Title 26—Internal Revenue--Volume 1
PART 1—INCOME TAXES
§ 1.987-7   Application of the section 987 regulations to partnerships and S corporations.
(a) Overview. This section provides rules relating to the application of the section 987 regulations to partnerships and S corporations. Paragraph (b) of this section provides the general rule that the section 987 regulations do not apply to partnerships. Paragraph (c) of this section identifies certain provisions of the section 987 regulations that are applicable to partnerships, subject to certain modifications. Paragraph (d) of this section provides special rules relating to suspended section 987 loss. Paragraph (e) of this section provides rules for adjusting a partner's basis in its partnership interest. Paragraph (f) of this section provides that S corporations are treated in the same manner as partnerships for purposes of the section 987 regulations. Paragraph (g) of this section provides examples that illustrate the rules of this section.
(b) Section 987 regulations generally do not apply to partnerships. Except as otherwise provided in this section, the section 987 regulations do not apply to a partnership, and the section 987 regulations do not apply to an eligible QBU if a partnership is the owner for Federal income tax purposes of the eligible QBU's assets and liabilities. However, a taxpayer must apply sections 987 and 989(a) to partnerships and eligible QBUs of partnerships in a reasonable manner using a method that is applied consistently from year to year with respect to a particular partnership or eligible QBU. In addition, all members of the same controlled group must apply the same method consistently with respect to a particular partnership or eligible QBU.
(c) Provisions of the section 987 regulations that apply to partnerships —(1) In general —(i) Eligible QBU. The rules described in paragraph (c)(2) of this section apply to an eligible QBU if a partnership is the owner for Federal income tax purposes of the eligible QBU's assets and liabilities and either—
(A) The partnership (or a partner) treats the eligible QBU as a qualified business unit of the partnership that is subject to section 987 (for example, under an entity approach); or
(B) A partner in the partnership treats all or a portion of the eligible QBU as a qualified business unit of the partner that is subject to section 987 (for example, under an aggregate approach).
(ii) Partnership. The rules described in paragraph (c)(2) of this section apply to a partnership if a partner in the partnership treats the partnership itself (or an interest in the partnership) as a qualified business unit that is subject to section 987 (for example, under an entity approach).
(2) Applicable provisions —(i) In general. Sections 1.987-6 (character and source of section 987 gain or loss), 1.987-9(d) (information on a dedicated section 987 form), §§ 1.987-11 through 1.987-13 (suspended section 987 loss, deferral of section 987 gain or loss, and suspended section 987 loss upon terminations, respectively), and § 1.987-15 (applicability dates) apply to a QBU described in paragraph (c)(1) of this section, subject to the modifications described in this paragraph (c) and in paragraph (d) of this section.
(ii) Annual recognition election. An annual recognition election under § 1.987-5(b)(2) applies to a QBU described in paragraph (c)(1) of this section, subject to the modifications described in this paragraph (c). In each taxable year of the owner of a QBU described in paragraph (c)(1) of this section in which an annual recognition election is in effect, the owner recognizes any unrecognized gain or loss with respect to the QBU under section 987(3) (other than suspended section 987 loss) as though the QBU terminated on the last day of the taxable year. Appropriate adjustments must be made to prevent the gain or loss from being taken into account again after it is recognized under this paragraph (c)(2)(ii) (for example, in the case of a taxpayer applying the 1991 proposed regulations, by adjusting the equity and basis pools to reflect the gain or loss recognized). The rules of § 1.987-1(g) apply with respect to an annual recognition election that is made by or for an owner of a QBU described in paragraph (c)(1) of this section.
(iii) Section 988 mark-to-market election. A section 988 mark-to-market election under § 1.987-3(b)(4)(ii) applies to a QBU described in paragraph (c)(1) of this section. The rules of § 1.987-1(g) apply with respect to a section 988 mark-to-market election that is made by or for an owner of a QBU described in paragraph (c)(1) of this section.
(3) Modifications to applicable provisions —(i) In general. An owner of a QBU described in paragraph (c)(1) of this section must adapt the rules described in paragraph (c)(2) of this section as necessary to recognize section 987 gain or loss in a manner that is consistent with the principles of those rules. For purposes of applying this section and the rules described in paragraph (c)(2) of this section to a QBU described in paragraph (c)(1) of this section, the definitions provided in the section 987 regulations apply with appropriate modifications. For example, in the case of a QBU described in paragraph (c)(1) of this section, the term section 987 gain or loss means gain or loss recognized under section 987(3), the term owner means the person that recognizes gain or loss under section 987(3), and the term section 987 QBU means any qualified business unit subject to section 987 (including a QBU described in paragraph (c)(1) of this section). In addition, references to other rules of the section 987 regulations must be adapted as necessary to apply section 987 in a manner that is consistent with the principles of this section and the rules described in paragraphs (c)(2) of this section. For example, references to the recognition of section 987 gain or loss under § 1.987-5 encompass any recognition of gain or loss under section 987(3).
(ii) Controlled group. For purposes of applying §§ 1.987-12 and 1.987-13, if a partner in a partnership is treated as the owner of an eligible QBU described in paragraph (c)(1)(i) of this section (for example, under an aggregate approach) before the QBU terminates, each member of the partnership's controlled group is treated as a member of the partner's controlled group at any time that the partner (or any member of the partner's controlled group, determined without regard to this paragraph (c)(3)(ii)) continues to be a direct or indirect partner in the partnership. This paragraph (c)(3)(ii) does not apply for purposes of the de minimis rule in § 1.987-11(c)(2).
(4) Terminating QBUs. In the case of a terminating QBU described in paragraph (c)(1) of this section, the rules of this section and the rules described in paragraph (c)(2) of this section apply immediately before the termination, but § 1.987-10 does not apply because § 1.987-10 is not applicable to a QBU described in paragraph (c)(1) of this section.
(d) Suspended section 987 loss —(1) In general —(i) Rules of § 1.987-11(c) and (d)(2) do not apply. The rules of § 1.987-11(c) and (d)(2) do not apply to a QBU described in paragraph (c)(1) of this section.
(ii) Suspension of section 987 loss. Except as provided in paragraph (d)(2) of this section, any loss that would otherwise be recognized under section 987(3) (after applying § 1.987-12) with respect to a QBU described in paragraph (d)(1)(ii)(A) or (B) of this section is not recognized and becomes suspended section 987 loss.
(A) Eligible QBU. This paragraph (d)(1)(ii) applies to an eligible QBU described in paragraph (c)(1)(i) of this section.
(B) Partnership. This paragraph (d)(1)(ii) applies to a partnership (or a partnership interest) described in paragraph (c)(1)(ii) of this section if at least 95 percent of the interests in partnership capital and profits are owned, directly or indirectly, by persons related to each other within the meaning of section 267(b) or section 707(b). For this purpose, ownership of an interest in partnership capital or profits is determined in accordance with the rules for constructive ownership provided in section 267(c), other than section 267(c)(3).
(2) Exceptions —(i) Method under which historic items do not give rise to section 987 gain or loss. Paragraph (d)(1)(ii) of this section does not apply to an eligible QBU described in paragraph (d)(1)(ii)(A) of this section if section 987 is consistently applied to the QBU using a method under which historic items of the QBU do not give rise to section 987 gain or loss (for example, a method that follows the principles of §§ 1.987-3 through 1.987-5).
(ii) Annual recognition election. Paragraph (d)(1)(ii) of this section does not apply in a taxable year in which an annual recognition election is in effect.
(iii) De minimis rule. Paragraph (d)(1)(ii) of this section does not apply in a taxable year described in § 1.987-11(c)(2).
(3) Recognition of suspended section 987 loss —(i) In general. Except as provided in paragraph (d)(3)(ii) of this section, suspended section 987 loss with respect to a QBU described in paragraph (d)(1)(ii)(A) or (B) of this section is recognized under the rules of §§ 1.987-11(e) and 1.987-13.
(ii) Partnership that is not engaged in a trade or business. In the case of a partnership described in paragraph (d)(1)(ii)(B) of this section that is not engaged in a trade or business, suspended section 987 loss cannot be recognized under § 1.987-13(b) through (d) (and thus can only be recognized under § 1.987-11(e)).
(iii) Application of the loss-to-the-extent-of-gain rule. If a partner in a partnership is the owner of a section 987 QBU described in paragraph (c)(1) of this section and also owns one or more section 987 QBUs that are not described in paragraph (c)(1) of this section, the loss-to-the-extent-of-gain rule of § 1.987-11(e) is applied by taking into account all of the owner's section 987 gain and suspended section 987 loss in each recognition grouping with respect to all of its section 987 QBUs (whether or not they are described in paragraph (c)(1) of this section).
(e) Adjustments to the basis of a partner's interest in the partnership. When, and to the extent that, a partner recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss at the partner level with respect to a partnership described in paragraph (c)(1)(ii) of this section or an eligible QBU of the partnership described in paragraph (c)(1)(i) of this section, the principles of sections 704(d) and 705 apply as though the item of income or loss was part of the partner's distributive share of partnership items. Thus, proper adjustments must be made to the partner's adjusted basis in the partnership under the principles of section 705, taking into account the principles of section 704(d).
(f) S corporations treated as partnerships. For purposes of the section 987 regulations, S corporations are treated in the same manner as partnerships and shareholders of S corporations are treated in the same manner as partners of partnerships.
(g) Examples. The following examples illustrate the principles of this section. For purposes of these examples, DC1 and DC2 are domestic corporations, and P is a foreign partnership. P is also the owner for Federal income tax purposes of the assets and liabilities of Business A, an eligible QBU that has the pound as its functional currency. DC1 and DC2 each own 50% of the capital and profits interests in P. If P is treated as a qualified business unit under section 989(a), P would have the euro as its functional currency due to activities unrelated to Business A.
(1) Example 1: Aggregate approach to section 987 —(i) Facts. DC1 and DC2 each apply section 987 using an aggregate approach, under which each partner's indirect interest in Business A is treated as a section 987 QBU of the partner. DC1 and DC2 each use the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to Business A. Neither DC1 nor DC2 has made an annual recognition election. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, DC1 and DC2 each would recognize section 987 loss of $10 million in year 1 with respect to Business A.
(ii) Analysis —(A) Application of loss suspension rule to Business A. Business A is an eligible QBU described in paragraph (c)(1)(i) of this section because a partnership (P) is the owner of Business A's assets and liabilities for federal income tax purposes and P's partners treat Business A as a section 987 QBU. Therefore, under paragraph (d)(1)(ii) of this section, the section 987 loss of DC1 and DC2 that would otherwise be recognized in year 1 becomes suspended section 987 loss, which DC1 and DC2 may recognize in year 1 or in future taxable years under §§ 1.987-11(e) and 1.987-13(b) through (d).
