 987 form.
(a) Overview.
(1) In general.
(2) Terms defined under prior § 1.987-12.
(b) Scope.
(1) Owner of a section 987 QBU.
(2) Deferral QBU owner and owner of outbound loss QBU.
(c) Transition date.
(1) In general.
(2) Terminating QBU.
(i) In general.
(ii) Ordering rule.
(d) Application of the section 987 regulations after the transition date.
(1) Owner functional currency net value on the last day of the preceding taxable year.
(2) Determination of historic rate.
(3) Transition exchange rate.
(i) In general.
(ii) Earnings only method.
(e) Pretransition gain or loss.
(1) In general.
(2) Amount of pretransition gain or loss for an owner that applied an eligible pretransition method.
(i) Owner of a section 987 QBU
(ii) Deferral QBU owner.
(iii) Owner of an outbound loss QBU.
(3) Amount of pretransition gain or loss for an owner that did not apply an eligible pretransition method.
(i) In general.
(ii) Computation of pretransition gain or loss.
(iii) Annual unrecognized section 987 gain or loss.
(iv) Deferral QBU owner.
(v) Owner of an outbound loss QBU.
(4) Eligible pretransition method.
(i) Earnings and capital method.
(ii) Other reasonable methods.
(iii) Other earnings only methods.
(iv) Error in the application of a section 987 method.
(v) Certain consistent practices not treated as errors.
(vi) Deferral of section 987 gain or loss until termination is not reasonable.
(vii) Anti-abuse rule.
(5) Recognition of pretransition gain or loss.
(i) In general.
(ii) Election to recognize pretransition section 987 gain or loss ratably over the transition period.
(6) Predecessor of an owner.
(i) In general.
(ii) Predecessor.
(7) Small business election.
(i) Scope.
(ii) Owner threshold.
(iii) QBU threshold.
(iv) Small business election.
(f) QBUs to which the fresh start transition method was applied.
(1) In general.
(2) Application of the section 987 regulations after the transition date.
(i) Owner functional currency net value on the last day of the preceding taxable year.
(ii) Determination of historic rate.
(iii) Unrecognized section 987 gain or loss.
(3) Taxpayers that are required to transition using the fresh start transition method.
(g) [Reserved]
(h) Determination of source and character.
(1) In general.
(2) Deferral QBU or outbound loss QBU.
(i) [Reserved]
(j) Adjustments to avoid double counting or omissions.
(k) Reporting.
(1) In general.
(2) QBUs for which reporting is required.
(i) In general.
(ii) QBUs to which the fresh start transition method was applied.
(3) Attachments not required where information is reported on a form.
(4) No change in method of accounting.
(l) Examples.
(1) Example 1: Earnings and capital method.
(i) Facts.
(ii) Analysis.
(2) Example 2: Earnings only method described in paragraph (e)(4)(ii) of this section.
(i) Facts.
(ii) Analysis.
(3) Example 3: Earnings only method described in paragraph (e)(4)(iii) of this section.
(i) Facts.
(ii) Analysis.
(4) Example 4: Owner did not apply section 987(3).
(i) Facts.
(ii) Analysis.
(5) Example 5: Error in application of method.
(i) Facts.
(ii) Analysis.
(6) Example 6: Consistent practice not treated as an error.
(i) Facts.
(ii) Analysis.
(a) In general.
(b) Cumulative suspended section 987 loss in a recognition grouping.
(1) In general.
(2) Combined QBU.
(3) Separated QBU.
(c) Suspension of section 987 loss for taxable years in which a current rate election is in effect and an annual recognition election is not in effect.
(1) In general.
(2) De minimis rule.
(3) Taxable year of controlled group members.
(i) In general.
(ii) Owner is a CFC.
(d) Suspension of net unrecognized section 987 loss upon making or revoking certain elections.
(1) Making an annual recognition election.
(2) Revoking a current rate election.
(e) Loss-to-the-extent of gain rule.
(1) In general.
(2) Separate determination for each recognition grouping.
(3) Amount of suspended section 987 loss recognized.
(i) Current year gain amount.
(ii) Lookback gain amount.
(iii) Suspended section 987 loss not taken into account.
(iv) Lookback period.
(v) Anti-abuse rule.
(4) Suspended section 987 loss recognized with respect to each section 987 QBU and suspended section 987 loss QBU.
(5) Section 381(a) transactions.
(i) In general.
(ii) Limitation for inbound section 381(a) transactions.
(6) Consolidated group members.
(i) In general.
(ii) Suspended section 987 losses arising in separate return limitation years.
(f) Recognition groupings.
(1) Sourcing and section 904 category.
(2) Statutory and residual groupings for CFC owners.
(g) Examples.
(1) Example 1: Suspension of section 987 loss and recognition of suspended section 987 loss.
(i) Facts.
(ii) Analysis.
(2) Example 2: Recognition of suspended section 987 loss by reason of gain recognized during the lookback period.
(i) Facts.
(ii) Analysis.
(iii) Alternative facts.
(iv) Analysis of alternative facts.
(3) Example 3: Suspension of section 987 loss when a current rate election is revoked.
(i) Facts.
(ii) Analysis.