(B) Annual recognition election. If DC1 and DC2 were subject to an annual recognition election in year 1, they would recognize section 987 gain or loss with respect to Business A as though Business A terminated at the end of year 1, and the loss suspension rule of paragraph (d)(1)(ii) of this section would not apply.
(C) FEEP method. If DC1 and DC2 applied section 987 to Business A under the principles of §§ 1.987-3 through 1.987-5, such that historic items of Business A did not give rise to section 987 gain or loss, the loss suspension rule of paragraph (d)(1)(ii) of this section would not apply.
(2) Example 2: Entity approach to section 987 —(i) Facts. P applies section 987 to Business A using an entity approach, under which Business A is treated as a section 987 QBU of P. P is treated as a qualified business unit under section 989(a) and uses the euro as its functional currency. P uses the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to Business A. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, P would recognize section 987 loss of $10 million in year 1 with respect to Business A. In addition, DC1 and DC2 apply section 987 to P using an entity approach, treating each partner's interest in P as a section 987 QBU. DC1 and DC2 each use the earnings and capital method described in the 1991 proposed regulations to apply section 987 with respect to P. Under the earnings and capital method, but for the application of paragraph (d)(1)(ii) of this section, DC1 and DC2 each would recognize section 987 loss of $10 million in year 1 with respect to P. Neither DC1 nor DC2 has made an annual recognition election.
(ii) Analysis —(A) Business A treated as a QBU subject to section 987. Business A is an eligible QBU described in paragraph (c)(1)(i) of this section because a partnership (P) is the owner of Business A's assets and liabilities for Federal income tax purposes, and P treats Business A as a QBU subject to section 987. Therefore, the loss suspension rule in paragraph (d)(1)(ii) of this section applies to suspend P's recognition of section 987 loss with respect to Business A.
(B ) Treatment of P as a section 987 QBU. P is a partnership described in paragraph (c)(1)(ii) of this section because DC1 and DC2 each treat their interest in P as a section 987 QBU. Under paragraph (d)(1)(ii)(B) of this section, if DC1 and DC2 are related within the meaning of section 267(b) or section 707(b), the loss suspension rule in paragraph (d)(1)(ii) of this section applies to suspend DC1's and DC2's recognition of section 987 loss with respect to their interest in P. However, if DC1 and DC2 are unrelated, the loss suspension rule in paragraph (d)(1)(ii) of this section does not apply.
§ 1.987-8   Termination of a section 987 QBU.
(a) Scope. This section provides rules regarding the termination of a section 987 QBU. Paragraph (b) of this section provides general rules for determining when a termination occurs. Paragraph (c) of this section provides exceptions to the general termination rules for certain transactions described in section 381(a). Paragraph (d) of this section is reserved. Paragraph (e) of this section describes certain effects of terminations. Paragraph (f) of this section contains examples that illustrate the principles of this section.
(b) In general. Except as provided in paragraph (c) of this section, a section 987 QBU terminates if the conditions described in any one of paragraphs (b)(1) through (6) of this section are satisfied.
(1) Trade or business ceases. A section 987 QBU ceases its trade or business. When a section 987 QBU ceases its trade or business is determined based on all the facts and circumstances, provided that an owner may continue to treat a section 987 QBU as a section 987 QBU for a reasonable period during the winding up of such trade or business, which period may in no event exceed two years from the date on which such QBU ceases its activities carried on for profit. See paragraph (f)(1) of this section ( Example 1 ).
(2) Substantially all assets transferred. The section 987 QBU transfers substantially all (within the meaning of section 368(a)(1)(C)) of its assets to its owner. For purposes of this paragraph (b)(2), the amount of assets transferred from the section 987 QBU to its owner as a result of a transaction is reduced by the amount of assets transferred from the owner to the section 987 QBU pursuant to the same transaction. See paragraphs (f)(2), (6), and (7) of this section ( Examples 2, 6, and 7 ).
(3) Owner no longer a CFC. A foreign corporation that is a controlled foreign corporation that is the owner of a section 987 QBU ceases to be a controlled foreign corporation as a result of a transaction or series of transactions after which persons that were related to the corporation within the meaning of section 267(b) immediately before the transaction or series of transactions collectively own sufficient interests in the corporation such that the corporation would continue to be considered a controlled foreign corporation if such persons were United States shareholders within the meaning of section 951(b). See paragraph (f)(3) of this section ( Example 3 ).
(4) Owner ceases to exist. The owner of the section 987 QBU ceases to exist (including in connection with a transaction described in section 381(a)). See paragraph (f)(4) of this section ( Example 4 ).
(5) Section 987 QBU ceases to be an eligible QBU with a functional currency different from its owner. The section 987 QBU ceases to be an eligible QBU that has a functional currency different from its owner. See § 1.985-5(d)(2) and (e)(4)(iii) (providing that a termination resulting from a change in functional currency occurs on the last day of the last taxable year ending before the year of change).
(6) Change in form of ownership. An individual or corporation that was the direct owner of a section 987 QBU ceases to be the direct owner of the section 987 QBU (for example, because the assets of the section 987 QBU are transferred to a partnership).
(c) Transactions described in section 381(a) —(1) Liquidations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner ( distributor ) of a section 987 QBU ceases to exist in a liquidation described in section 332 pursuant to which it transfers the section 987 QBU to another corporation ( distributee ), except in the following cases:
(i) The distributor is a domestic corporation and the distributee is a foreign corporation.
(ii) The distributor is a foreign corporation and the distributee is a domestic corporation.
(iii) The distributor and the distributee are both foreign corporations and the functional currency of the distributee is the same as the functional currency of the distributor's section 987 QBU.
(2) Reorganizations. Notwithstanding paragraph (b) of this section, a termination does not occur when the owner ( transferor ) of the section 987 QBU ceases to exist in a reorganization described in section 381(a)(2) pursuant to which it transfers the section 987 QBU to another corporation ( acquiring corporation ), except in the following cases:
(i) The transferor is a domestic corporation and the acquiring corporation is a foreign corporation.
(ii) The transferor is a foreign corporation and the acquiring corporation is a domestic corporation.
(iii) The transferor is a controlled foreign corporation immediately before the transfer, the acquiring corporation is a foreign corporation that is not a controlled foreign corporation immediately after the transfer, and the acquiring corporation was related to the transferor within the meaning of section 267(b) immediately before the transfer.
(iv) The transferor and the acquiring corporation are foreign corporations and the functional currency of the acquiring corporation is the same as the functional currency of the transferor's section 987 QBU.
(d) [Reserved]
(e) Effect of terminations. A termination of a section 987 QBU as determined in this section is treated as a remittance of all the gross assets of the section 987 QBU to its owner immediately before the section 987 QBU terminates. Thus, except as otherwise provided in the section 987 regulations, a termination generally results in the recognition of any net unrecognized section 987 gain or loss of the section 987 QBU (unless it is treated as deferred section 987 gain or loss or suspended section 987 loss). See § 1.987-5(c)(3) (generally recognizing section 987 gain or loss on a termination) and §§ 1.987-11 through 1.987-13 (suspending section 987 gain or loss and deferring section 987 loss in certain instances).
(f) Examples. The following examples illustrate the principles of this section. Except as otherwise provided, U.S. Corp is a domestic corporation that has the U.S. dollar as its functional currency, and Business A is a section 987 QBU.
(1) Example 1: Cessation of operations —(i) Facts. U.S. Corp is the owner of Business A, a sales office of U.S. Corp in Country X. Business A ceases sales activities on December 31, year 1. During year 2, Business A sells all of the assets used in its sales activities and winds up its business, settling outstanding accounts.
(ii) Analysis. Business A's trade or business ceases on December 31, year 1. The cessation of Business A's trade or business causes a termination of the Business A section 987 QBU under paragraph (b)(1) of this section on December 31, year 1, unless U.S. Corp chooses to continue to treat Business A as a section 987 QBU until completion of the wind-up activities in year 2. If U.S. Corp chooses to continue to treat Business A as a section 987 QBU during the wind-up of Business A, the Business A section 987 QBU would terminate under paragraph (b)(1) of this section upon completion of the wind-up in year 2.
(2) Example 2: Transfer of a section 987 QBU to a member of a consolidated group —(i) Facts. U.S. Corp, the owner of Business A, transfers all the assets and liabilities of Business A to DS, a domestic corporation all of the stock of which is owned by U.S. Corp, in a transaction qualifying under section 351. U.S. Corp and DS are members of the same consolidated group.
(ii) Analysis. Pursuant to § 1.987-2(c)(2)(i) and (ii), as a result of the deemed exchange of the assets and liabilities of Business A for DS stock in a section 351 transaction, Business A is treated as transferring its assets and liabilities to U.S. Corp immediately before the transfer by U.S. Corp of the assets and liabilities to DS. Because a section 351 transaction is not a transaction described in section 381(a)(2), the transfer of all of the assets of Business A to U.S. Corp causes a termination of the Business A section 987 QBU under paragraph (b)(2) of this section.
(3) Example 3: Cessation of controlled foreign corporation status —(i) Facts. Foreign parent (FP) is a foreign corporation that owns all the stock of U.S. Corp, a domestic corporation. U.S. Corp owns all of the stock of FC, a controlled foreign corporation as defined in section 957. FC is the owner of Business A. U.S. Corp liquidates into FP. FC no longer constitutes a controlled foreign corporation after the liquidation.
(ii) Analysis. Because FC ceases to qualify as a controlled foreign corporation as a result of a transaction after which persons that were related to FC within the meaning of section 267(b) immediately before the transaction collectively own sufficient interests in FC such that FC would continue to be considered a controlled foreign corporation if such persons were United States shareholders within the meaning of section 951(b), the Business A section 987 QBU terminates pursuant to paragraph (b)(3) of this section.
(4) Example 4: Section 332 liquidation —(i) Facts. U.S. Corp owns all of the stock of FC, a foreign corporation. FC is the owner of Business A. Pursuant to a liquidation described in section 332, FC distributes all of its assets and liabilities to U.S. Corp.
(ii) Analysis. FC's liquidation causes a termination of the Business A section 987 QBU as provided in paragraph (b)(4) of this section because FC ceases to exist as a result of the liquidation. The exception for certain section 332 liquidations provided under paragraph (c)(1) of this section does not apply because U.S. Corp is a domestic corporation and FC is a foreign corporation. See paragraph (c)(1)(ii) of this section.
(5) [Reserved]
(6) Example 6: Deemed transfers to a CFC upon a check-the-box election—(i) Facts. In year 1, U.S. Corp forms an entity in a foreign country, Entity A. Entity A owns Business A, which has the pound as its functional currency. Entity A forms Entity B in another foreign country. Entity B owns Business B, a section 987 QBU that has the euro as its functional currency. At the time of formation, Entity A and Entity B elect to be DEs. In year 6, Entity A files an election on Form 8832 to be classified as a corporation under § 301.7701-3(g)(1)(iv) of this chapter and becomes a CFC (FC) owned directly by U.S. Corp. FC has the pound as its functional currency.
(ii) Analysis —(A) Under § 1.987-1(b)(5), U.S. Corp is the owner of Business A and Business B. In year 6, when Entity A elects to be classified as a corporation, U.S. Corp is deemed to contribute the assets and liabilities of Business A and Business B to FC under section 351 in exchange for FC stock. Pursuant to § 1.987-2(c)(2)(i) and (ii), as a result of the deemed exchange of the assets and liabilities of Business A and Business B for FC stock in a section 351 transaction, Business A and Business B are each treated as transferring their assets and liabilities to U.S. Corp immediately before U.S. Corp's transfer of such assets and liabilities to FC. The transfer of assets from Business A and Business B to U.S. Corp causes terminations of those section 987 QBUs under paragraph (b)(2) of this section. The assets and liabilities of Business A and Business B are now owned by FC, but because FC and Business A have the same functional currency, only Business B qualifies as a section 987 QBU to which section 987 applies.
(B) Terminations also would have occurred in year 6 if U.S. Corp had contributed Entity A and Entity B to an existing foreign corporation owned by U.S. Corp or to a newly created foreign corporation owned by U.S. Corp pursuant to a section 351 exchange because the transfer of all of the assets of Business A and Business B would cause terminations of those section 987 QBUs under paragraph (b)(2) of this section.
(7) Example 7: Sale of a section 987 QBU to a member of a consolidated group—(i) Facts. U.S. Corp, the owner of Business A, sells all of the assets and liabilities of Business A to DS, a domestic corporation, in exchange for cash. U.S. Corp and DS are members of the same consolidated group. The cash received on the sale is recorded on the books of U.S. Corp.
(ii) Analysis. Pursuant to § 1.987-2(c)(2)(i) and (ii), Business A is treated as transferring all of its assets and liabilities to U.S. Corp immediately before the sale by U.S. Corp to DS. As a result of this deemed transfer from Business A to U.S. Corp, the Business A section 987 QBU terminates under paragraph (b)(2) of this section.
§ 1.987-8T   Termination of a section 987 QBU (temporary).
(a) through (c) [Reserved] For further guidance, see § 1.987-8(a) through (c).
(d) Annual deemed termination election. A taxpayer, including a taxpayer described in § 1.987-1(b)(1)(ii) to which §§ 1.987-1 through 1.987-11 generally do not apply, may elect under this paragraph (d) to deem all of the section 987 QBUs of which it is an owner to terminate on the last day of each taxable year for which the election is in effect. See § 1.987-8(e) regarding the effect of such a deemed termination. The owner of a section 987 QBU that is deemed to terminate under this paragraph is treated as having transferred all of the assets and liabilities attributable to such section 987 QBU to a new section 987 QBU on the first day of the following taxable year.
(e) through (f) [Reserved] For further guidance, see § 1.987-8(e) through (f).
(g) Effective/applicability date. This section applies to taxable years beginning on or after December 7, 2016.
(h) Expiration date. The applicability of this section expires on December 6, 2019.
§ 1.987-9   Recordkeeping requirements.
(a) In general. An owner (or the authorized person on behalf of an owner) must keep a copy of the statement described in § 1.987-1(g)(3)(i) for each section 987 election made by or on behalf of the owner (if not required to be made on a form published by the Commissioner) and reasonable records sufficient to establish section 987 taxable income or loss and section 987 gain or loss with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU, as applicable, for each taxable year.
(b) Supplemental information. A person's obligation to maintain records under section 6001 and paragraph (a) of this section is not satisfied unless the following information is maintained in those records with respect to each section 987 QBU, successor deferral QBU, and successor suspended loss QBU for each taxable year:
(1) The amount of the items of income, gain, deduction, or loss attributed to the section 987 QBU in the functional currency of the section 987 QBU and its owner.
(2) The adjusted balance sheet of the section 987 QBU in the functional currency of the section 987 QBU and its owner. If a current rate election is in effect and the owner computes QBU net value under § 1.987-4(e)(2)(iii) without preparing an adjusted balance sheet, the information needed to apply § 1.987-4(e)(2)(iii) must be maintained in lieu of an adjusted balance sheet.
(3) The exchange rates used to translate items of income, gain, deduction, or loss of the section 987 QBU into the owner's functional currency and, if a spot rate convention is used, the manner in which the convention is determined.
(4) The exchange rates used to translate the assets and liabilities of the section 987 QBU into the owner's functional currency and, if a spot rate convention is used, the manner in which the convention is determined.
(5) The amount of assets and liabilities transferred by the owner to the section 987 QBU determined in the functional currency of the owner and the section 987 QBU.
(6) The amount of assets and liabilities transferred by the section 987 QBU to the owner determined in the functional currency of the owner and the section 987 QBU.
(7) The amount of the unrecognized section 987 gain or loss for the taxable year determined under § 1.987-4(d).
(8) The amount of the net accumulated unrecognized section 987 gain or loss for the taxable year determined under § 1.987-4(c).
(9) The amount of the remittance and the remittance proportion for the taxable year.
(10) The computations required under §§ 1.861-9(g) and 1.861-9T(g) for purposes of sourcing and characterizing section 987 gain or loss, deferred section 987 gain or loss, suspended section 987 loss, or pretransition gain or loss under § 1.987-6.
(11) The cumulative suspended section 987 loss in each recognition grouping.
(12) The outstanding deferred section 987 gain or loss in each recognition grouping.
(13) The transition information required to be determined under § 1.987-10(k).
(14) The identification required under § 1.987-14(c) with respect to a section 987 hedging transaction.
(c) Retention of records. The records required by this section, or records that support the information required on a form published by the Commissioner regarding section 987, must be maintained and kept available for inspection by the Internal Revenue Service for so long as the contents thereof may become relevant in the administration of the Internal Revenue Code.
(d) Information on a dedicated section 987 form. Information necessary to determine section 987 gain or loss and section 987 taxable income or loss must be reported on a form prescribed for that purpose (or, until that form is published, on Form 8858 or its successor) in accordance with the applicable forms and instructions. A taxpayer satisfies its obligation described in paragraphs (a) and (b) of this section to the extent that the taxpayer provides the specific information required on Form 8858 (or its successor) or other form prescribed for this purpose (including the information required by the instructions accompanying those forms).
§ 1.987-10   Transition rules.
(a) Overview —(1) In general. This section provides transition rules for the first taxable year in which the section 987 regulations apply. Paragraph (b) of this section describes the scope of this section's application. Paragraph (c) of this section provides rules for determining the transition date. Paragraph (d) of this section provides rules relating to the application of the section 987 regulations after the transition date. Paragraph (e) of this section provides rules relating to the determination and recognition of pretransition gain or loss. Paragraph (f) of this section provides special rules for section 987 QBUs to which the fresh start transition method was applied. Paragraph (g) of this section is reserved. Paragraph (h) of this section provides rules relating to the source and character of pretransition gain or loss. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides adjustments to avoid double counting or omissions. Paragraph (k) of this section provides reporting requirements that apply in the taxable year beginning on the transition date. Paragraph (l) of this section provides examples illustrating the rules of this section.
(2) Terms defined under prior § 1.987-12. For purposes of this section, the terms deferral QBU, deferral QBU owner, successor QBU, outbound loss QBU, outbound section 987 loss, and qualified successor have the meaning provided in prior § 1.987-12.
(b) Scope —(1) Owner of a section 987 QBU. Except as provided in paragraph (f) of this section, any person that is an owner of a section 987 QBU on the applicable transition date and any person that is the owner of a terminating QBU on the termination date must apply the rules of this section with respect to the section 987 QBU.
(2) Deferral QBU owner and owner of outbound loss QBU. Except as provided in paragraph (f) of this section, a deferral QBU owner or the owner of an outbound loss QBU must apply the rules of this section with respect to the deferral QBU or outbound loss QBU if the deferral event or outbound loss event occurred before the applicable transition date. This paragraph (b)(2) does not apply to the owner of a terminating QBU.
(c) Transition date —(1) In general. Except as provided in paragraph (c)(2) of this section, the transition date for a section 987 QBU, deferral QBU, or outbound loss QBU is the first day of the first taxable year described in § 1.987-15(a)(1), (b), or (c) to which this section applies.
(2) Terminating QBU —(i) In general. With respect to a terminating QBU, the transition date is the day after the termination date. Until the transition date described in paragraph (c)(1) of this section, the owner of the terminating QBU must apply the section 987 regulations with respect to the terminating QBU, and any section 987 gain or loss attributable thereto, without regard to any section 987 elections (other than the election described in § 1.987-6(b)(2)(i)(C)).
(ii) Ordering rule. In the case of a terminating QBU, the transition rules of this section are applied immediately before the termination, and the consequences of the termination are determined under the section 987 regulations after applying this section.
(d) Application of the section 987 regulations after the transition date—(1) Owner functional currency net value on the last day of the preceding taxable year. Except as provided in paragraph (f) of this section, for purposes of applying § 1.987-4 in the taxable year beginning on the transition date, the owner functional currency net value of a section 987 QBU on the last day of the preceding taxable year under § 1.987-4(d)(1)(i)(B) is determined by translating the assets and liabilities that are attributable to the section 987 QBU on the day before the transition date into the owner's functional currency at the transition exchange rate described in paragraph (d)(3) of this section.
(2) Determination of historic rate. If a current rate election is not in effect for the taxable year beginning on the transition date, the historic rate for historic items that are attributable to a section 987 QBU on the day before the transition date (other than non-LIFO inventory subject to the simplified inventory method under § 1.987-3(c)(2)(iv)(A)) is the transition exchange rate described in paragraph (d)(3) of this section.
(3) Transition exchange rate —(i) In general. Except as provided in paragraph (d)(3)(ii) of this section, the transition exchange rate is the spot rate applicable to the day before the transition date.
(ii) Earnings only method. If an earnings only method described in paragraph (e)(4)(ii) of this section was applied with respect to a section 987 QBU before the transition date, and a current rate election is not in effect in the taxable year beginning on the transition date, the transition exchange rate for each historic item (other than inventory subject to the simplified inventory method under § 1.987-3(c)(2)(iv)(A)) is the pretransition translation rate described in paragraph (e)(2)(i)(C) of this section. This paragraph (d)(3)(ii) does not apply with respect to a terminating QBU.
(e) Pretransition gain or loss —(1) In general. Except as provided in paragraph (f) of this section, pretransition gain or loss is determined and recognized under this paragraph (e).
(2) Amount of pretransition gain or loss for an owner that applied an eligible pretransition method —(i) Owner of a section 987 QBU. If an owner of a section 987 QBU described in paragraph (b)(1) of this section applied an eligible pretransition method with respect to the section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. See paragraphs (l)(1) through (3) of this section ( Examples 1 through 3 ) for an illustration of this rule.