(a) Overview.
(1) Scope.
(2) Exceptions.
(i) Annual recognition election.
(ii) De minimis rule.
(b) Treatment of section 987 gain and loss in connection with a deferral event.
(1) Gain or loss recognized (or suspended) in the taxable year of a deferral event.
(2) Deferred section 987 gain or loss.
(i) In general.
(ii) Deferred section 987 gain or loss attributable to a successor deferral QBU.
(c) Recognition (or suspension) of deferred section 987 gain or loss following a deferral event.
(1) Recognition upon a subsequent remittance.
(i) In general.
(ii) Amount.
(iii) Deemed remittance by a successor deferral QBU.
(2) Deferral events and outbound loss events with respect to a successor deferral QBU.
(d) Successor deferral QBU becomes a successor suspended loss QBU.
(e) Anti-abuse rule.
(f) Combinations and separations of successor deferral QBUs.
(1) Combined QBU.
(2) Separated QBU.
(g) Definitions.
(1) Deferral event.
(i) Events.
(ii) Assets on books of successor deferral QBU.
(2) Successor deferral QBU.
(3) Original deferral QBU owner.
(4) Qualified successor.
(h) Examples.
(1) Example 1: Contribution of a section 987 QBU with net unrecognized section 987 gain to a member of the controlled group.
(i) Facts.
(ii) Analysis.
(2) Example 2: Contribution of a section 987 QBU with net unrecognized section 987 loss to a member of the controlled group when a current rate election is in effect.
(i) Facts.
(ii) Analysis.
(3) Example 3: Election to be classified as a corporation.
(i) Facts.
(ii) Analysis.
(4) Example 4: Partial recognition of deferred gain or loss.
(i) Facts.
(ii) Analysis.
(a) Overview.
(1) In general.
(2) Ordering rule.
(b) Termination of a section 987 QBU with suspended loss.
(1) Suspended section 987 loss becomes suspended section 987 loss with respect to a successor suspended loss QBU.
(i) Successor suspended loss QBU.
(ii) Attribution of suspended section 987 loss to successor suspended loss QBU.
(2) Recognition of suspended section 987 loss.
(c) Termination of a successor suspended loss QBU.
(1) Successor to the successor suspended loss QBU.
(i) Successor suspended loss QBU.
(ii) Attribution of suspended section 987 loss to successor suspended loss QBU.
(2) Recognition of suspended section 987 loss.
(d) Transfer of successor suspended loss QBU owner.
(e) Transfer of original suspended loss QBU owner.
(f) Owner ceases to exist.
(g) Inbound nonrecognition transactions-no carryover of suspended section 987 loss.
(h) Outbound transactions-recognition or suspension of net unrecognized section 987 loss.
(1) In general.
(2) Outbound loss event.
(3) Loss recognition upon an outbound loss event
(4) Loss suspension upon outbound loss event.
(i) [Reserved]
(j) Termination of a successor suspended loss QBU.
(k) Anti-abuse.
(l) Definitions.
(1) Original suspended loss QBU owner.
(i) In general.
(ii) Successors.
(2) Successor suspended loss QBU.
(3) Successor suspended loss QBU owner.
(4) Ownership interests.
(5) Significant portion.
(m) Examples.
(1) Example 1: Trade or business of a section 987 QBU ceases.
(i) Facts.
(ii) Analysis.
(2) Example 2: Trade or business of a section 987 QBU is sold to a third party.
(i) Facts.
(ii) Analysis.
(3) Example 3: Outbound loss event.
(i) Facts.
(ii) Analysis.
(a) Overview.
(b) Section 987 hedging transaction.
(1) In general.
(2) Requirements.
(i) Identification.
(ii) Current rate election.
(iii) Mark-to-market method of accounting.
(iv) Treatment under U.S. generally accepted accounting principles.
(v) Hedge entered into by owner of the hedged QBU.
(3) Anti-abuse rule.
(4) Partial termination of a section 987 hedging transaction.
(c) Identification requirements.
(1) In general.
(2) Inadvertent error.
(d) Taxation of section 987 hedging transactions.
(1) Hedging gain or loss with respect to a hedged QBU.
(2) Adjustment to unrecognized section 987 gain or loss for the taxable year.
(i) Hedging loss.
(ii) Hedging gain.
(3) Termination of a hedged QBU.
(e) Examples.
(1) Example 1: Section 987 hedging transaction.
(i) Facts.
(ii) Analysis.
(2) Example 2: Excess hedging gain from a section 987 hedging transaction.
(i) Facts.
(ii) Analysis.
(a) Applicability date of section 987 regulations.
(1) In general.
(2) Applicability date for a terminating QBU.
(b) Application of the section 987 regulations to taxable years beginning on or before December 31, 2024, and ending after November 9, 2023.
(c) Application of the 2016 and 2019 section 987 regulations.
(1) In general.
(2) Application to section 987 QBUs not owned on the transition date.
(3) Modifications of defined terms for purposes of this paragraph (c).
(i) Application of § 1.987-10 in lieu of prior § 1.987-10.
(ii) Partnerships not included in section 987 electing group.
(iii) Transition date.
(d) Prior § 1.987-12.