(A) Deemed termination amount. The deemed termination amount is the amount of section 987 gain or loss that would have been recognized by the owner under the eligible pretransition method if the section 987 QBU terminated and transferred all of its assets and liabilities to the owner on the day before the transition date and §§ 1.987-12 and 1.987-13 and prior § 1.987-12 did not apply.
(B) Owner functional currency net value adjustment. The owner functional currency net value adjustment may be either positive or negative and is equal to the amount described in paragraph (e)(2)(i)(B)( 1 ) of this section reduced by the amount described in paragraph (e)(2)(i)(B)( 2 ) of this section.
( 1 ) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner's functional currency at the transition exchange rate.
( 2 ) The basis of the assets, reduced by the amount of liabilities, that are attributable to the section 987 QBU on the day before the transition date, translated into the owner's functional currency at the pretransition translation rate.
(C) Pretransition translation rate. The pretransition translation rate is the rate that would be used under the eligible pretransition method to determine the basis of an asset or the amount of a liability in the hands of the owner of a section 987 QBU if the section 987 QBU transferred all of its assets and liabilities to the owner on the day before the transition date.
(ii) Deferral QBU owner. If a deferral QBU owner described in paragraph (b)(2) of this section applied an eligible pretransition method with respect to the deferral QBU, the amount of pretransition gain or loss with respect to the deferral QBU is equal to the deferred section 987 gain or loss (determined under prior § 1.987-12) that was not recognized before the transition date with respect to the deferral QBU.
(iii) Owner of an outbound loss QBU. If the owner of an outbound loss QBU described in paragraph (b)(2) of this section applied an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the outbound section 987 loss that was not added to the basis of stock or recognized under prior § 1.987-12 before the transition date with respect to the outbound loss QBU.
(3) Amount of pretransition gain or loss for an owner that did not apply an eligible pretransition method —(i) In general. If the owner of a section 987 QBU described in paragraph (b)(1) of this section did not apply an eligible pretransition method with respect to the section 987 QBU, the amount of pretransition gain or loss with respect to the section 987 QBU is determined under paragraph (e)(3)(ii) of this section. See paragraph (l)(4) of this section ( Example 4 ) for an illustration of this rule.
(ii) Computation of pretransition gain or loss. With respect to a section 987 QBU described in paragraph (e)(3)(i) of this section, pretransition gain or loss is equal to the amount described in paragraph (e)(3)(ii)(A) of this section reduced by the amount described in paragraph (e)(3)(ii)(B) of this section.
(A) The sum of the owner's annual unrecognized section 987 gain or loss determined under paragraph (e)(3)(iii) of this section with respect to the section 987 QBU for all taxable years ending before the transition date and beginning after September 7, 2006, in which it was the owner of the section 987 QBU.
(B) The total net amount of section 987 gain or loss recognized by the owner with respect to the section 987 QBU in all taxable years ending before the transition date and beginning after September 7, 2006.
(iii) Annual unrecognized section 987 gain or loss. An owner of a section 987 QBU described in paragraph (e)(3)(i) of this section determines annual unrecognized section 987 gain or loss with respect to a section 987 QBU under the rules of § 1.987-4(d), applied as though a current rate election was in effect for all relevant taxable years, and subject to the following modifications—
(A) Only § 1.987-4(d)(1) and (10) (steps 1 and 10) are applied; and
(B) Section 1.987-4(d)(10) is applied by replacing “paragraphs (d)(1) through (9) of this section” with “paragraph (d)(1) of this section.”
(iv) Deferral QBU owner. If a deferral QBU owner described in paragraph (b)(2) of this section did not apply an eligible pretransition method with respect to the deferral QBU, the pretransition gain or loss with respect to the deferral QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the deferral QBU if the transition date was the day of the deferral event, reduced by the amount of deferred section 987 gain or loss (determined under prior § 1.987-12) recognized before the actual transition date.
(v) Owner of an outbound loss QBU. If the owner of an outbound loss QBU described in paragraph (b)(2) of this section did not apply an eligible pretransition method with respect to the outbound loss QBU, the pretransition loss with respect to the outbound loss QBU is equal to the amount that would be determined under paragraph (e)(3)(ii) of this section with respect to the outbound loss QBU if the transition date was the day of the outbound loss event, reduced by any outbound section 987 loss recognized or added to the basis of stock under prior § 1.987-12 before the actual transition date.
(4) Eligible pretransition method. An eligible pretransition method means a method of applying section 987 before the transition date that is described in paragraphs (e)(4)(i) through (iii) of this section. An owner is treated as applying an eligible pretransition method with respect to a section 987 QBU only if it applied an eligible pretransition method with respect to the QBU on a return filed before November 9, 2023.
(i) Earnings and capital method. An earnings and capital method is an eligible pretransition method if it is applied in a reasonable manner. For purposes of this paragraph (e)(4)(i), an earnings and capital method means a method of applying section 987 that requires section 987 gain or loss to be determined and recognized with respect to both the earnings of the section 987 QBU and capital contributed to the section 987 QBU (for example, the method prescribed in the 1991 proposed regulations under section 987). See paragraph (l)(1) of this section ( Example 1 ) for an illustration of this rule.
(ii) Other reasonable methods. Any reasonable method of applying section 987 is an eligible pretransition method if it produces the same total amount of income over the life of the owner of a section 987 QBU as the method described in paragraph (e)(4)(i) of this section (taking into account the aggregate of section 987 gain or loss, section 987 taxable income or loss, and income or loss recognized by the owner of the section 987 QBU with respect to property transferred between the section 987 QBU and the owner or any QBU of the owner). See paragraph (l)(2) of this section ( Example 2 ) for an illustration of this rule.
(iii) Other earnings only methods. An earnings only method that does not meet the requirements of paragraph (e)(4)(ii) of this section is an eligible pretransition method, provided that—
(A) The earnings only method was first applied by the owner on a return filed before November 9, 2023;
(B) The earnings only method was applied consistently to all section 987 QBUs of the owner since the first taxable year in which the owner applied an eligible pretransition method; and
(C) The owner of the section 987 QBU otherwise applied section 987 in a reasonable manner. See paragraph (l)(3) of this section ( Example 3 ) for an illustration of this rule.
(iv) Error in the application of a section 987 method. If an owner generally applied section 987 with respect to a section 987 QBU before the transition date under a method described in paragraph (e)(4)(i), (ii), or (iii) of this section but made errors in the application of the method or failed to apply the method to every taxable year since the QBU's inception, the owner is considered to have applied an eligible pretransition method with respect to the QBU. However, pretransition gain or loss must be determined under paragraph (e)(2) of this section as though the eligible pretransition method was applied without error since the section 987 QBU's inception. See paragraph (l)(5) of this section ( Example 5 ) for an illustration of this rule.
(v) Certain consistent practices not treated as errors —(A) In general. If an owner generally applied section 987 with respect to a section 987 QBU before the transition date under a method described in paragraph (e)(4)(i), (ii), or (iii) of this section and used a consistent practice described in paragraph (e)(4)(v)(B) of this section for purposes of applying that method, the owner is considered to have applied an eligible pretransition method with respect to the QBU. In addition, the consistent practice is not treated as an error under paragraph (e)(4)(iv) of this section. Therefore, the owner must take the consistent practice into account in determining pretransition gain or loss under paragraph (e)(2) of this section. See paragraph (l)(6) of this section ( Example 6 ) for an illustration of this rule.
(B) Practices not treated as errors —( 1 ) Reasonable conventions. The use of a reasonable convention (for example, the use of a yearly average exchange rate rather than the applicable spot rate to translate frequently recurring transfers) is a practice described in this paragraph (e)(4)(v)(B).
( 2 ) Disregarded transactions. If, in determining the amount of a remittance that requires the recognition of gain or loss under section 987(3), an owner of a QBU consistently disregarded certain transfers to or from the QBU (other than transfers from the QBU to the owner that would be treated as distributions if the QBU were treated as a separate corporation), the owner is considered to have applied a practice described in this paragraph (e)(4)(v)(B) with respect to the QBU, provided that the owner otherwise accounts for the disregarded transfers in a reasonable manner (for example, under the method described in the 1991 proposed regulations, by taking the disregarded transfers into account in computing equity and basis pools so as to properly reflect the owner's net equity in the QBU and its functional currency basis in the QBU).
(vi) Deferral of section 987 gain or loss until termination is not reasonable. For purposes of this paragraph (e)(4), a method under which the owner of a section 987 QBU defers the recognition of section 987 gain or loss until the section 987 QBU is terminated, sold, or liquidated is not a reasonable method.
(vii) Anti-abuse rule. If an owner changes its pretransition method of applying section 987 with a principal purpose of reducing its pretransition gain or increasing its pretransition loss, the Commissioner may redetermine pretransition gain or loss based on the owner's original method of applying section 987 or by treating the owner as not applying an eligible pretransition method.
(5) Recognition of pretransition gain or loss —(i) In general. Except as provided in paragraph (e)(5)(ii) of this section, pretransition gain is recognized under paragraph (e)(5)(i)(A) of this section and pretransition loss is recognized under paragraph (e)(5)(i)(B) of this section.
(A) Pretransition gain. Pretransition gain with respect to a section 987 QBU is treated as net accumulated unrecognized section 987 gain (within the meaning of § 1.987-4(c)). Pretransition gain with respect to a deferral QBU is treated as deferred section 987 gain and is attributed to one or more successor deferral QBUs under the principles of § 1.987-12(b)(2) and (c)(2).
(B) Pretransition loss —( 1 ) In general. Except as provided in paragraph (e)(5)(i)(B)( 2 ) of this section, pretransition loss with respect to a section 987 QBU, a deferral QBU, or an outbound loss QBU is treated as suspended section 987 loss with respect to the section 987 QBU, the deferral QBU, or the outbound loss QBU. In the case of a deferral QBU or outbound loss QBU, suspended section 987 loss is attributed to one or more successor suspended loss QBUs under the principles of § 1.987-13(b)(1) and (c)(1).
( 2 ) Current rate election. If a current rate election is in effect (and an annual recognition election is not in effect) in the taxable year beginning on the transition date, pretransition loss with respect to a section 987 QBU (other than a terminating QBU) is treated as net accumulated unrecognized section 987 loss (within the meaning of § 1.987-4(c)), and pretransition loss with respect to a deferral QBU is treated as deferred section 987 loss and is attributed to one or more successor deferral QBUs under the principles of § 1.987-12(b)(2) and (c)(2).
(ii) Election to recognize pretransition section 987 gain or loss ratably over the transition period —(A) In general. A taxpayer may elect to recognize pretransition gain or loss ratably over the transition period. If an election is made to recognize pretransition gain or loss ratably over the transition period, then paragraph (e)(5)(i) of this section does not apply, and each owner to which the election applies recognizes one tenth of its pretransition gain or loss with respect to each section 987 QBU, original deferral QBU, and outbound loss QBU in each taxable year for ten taxable years beginning with the taxable year that begins on the transition date described in paragraph (c)(1) of this section. See § 1.987-1(g) for rules relating to section 987 elections (including consistency rules).
(B) Special rules for certain transactions —( 1 ) Scope. This paragraph (e)(5)(ii)(B) applies if a corporation ( acquiring corporation ) acquires the assets of an owner that is subject to an election under paragraph (e)(5)(ii)(A) of this section in a transaction described in section 381(a), and either the owner is a foreign corporation and the acquiring corporation is a domestic corporation or the owner is a domestic corporation and the acquiring corporation is a foreign corporation. This paragraph (e)(5)(ii)(B) also applies to any transaction entered into with a principal purpose of avoiding the recognition of pretransition gain under paragraph (e)(5)(ii)(A) of this section.
( 2 ) Recognition of pretransition gain or loss. In the case of a transaction described in paragraph (e)(5)(ii)(B)( 1 ) of this section, pretransition gain or loss that has not been recognized under paragraph (e)(5)(ii)(A) of this section ceases to be subject to the election to be recognized ratably over the transition period. Any unrecognized pretransition gain is recognized immediately before the transaction, and any unrecognized pretransition loss becomes suspended section 987 loss immediately before the transaction. As a result, the suspended section 987 loss may be recognized to the extent of section 987 gain recognized in the same recognition grouping pursuant to § 1.987-11(e). See also § 1.987-13(g) (providing that any remaining suspended section 987 loss does not carry over to the acquiring corporation upon an inbound transaction to which section 381(a) applies).
(C) Terminating QBU. This paragraph (e)(5)(ii)(C) applies with respect to a terminating QBU if, in the taxable year beginning on the transition date described in paragraph (c)(1) of this section, the owner of the terminating QBU elects to recognize pretransition gain or loss ratably over the transition period. Any deferred section 987 gain or loss or suspended section 987 loss with respect to the terminating QBU that was not recognized before the transition date described in paragraph (c)(1) of this section is treated as pretransition gain or loss for purposes of this paragraph (e)(5)(ii) (and ceases to be treated as deferred section 987 gain or loss or suspended section 987 loss). The pretransition gain or loss is recognized ratably over ten taxable years beginning with the taxable year that begins on the transition date described in paragraph (c)(1) of this section.
(6) Predecessor of an owner —(i) In general. For purposes of this paragraph (e), references to an owner of a section 987 QBU, a deferral QBU owner, and the owner of an outbound loss QBU include a predecessor described in paragraph (e)(6)(ii) of this section.
(ii) Predecessor. If a corporation ( acquiring corporation ) becomes the owner of a section 987 QBU in a transaction described in section 381(a) in which the section 987 QBU does not terminate, the corporation that was the owner of the section 987 QBU immediately before the transaction is a predecessor of the acquiring corporation. If a corporation ( acquiring corporation ) becomes a qualified successor of a deferral QBU owner or the owner of an outbound loss QBU (each, a transferor corporation ), the transferor corporation is a predecessor of the acquiring corporation. A predecessor of a corporation includes the predecessor of a predecessor of the corporation.
(7) Small business election —(i) Scope. This paragraph (e)(7) applies if the owner of a QBU meets the threshold described in paragraph (e)(7)(ii) of this section and the QBU meets the threshold described in paragraph (e)(7)(iii) of this section. This paragraph (e)(7) does not apply with respect to a terminating QBU.
(ii) Owner threshold. An owner of a QBU meets the requirements of this paragraph (e)(7)(ii) if the owner would qualify for the small business exemption provided in section 163(j)(3) for the taxable year beginning on the transition date described in paragraph (c)(1) of this section.
(iii) QBU threshold. A QBU meets the requirements of this paragraph (e)(7)(iii) if the assets attributable to the QBU have an adjusted basis (translated at the spot rate applicable to the last day of each taxable year) of $10 million or less at the end of each of the three taxable years of the owner ending before the transition date described in paragraph (c)(1) of this section (or, if the QBU was not in existence for three taxable years, each taxable year ending before the transition date in which the QBU existed). For this purpose, all QBUs owned by members of the same controlled group that have the same country of residence (as defined in section 988(a)(3)(B)) are treated as a single QBU. Solely for purposes of applying this paragraph (e)(7)(iii) in the case of a deferral QBU or outbound loss QBU described in paragraph (b)(2) of this section, the termination date is treated as the transition date.
(iv) Small business election. If the owner of a QBU meets the requirements of paragraph (e)(7)(ii) of this section, the owner may elect to treat all QBUs that meet the requirements of paragraph (e)(7)(iii) of this section as having no pretransition gain or loss.
(f) QBUs to which the fresh start transition method was applied —(1) In general. Paragraphs (d) and (e) of this section do not apply with respect to any section 987 QBU, deferral QBU, or outbound loss QBU with respect to which the taxpayer applied the rules of prior § 1.987-10 (or applied § 1.987-10 of the 2006 proposed regulations in a reasonable manner) on a return filed before November 9, 2023 or pursuant to paragraph (f)(3) of this section.
(2) Application of the section 987 regulations after the transition date —(i) Owner functional currency net value on the last day of the preceding taxable year. For purposes of applying § 1.987-4 with respect to a section 987 QBU described in paragraph (f)(1) of this section for the taxable year beginning on the transition date, the owner functional currency net value of the section 987 QBU on the last day of the preceding taxable year under § 1.987-4(d)(1)(i)(B) is the amount that was determined for the preceding taxable year under prior § 1.987-4(d)(1)(A) or § 1.987-4(d)(1)(A) of the 2006 proposed section 987 regulations, as applicable.
(ii) Determination of historic rate. For purposes of applying the section 987 regulations with respect to historic items (other than inventory subject to the simplified inventory method under § 1.987-3(c)(2)(iv)(A)) that are attributable to the section 987 QBU on the day before the transition date, a taxpayer must use the same historic rates as were used under the taxpayer's application of the 2016 and 2019 section 987 regulations or the 2006 proposed section 987 regulations, as applicable, in place of the historic rates that otherwise would be determined under § 1.987-1(c)(3).
(iii) Unrecognized section 987 gain or loss —(A) Net accumulated unrecognized section 987 gain or loss of a section 987 QBU. In taxable years beginning on or after the transition date, for purposes of calculating the net accumulated unrecognized section 987 gain or loss of a section 987 QBU described in paragraph (f)(1) of this section under § 1.987-4(c)—
( 1 ) Amounts determined under prior § 1.987-4(d) or under § 1.987-4(d) or § 1.987-10 of the 2006 proposed section 987 regulations, as applicable, are included in amounts determined under § 1.987-4(d) for all prior taxable years; and
( 2 ) Amounts taken into account under prior § 1.987-5(a) or under § 1.987-5(a) of the 2006 proposed section 987 regulations, as applicable, are included in amounts recognized under § 1.987-5(a) for all prior taxable years. For this purpose, amounts taken into account under prior § 1.987-5(a) or under § 1.987-5(a) of the 2006 proposed section 987 regulations, as applicable, are determined without regard to prior § 1.987-12 or prior § 1.987-12T.
(B) Deferred section 987 gain or loss attributable to a successor deferral QBU. In the taxable year beginning on the transition date, the outstanding deferred section 987 gain or loss (as determined under prior § 1.987-12) of a deferral QBU described in paragraph (f)(1) of this section becomes deferred section 987 gain or loss (within the meaning of § 1.987-12). The deferred section 987 gain or loss is attributed to one or more successor deferral QBUs under the principles of § 1.987-12(b)(2) and (c)(2).
(C) Outbound section 987 loss attributable to a successor suspended loss QBU. In the taxable year beginning on the transition date, outbound section 987 loss of an outbound loss QBU described in paragraph (f)(1) of this section that has not been recognized or added to the basis of stock under prior § 1.987-12 becomes suspended section 987 loss. The suspended section 987 loss is attributed to one or more successor suspended loss QBUs under the principles of § 1.987-13(b)(1) and (c)(1).
(3) Taxpayers that are required to transition using the fresh start transition method. If a taxpayer is subject to a consent agreement under which it is required to apply the fresh start transition method with respect to a section 987 QBU, then the taxpayer must apply the transition rules of prior § 1.987-10 to that section 987 QBU for the taxable year beginning on the transition date and immediately before the taxpayer applies this section. In applying this section, the taxpayer is treated as having applied prior § 1.987-10 to the section 987 QBU.
(g) [Reserved]
(h) Determination of source and character —(1) In general. Except as provided in paragraph (h)(2) of this section, the source and character of pretransition gain or loss is determined under the rules of § 1.987-6. See § 1.987-6(b)(1) (timing of source and character determination).
(2) Deferral QBU or outbound loss QBU. Notwithstanding paragraph (h)(1) of this section and § 1.987-6, the source and character of pretransition gain or loss with respect to a deferral QBU or an outbound loss QBU described in paragraph (b)(2) of this section is the same as the source and character of the outstanding deferred section 987 gain or loss (determined under prior § 1.987-12) of the deferral QBU or the outbound section 987 loss of the outbound loss QBU (determined under prior § 1.987-12(e)).
(i) [Reserved]
(j) Adjustments to avoid double counting or omissions. If a difference between the treatment of any item under the section 987 regulations and the treatment of the item under the taxpayer's prior section 987 method would result in income, gain, deduction, or loss (including section 988 gain or loss) being taken into account more than once or not being taken into account, then pretransition gain or loss, as determined under paragraphs (e)(2) and (3) of this section, is adjusted to account for the difference. In case of a QBU described in paragraph (f)(1) of this section, appropriate adjustments must be made under the principles of paragraph (e)(5) of this section. In the case of a terminating QBU, the determination as to whether an adjustment is required under this paragraph (j) is made after taking into account section 988 gain or loss recognized in connection with the termination.
(k) Reporting —(1) In general. Except as otherwise provided in this paragraph (k), a statement titled “Section 987 Transition Information” must be attached to an owner's timely filed (including extensions) return for the taxable year beginning on the transition date providing the following information for each QBU described in paragraph (k)(2) of this section:
(i) A description of each QBU, the QBU's principal place of business, and a description of the prior method used by the taxpayer to determine its section 987 gain or loss, deferred section 987 gain or loss, or outbound section 987 loss with respect to the QBU, including an explanation as to whether such method was an eligible pretransition method.
(ii) The pretransition gain or loss with respect to each QBU and the computations used to determine pretransition gain or loss.
(iii) Whether the authorized person has elected to recognize pretransition gain or loss ratably over the transition period pursuant to paragraph (e)(5)(ii) of this section.
(iv) Whether the authorized person has made a small business election under paragraph (e)(7) of this section and the computations used to determine eligibility for the election.
(v) With respect to each QBU for which any adjustment is made under paragraph (j) of this section, a description of each adjustment and the basis for computing the adjustment.
(vi) A list of the QBUs described in paragraph (f)(1) of this section, or a statement that no QBUs are described in paragraph (f)(1) of this section.
(2) QBUs for which reporting is required —(i) In general. Except as provided in paragraph (k)(2)(ii) of this section, the information described in paragraph (k)(1) of this section must be provided with respect to—
(A) Each section 987 QBU described in paragraph (b)(1) of this section;
(B) Each deferral QBU described in paragraph (b)(2) of this section and each of its successor deferral QBUs; and
(C) Each outbound loss QBU described in paragraph (b)(2) of this section and each of its successor suspended loss QBUs.
(ii) QBUs to which the fresh start transition method was applied. A taxpayer is not required to provide the information described in paragraphs (k)(1)(i) through (iv) of this section with respect to a QBU described in paragraph (f)(1) of this section.
(3) Attachments not required where information is reported on a form. This paragraph (k) does not apply to the extent provided on a form or instructions published by the Commissioner.
(4) No change in method of accounting. The application of this section is not treated as a change in method of accounting for purposes of sections 446 and 481.
(l) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC is a domestic corporation with the U.S. dollar as its functional currency and Branch is a section 987 QBU with the euro as its functional currency. DC has a taxable year ending December 31, and the transition date is January 1, year 4. For purposes of the examples, except as otherwise indicated, assume that no section 987 elections are in effect.
(1) Example 1: Earnings and capital method —(i) Facts —(A) Formation of Branch and Branch's operations. DC formed Branch on November 30, year 1, with a contribution of €150. In year 1, Branch purchased a parcel of unimproved land for €100. In year 2, Branch earned €25. In year 3, Branch again earned €25. On June 30, year 3, Branch distributed €100 cash to DC, and DC immediately exchanged the €100 for $135.
(B) Exchange rates. The relevant exchange rates are shown below.
Table 1 to Paragraph (l)(1)(i)(B) —Exchange Rates
(C) Pretransition method. DC used the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch before the transition date. Under this method, DC maintains an equity pool in euros (Branch's functional currency) and a basis pool in U.S. dollars (DC's functional currency). When Branch makes a remittance (whether out of earnings or capital), DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the basis pool attributable to the remittance. DC's basis in assets distributed from Branch is equal to Branch's basis in the assets, translated into U.S. dollars at the spot rate on the date of the remittance. Branch's earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner.
(D) Application of the pretransition method before the transition date. For purposes of determining section 987 gain or loss recognized as a result of the June 30, year 3, remittance, DC was required to determine the amount in Branch's equity and basis pools. Branch's equity pool was equal to €200, and its basis pool was equal to $210, as shown in the table below. Because the remittance was equal to 50% of the equity pool (€100), 50% of the basis pool, or $105, was attributable to the remittance. The amount of the remittance was $135 (€100 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $30, equal to the difference between the amount of the remittance ($135) and the portion of the basis pool attributable to the remittance ($105). As a result of the remittance, the equity pool was reduced by the amount distributed (€100), and the basis pool was reduced by the portion of the basis pool attributable to the remittance ($105). Therefore, after the remittance, the equity pool was equal to €100, and the basis pool was equal to $105. In the hands of DC, the euros distributed had a basis of $135 (equal to the €100 distribution translated at the spot rate on June 30, year 3, of €1 = $1.35). DC did not recognize section 988 gain or loss when it exchanged the euros for $135.
Table 2 to Paragraph (l)(1)(i)(D) —Year 3 Equity and Basis Pools
(ii) Analysis —(A) DC's method is an eligible pretransition method. Before the transition date, DC followed the method prescribed in the 1991 proposed regulations under section 987 with respect to Branch. This method is an eligible pretransition method under paragraph (e)(4)(i) of this section. Therefore, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.
(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC's pretransition gain or loss with respect to Branch is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(1)(ii)(B)( 1 ) and ( 2 ) of this section ( Example 1 ), DC's deemed termination amount is $35 and its owner functional currency net value adjustment is zero. Therefore, DC has $35 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch's net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $3.50 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.
( 1 ) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all its assets and liabilities to DC (the land with a basis of €100) on December 31, year 3. Under DC's eligible pretransition method, DC would have recognized section 987 gain of $35, determined by subtracting the remaining basis pool of $105 from the amount of the remittance of $140 (€100 translated at the spot rate on December 31, year 3, of €1 = $1.40). Therefore, the deemed termination amount is $35.
( 2 ) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate. Under paragraph (d)(3)(i) of this section, the transition exchange rate is the spot rate applicable to December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC's eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC's eligible pretransition method, if Branch transferred the land to DC, DC's basis in the land would be equal to Branch's basis (€100) translated at the spot rate on the date of the remittance. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero.
(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.
(2) Example 2: Earnings only method described in paragraph (e)(4)(ii) of this section —(i) Facts —(A) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section ( Example 1 ), except that DC uses an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(2)(i)(B) of this section. In addition, a current rate election is in effect for Year 4.
(B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch's functional currency) and a basis pool in U.S. dollars (DC's functional currency) with respect to Branch's earnings. DC also maintains separate equity and basis pools with respect to Branch's capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. DC's basis in assets distributed out of Branch's earnings is equal to Branch's basis in the assets translated at the spot rate on the date of the remittance. DC's basis in assets distributed out of Branch's capital is equal to the portion of the capital basis pool attributable to the distribution. Branch's earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC otherwise applies section 987 in a reasonable manner.
(C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed €100 cash to DC. Of this amount, €50 represented a remittance out of earnings, and €50 represented a distribution out of capital.
( 1 ) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch's earnings equity pool was equal to €50, and its earnings basis pool was equal to $60, as shown in the table below. Because Branch remitted 100% of the earnings equity pool (€50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero. In the hands of DC, the €50 distributed out of earnings had a basis of $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35).
Table 3 to Paragraph ( l )(2)( i )(C)( 1 )—Earnings Equity and Basis Pools
( 2 ) Distribution out of capital. The basis of the €50 distributed out of capital was equal to the portion of the capital basis pool attributable to the distribution. For this purpose, the capital equity pool was equal to €150, and the capital basis pool was equal to $150, as shown in the table below. Because Branch distributed 33% of the capital equity pool, or €50, 33% of the capital basis pool, or $50, was attributable to the distribution. In the hands of DC, the €50 distributed out of capital had a basis of $50. As a result of the capital distribution, the capital equity pool was reduced to €100 and the capital basis pool was reduced to $100.
Table 4 to Paragraph ( l )(2)( i )(C)( 2 )—Capital Equity and Basis Pools
( 3 ) Section 988 gain recognized. On June 30, year 3, DC exchanged €100 with an aggregate basis of $117.50 (equal to the sum of the $67.50 basis of the remittance out of earnings and the $50 basis of the distribution out of capital) for $135. Therefore, DC recognized $17.50 of gain under section 988.
(ii) Analysis —(A) DC's method is an eligible pretransition method. Before the transition date, DC followed a reasonable method of applying section 987 that would result in the same total amount of income over the life of DC ($125) as an earnings and capital method, as explained in paragraphs (l)(2)(ii)(A)( 1 ) and ( 2 ) of this section ( Example 2 ). Therefore, this method is an eligible pretransition method under paragraph (e)(4)(ii) of this section. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.
( 1 ) DC's total amount of income under its pretransition method. Under DC's pretransition method, DC recognized $7.50 of section 987 gain and $17.50 of section 988 gain in year 3. In addition, on December 31, year 3, DC had $40 of embedded gain in its capital equity and basis pools (equal to the difference between its capital equity pool of €100, translated at the spot rate on December 31, year 3, of €1 = $1.40, and its capital basis pool of $100) which will be taken into account in the future (when Branch distributes property out of capital and the property is sold). DC also recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC's total income (recognized and unrecognized) with respect to Branch is $125.
( 2 ) DC's total amount of income under an earnings and capital method. If DC had instead applied an earnings and capital method, as described in paragraph (l)(1)(i)(C) of this section ( Example 1 ), DC would have recognized section 987 gain of $30 in year 3 and would not have recognized section 988 gain in year 3, as explained in paragraph (l)(1)(i)(D) of this section. On December 31, year 3, DC would have unrecognized section 987 gain in its equity and basis pools of $35 ( see paragraph (l)(1)(ii)(B)( 1 ) of this section ( Example 1 )). DC would also have recognized $60 of earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 3). Thus, DC's total income (recognized and unrecognized) with respect to Branch is $125.
(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC's pretransition gain or loss with respect to Branch is equal to sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(2)(ii)(B)( 1 ) and ( 2 ) of this section ( Example 2 ), the deemed termination amount is zero and the owner functional currency net value adjustment is $40. Therefore, DC has $40 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch's net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.
( 1 ) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3. Under DC's eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, this would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero.
( 2 ) Owner functional currency net value adjustment. On December 31, year 3, Branch had no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of Branch's land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of Branch's land, translated into U.S. dollars at the pretransition translation rate on December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under the eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC. Under DC's eligible pretransition method, DC's basis in assets distributed from Branch is equal to the portion of the capital basis pool attributable to the distribution. If Branch transferred the land with a basis of €100 to DC on December 31, year 3, its remaining capital basis pool of $100 would be attributable to the distribution, and the land would have a basis of $100 in the hands of DC. Because the land had a basis of €100 in the hands of Branch, and would have a basis of $100 in the hands of DC if it were distributed on December 31, year 3, the pretransition translation rate is €1 = $1. Under paragraph (d)(3)(i) of this section, because a current rate election is in effect for year 4, the transition exchange rate is the spot rate applicable to December 31, year 3. The €100 basis of Branch's land, translated at the spot rate on December 31, year 3 of €1 = $1.40 is equal to $140. The €100 basis of Branch's land, translated at the pretransition translation rate on December 31, year 3 of €1 = $1 is equal to $100. Therefore, the owner functional currency net value adjustment is equal to $40 ($140−$100).
(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.
(iii) Alternative facts —(A) No current rate election. Assume the facts are the same as described in paragraph (l)(2)(i) of this section ( Example 2 ), except that a current rate election is not in effect for year 4.
(B) Analysis. As explained in paragraph (l)(2)(ii)(A) of this section ( Example 2 ), DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section. Because a current rate election is not in effect, the transition exchange rate is determined under paragraph (d)(3)(ii) of this section.
( 1 ) Transition exchange rate. DC applied an earnings only method described in paragraph (e)(4)(ii) of this section before the transition date. Under paragraph (d)(3)(ii) of this section, because a current rate election is not in effect for year 4, the transition exchange rate for Branch's land is equal to the pretransition translation rate. As explained in paragraph (l)(2)(ii)(B)( 2 ) of this section ( Example 2 ), the pretransition translation rate is €1 = $1.
( 2 ) Pretransition gain or loss. Because the transition exchange rate for the land (Branch's sole asset) is equal to the pretransition translation rate, the owner functional currency net value adjustment is zero. As explained in paragraph (l)(2)(ii)(B)( 1 ) of this section ( Example 2 ), the deemed termination amount is also zero. Therefore, DC has no pretransition gain or loss with respect to Branch.
( 3 ) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the transition exchange rate, which is the pretransition translation rate of €1 = $1. Therefore, the owner functional currency net value of Branch on the last day of year 3 is $100.
(3) Example 3: Earnings only method described in paragraph (e)(4)(iii) of this section —(i) Facts —(A) In general. The facts and exchange rates are the same as in paragraph (l)(1) of this section ( Example 1 ), except that DC used an earnings only method with respect to Branch before the transition date, as described in paragraph (l)(3)(i)(B) of this section.
(B) Pretransition method. Under the earnings only method, DC maintains an equity pool in euros (Branch's functional currency) and a basis pool in U.S. dollars (DC's functional currency) with respect to Branch's earnings. However, DC does not maintain separate equity and basis pools with respect to Branch's capital. Distributions are treated as being made first out of earnings and then out of capital. When Branch makes a remittance out of earnings, DC recognizes section 987 gain or loss equal to the difference between the amount of the remittance (translated into U.S. dollars at the spot rate on the date of the remittance) and the portion of the earnings basis pool attributable to the remittance. No section 987 gain or loss is recognized on a distribution out of capital. Under DC's pretransition method, DC's basis in assets distributed by Branch (whether out of earnings or capital) is equal to Branch's basis in the assets translated at the spot rate on the date of the distribution. Branch's earnings are translated into U.S. dollars at the average exchange rate for the taxable year. DC first applied its earnings only method on a return filed before November 9, 2023. In addition, DC applied its earnings only method consistently to all of its section 987 QBUs and otherwise applied section 987 in a reasonable manner.
(C) Application of the pretransition method before the transition date. On June 30, year 3, Branch distributed €100 cash to DC. Of this amount, €50 represented a remittance out of earnings, and €50 represented a distribution out of capital.
( 1 ) Remittance out of earnings. For purposes of determining section 987 gain or loss recognized on the remittance, Branch's earnings equity pool was equal to €50, and its earnings basis pool was equal to $60, as shown in the table below. Because Branch remitted 100% of the earnings equity pool (€50), the entire earnings basis pool, or $60, was attributable to the remittance. The value of the remittance was $67.50 (€50 translated at the spot rate on June 30, year 3, of €1 = $1.35). Therefore, in year 3, DC recognized section 987 gain of $7.50, equal to the difference between the value of the remittance ($67.50) and the portion of the basis pool attributable to the remittance ($60). As a result of the remittance, the earnings equity pool and the earnings basis pool were each reduced to zero.
Table 5 to Paragraph ( l )(3)( i )(C)( 1 )—Earnings Equity and Basis Pools
( 2 ) Basis of euros distributed. In the hands of DC, the €100 distributed had a basis of $135 (€100 translated at the spot rate on June 30, year 3, of €1 = $1.35). DC did not recognize gain or loss under section 988 when it exchanged the €100 for $135.
(ii) Analysis —(A) DC's method is an eligible pretransition method. Unlike in paragraph (l)(2) of this section ( Example 2 ), DC's earnings only method would not result in the same total amount of income over the life of DC as an earnings and capital method described in paragraph (e)(4)(i) of this section because DC does not maintain capital basis and equity pools and DC translates the basis of all property distributed from Branch at the spot rate on the distribution date. However, this method is an eligible pretransition method under paragraph (e)(4)(iii) of this section because DC first applied its earnings only method on a return filed before November 9, 2023, DC applied its earnings only method consistently to all of its section 987 QBUs, and DC otherwise applied section 987 in a reasonable manner. Consequently, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.
(B) Pretransition gain or loss. Under paragraph (e)(2) of this section, DC's pretransition gain or loss with respect to Branch is equal to the sum of the deemed termination amount described in paragraph (e)(2)(i)(A) of this section and the owner functional currency net value adjustment described in paragraph (e)(2)(i)(B) of this section. As explained in paragraphs (l)(3)(ii)(B)( 1 ) and ( 2 ) of this section ( Example 3 ), the deemed termination amount is zero and the owner functional currency net value adjustment is zero. Therefore, DC has no pretransition gain or loss with respect to Branch.
( 1 ) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this section, the deemed termination amount is the amount of section 987 gain or loss that would have been recognized by DC under the eligible pretransition method if Branch terminated and transferred all of its assets and liabilities to DC on December 31, year 3. Under DC's eligible pretransition method, if Branch had transferred all of its assets and liabilities to DC, it would have been treated as a distribution out of capital. Under its eligible pretransition method, DC would not have recognized section 987 gain or loss on a distribution out of capital. Therefore, the deemed termination amount is zero.
( 2 ) Owner functional currency net value adjustment. On December 31, year 3, Branch has no liabilities and only one asset: land with a basis of €100. Under paragraph (e)(2)(i)(B) of this section, the owner functional currency net value adjustment is equal to the basis of the land, translated into U.S. dollars at the transition exchange rate, reduced by the basis of the land, translated into U.S. dollars at the pretransition translation rate. Under paragraph (d)(3)(i) of this section, the transition exchange rate is the spot rate applicable to December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the pretransition translation rate is the rate that would be used under DC's eligible pretransition method to determine the basis of the land in the hands of DC if Branch transferred the land to DC on December 31, year 3. Under DC's eligible pretransition method, if Branch transferred the land to DC, DC's basis in the land would be equal to Branch's basis (€100) translated at the spot rate on the date of the distribution. Therefore, the pretransition translation rate on December 31, year 3, is equal to the spot rate on December 31, year 3. Consequently, the owner functional currency net value adjustment is zero.
(C) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.
(4) Example 4: Owner did not apply section 987(3) —(i) Facts. The facts and exchange rates are the same as in paragraph (l)(1) of this section ( Example 1 ), except that DC did not apply section 987(3) with respect to Branch and did not recognize section 987 gain or loss with respect to Branch before the transition date.
(ii) Analysis —(A) DC's method is not an eligible pretransition method. Because DC did not apply section 987(3) with respect to Branch before the transition date, DC did not apply an eligible pretransition method under paragraph (e)(4) of this section. Therefore, DC determines pretransition gain or loss under paragraph (e)(3) of this section.
(B) Pretransition gain or loss. Under paragraph (e)(3) of this section, DC's pretransition gain or loss with respect to Branch is equal to the annual unrecognized section 987 gain or loss with respect to Branch for all taxable years ending before the transition date in which DC was the owner of Branch (that is, years 1 through 3), reduced by section 987 gain or loss recognized by DC before the transition date. As explained in paragraphs (l)(4)(ii)(C) through (E) of this section ( Example 4 ), DC's annual unrecognized section 987 gain for year 1 is $7.50, DC's annual unrecognized section 987 gain for year 2 is $16.25, and DC's annual unrecognized section 987 gain for year 3 is $23.75. DC did not recognize any section 987 gain or loss with respect to Branch before the transition date. Therefore, DC has $47.50 of pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) of this section, the pretransition gain is treated as Branch's net accumulated unrecognized section 987 gain. However, if DC elects to recognize its pretransition gain ratably over the transition period under paragraph (e)(5)(ii) of this section, the pretransition gain is not treated as net accumulated unrecognized section 987 gain. Instead, DC recognizes $4.75 (one tenth of its pretransition gain) for each of the ten taxable years from year 4 through year 13.
(C) Annual unrecognized section 987 gain or loss for year 1. Under paragraph (e)(3)(iii) of this section, annual unrecognized section 987 gain or loss with respect to a section 987 QBU is determined under the rules of § 1.987-4(d), applied as though a current rate election was in effect for all relevant taxable years (such that all items are treated as marked items), but modified so that only §§ 1.987-4(d)(1) (change in owner functional currency net value) and 1.987-4(d)(10) (adjustment for residual increase or decrease to net assets) are applied. As explained in paragraphs (l)(4)(ii)(C)( 1 ) and ( 2 ) of this section ( Example 4 ), in year 1, the change in owner functional currency net value under § 1.987-4(d)(1) is an increase of $165, and there is a negative adjustment of $157.50 under § 1.987-4(d)(10). Therefore, DC's annual unrecognized section 987 gain for year 1 is $7.50.
( 1 ) Change in owner functional currency net value for year 1. On December 31, year 1, Branch held land with a basis of €100 and €50 cash. Therefore, on the last day of year 1, Branch's owner functional currency net value is $165 (150 euros translated at the spot rate on December 31, year 1, of €1 = $1.10). Because Branch was formed in year 1, its owner functional currency net value on the last day of the preceding taxable year is zero. See § 1.987-4(d)(1)(iii). Therefore, the change in owner functional currency net value is an increase of $165.
( 2 ) Residual increase to net assets for year 1. Under § 1.987-4(d)(10), unrecognized section 987 gain or loss for a taxable year is decreased by any residual increase to net assets (and increased by any residual decrease to net assets), translated into the owner's functional currency at the yearly average exchange rate for the taxable year. For this purpose, the residual increase (or decrease) to net assets is equal to the change in net value of the section 987 QBU, determined in the section 987 QBU's functional currency (that is, the QBU net value). See § 1.987-4(d)(10)(ii)(B) and (e)(2)(ii). On December 31, year 1, Branch held land with a basis of €100 euros and €50 cash. Therefore, on the last day of year 1, Branch has a QBU net value of €150. Because Branch was formed in year 1, its QBU net value on the last day of the preceding taxable year is zero. See § 1.987-4(d)(1)(iii). Therefore, the residual increase to net assets is €150. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $157.50 for year 1 (equal to €150 translated at the yearly average exchange rate for year 1 of €1 = $1.05).
(D) Annual unrecognized section 987 gain or loss for year 2. As explained in paragraphs (l)(4)(ii)(D)( 1 ) and ( 2 ) of this section ( Example 4 ), in year 2, the change in owner functional currency net value under § 1.987-4(d)(1) is an increase of $45, and there is a negative adjustment of $28.75 under § 1.987-4(d)(10). Therefore, DC's annual unrecognized section 987 gain for year 2 is $16.25.
( 1 ) Change in owner functional currency net value for year 2. On December 31, year 2, Branch held land with a basis of €100 and €75 cash. Therefore, on the last day of year 2, Branch's owner functional currency net value is $210 (175 euros translated at the spot rate on December 31, year 2, of €1 = $1.20). As explained in paragraph (l)(4)(ii)(C)( 1 ) of this section ( Example 4 ), Branch's owner functional currency net value on the last day of year 1 was $165. Therefore, the change in owner functional currency net value is an increase of $45.
( 2 ) Residual increase to net assets for year 2. On December 31, year 2, Branch held land with a basis of €100 and €75 cash. Therefore, on the last day of year 2, Branch has a QBU net value of €175. As explained in paragraph (l)(4)(ii)(C)( 2 ) of this section ( Example 4 ), Branch had a QBU net value of €150 on December 31, year 1. Therefore, the residual increase to net assets is €25. This results in a negative adjustment to annual unrecognized section 987 gain or loss of $28.75 for year 2 (equal to a reduction of €25, translated at the yearly average exchange rate for year 2 of €1 = $1.15).
(E) Annual unrecognized section 987 gain or loss for year 3. As explained in paragraphs (l)(4)(ii)(E)( 1 ) and ( 2 ) of this section ( Example 4 ), in year 3, the change in owner functional currency net value under § 1.987-4(d)(1) is a decrease of $70, and there is a positive adjustment of $93.75 under § 1.987-4(d)(10). Therefore, DC's annual unrecognized section 987 gain for year 3 is $23.75.
( 1 ) Change in owner functional currency net value for year 3. On December 31, year 3, Branch held land with a basis of €100. Therefore, on the last day of year 3, Branch's owner functional currency net value is $140 (100 euros translated at the spot rate on December 31, year 3, of €1 = $1.40). As explained in paragraph (l)(4)(ii)(D)( 1 ) of this section ( Example 4 ), Branch's owner functional currency net value on the last day of year 2 was $210. Therefore, the change in owner functional currency net value is a decrease of $70.
( 2 ) Residual decrease to net assets for year 3. On December 31, year 3, Branch held land with a basis of €100. Therefore, on the last day of year 3, Branch has a QBU net value of €100. As explained in paragraph (l)(4)(ii)(D)( 2 ) of this section ( Example 4 ), Branch had a QBU net value of €175 on December 31, year 2. Therefore, the residual decrease to net assets is €75. This results in a positive adjustment to annual unrecognized section 987 gain or loss of $93.75 for year 3 (equal to €75, translated at the yearly average exchange rate for year 3 of €1 = $1.25).
(F) Determination of unrecognized section 987 gain or loss in year 4. For purposes of determining unrecognized section 987 gain or loss in year 4 under § 1.987-4(d), the owner functional currency net value of Branch on the last day of year 3 is determined by translating the €100 basis of the land at the spot rate on December 31, year 3 (€1 = $1.40). Therefore, the owner functional currency net value of Branch on the last day of year 3 is $140.
(5) Example 5: Error in application of method —(i) Facts. The facts are the same as described in paragraph (l)(1)(i) of this section ( Example 1 ), except that DC inadvertently miscalculated the amount of the June 30, year 3, remittance as being €90 rather than €100. This reduced the amount of section 987 gain recognized by DC in year 3.
(ii) Analysis. DC committed an error in its application of the earnings and capital method to Branch. Under paragraph (e)(4)(iv)(A) of this section, DC is nonetheless treated as having applied an eligible pretransition method. However, under paragraph (e)(4)(iv)(B) of this section, DC must determine its pretransition gain or loss as though the error had not been made. Therefore, DC computes its pretransition gain or loss as described in paragraph (l)(1)(ii)(B) of this section ( Example 1 ). DC has $35 of pretransition gain with respect to Branch.
(6) Example 6: Consistent practice not treated as an error —(i) Facts. Before the transition date, DC used the earnings and capital method described in the 1991 proposed regulations under section 987 with respect to Branch, as described in paragraph (l)(1)(i) of this section ( Example 1 ). In years 1, 2, and 3, Branch made recurring purchases of inventory from Owner, which Branch sold to unrelated customers. In connection with the purchase transactions, Branch transferred cash to Owner, and Owner transferred inventory to Branch. Owner did not take these transfers into account in determining the amount of any remittance and, accordingly, did not recognize section 987 gain or loss with respect to these transfers. However, Owner consistently adjusted Branch's equity and basis pools in a reasonable manner to reflect all transfers between Owner and Branch; for this purpose, the amount of each transfer made in connection with the purchase transactions was translated using the average rate for the relevant taxable year. Owner also adjusted Branch's equity and basis pools to account for Branch's income from the sale of inventory.
(ii) Analysis —(A) DC's method is an eligible pretransition method. Before the transition date, DC followed the earnings and capital method described in the 1991 proposed regulations under section 987 with respect to Branch. This method is an eligible pretransition method under paragraph (e)(4)(i) of this section. Therefore, DC determines its pretransition gain or loss with respect to Branch under paragraph (e)(2) of this section.
(B) Effect of consistent practice. Before the transition date, Owner engaged in a consistent practice under which Owner did not account for inventory purchase transactions in determining the amount of a remittance requiring the recognition of gain or loss under section 987(3). However, Owner consistently accounted for the disregarded transfers in a reasonable manner for purposes of computing its equity and basis pools. Under paragraph (e)(4)(v) of this section, this consistent practice is not treated as an error in the application of a pretransition method and does not preclude Owner's method from being treated as an eligible pretransition method. Therefore, Owner must take this consistent practice into account in determining pretransition gain or loss under paragraph (e)(2) of this section. In particular, Owner must use the equity and basis pools computed under its consistent practice (rather than the equity and basis pools it would have computed if it had historically taken the disregarded transfers into account in determining the amount of remittances) to determine the deemed termination amount under paragraph (e)(2)(i)(A) of this section.
§ 1.987-11   Suspended section 987 loss relating to certain elections; loss-to-the-extent-of-gain rule.
(a) In general. This section provides rules relating to suspended section 987 loss. Paragraph (b) of this section provides rules for computing the cumulative suspended section 987 loss with respect to a section 987 QBU or successor suspended loss QBU. Paragraph (c) of this section provides rules that suspend section 987 loss that would otherwise be recognized when a current rate election is in effect. Paragraph (d) of this section provides rules that treat net unrecognized section 987 loss and deferred section 987 loss as suspended section 987 loss when an annual recognition election is made or a current rate election is revoked. Paragraph (e) of this section describes the extent to which suspended section 987 loss is recognized under a loss-to-the-extent-of-gain rule. Paragraph (f) of this section provides rules for determining recognition groupings based on the source and character of section 987 gain or loss. Paragraph (g) of this section provides examples illustrating the rules of this section.
(b) Cumulative suspended section 987 loss in a recognition grouping —(1) In general. The cumulative suspended section 987 loss in a recognition grouping with respect to a section 987 QBU or a successor suspended loss QBU for the current taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping for the prior taxable year, decreased by the amount of suspended section 987 loss in the recognition grouping that was recognized with respect to the QBU under paragraph (e) of this section or under § 1.987-13(b) through (d) in the prior taxable year, and increased by the amount that becomes suspended section 987 loss in the recognition grouping with respect to the QBU in the current taxable year (including under § 1.987-10(e)(5)(i)(B)( 1 )). If the taxable year is the first taxable year of the section 987 QBU (or the first taxable year in which the section 987 regulations apply), the cumulative suspended section 987 loss for the prior taxable year is zero. An owner's (or original suspended loss QBU owner's) total cumulative suspended section 987 loss in a recognition grouping is equal to the sum of its cumulative suspended section 987 gain or loss with respect to each section 987 QBU and successor suspended loss QBU.
(2) Combined QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a combination, the cumulative suspended section 987 loss in a recognition grouping with respect to a combined QBU for the prior taxable year is equal to the sum of the cumulative suspended section 987 loss in the recognition grouping with respect to each combining QBU for the prior taxable year; the suspended section 987 loss in a recognition grouping with respect to a combined QBU that was recognized in the prior taxable year is equal to sum of the suspended section 987 loss in the recognition grouping with respect to each combining QBU that was recognized in the prior taxable year.
(3) Separated QBU. For purposes of paragraph (b)(1) of this section, in the taxable year of a separation, the cumulative suspended section 987 loss in a recognition grouping with respect to a separated QBU for the prior taxable year is equal to the cumulative suspended section 987 loss in the recognition grouping with respect to the separating QBU for the prior taxable year multiplied by the separation fraction; the suspended section 987 loss in a recognition grouping with respect to a separated QBU that was recognized in the prior taxable year is equal to the suspended section 987 loss in the recognition grouping with respect to the separating QBU that was recognized in the prior taxable year multiplied by the separation fraction.
(c) Suspension of section 987 loss for taxable years in which a current rate election is in effect and an annual recognition election is not in effect —(1) In general. Except as provided in paragraph (c)(2) of this section, in a taxable year in which a current rate election is in effect and an annual recognition election is not in effect, to the extent that an owner's net unrecognized section 987 loss with respect to a section 987 QBU would otherwise be recognized under § 1.987-5 (including pursuant to § 1.987-12(b)), or its deferred section 987 loss would otherwise be recognized under § 1.987-12(c), the net unrecognized section 987 loss or deferred section 987 loss is not recognized by the owner and instead becomes suspended section 987 loss. See paragraph (g)(1) of this section ( Example 1 ) for an illustration of this rule.
(2) De minimis rule. Paragraph (c)(1) of this section does not apply in a taxable year of an owner in which the total amount of net unrecognized section 987 loss or deferred section 987 loss of the owner and all members of the owner's controlled group that would (but for the application of this paragraph (c)(2) and § 1.987-7(d)(2)(iii)) become suspended section 987 loss under paragraph (c)(1) of this section or § 1.987-7(d) does not exceed the lesser of—
(i) $3 million; or
(ii) Two percent of the total amount of gross income of the owner and all members of the owner's controlled group for the taxable year.
(3) Taxable year of controlled group members —(i) In general. Except as provided in paragraph (c)(3)(ii) of this section, for purposes of applying paragraph (c)(2) of this section with respect to an owner, suspended section 987 loss and gross income of a member of the owner's controlled group is determined by reference to the member's suspended section 987 loss and gross income for its taxable year ending with or within the owner's taxable year.
(ii) Owner is a CFC. For purposes of applying paragraph (c)(2) of this section with respect to an owner that is a CFC, suspended section 987 loss and gross income of a member of the owner's controlled group is determined by reference to the member's suspended section 987 loss and gross income for its taxable year ending with or within the owner's required year described in section 898(c)(1), without regard to section 898(c)(2).
(d) Suspension of net unrecognized section 987 loss upon making or revoking certain elections —(1) Making an annual recognition election. At the beginning of the first taxable year for which an annual recognition election is in effect, an owner's net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss if either—
(i) A current rate election was in effect for the immediately preceding taxable year; or
(ii) A current rate election was not in effect for the immediately preceding taxable year and, as of the beginning of the taxable year, the sum of the owner's net accumulated unrecognized section 987 loss and deferred section 987 loss exceeds the sum of the owner's net accumulated unrecognized section 987 gain and deferred section 987 gain by more than $5 million.
(2) Revoking a current rate election. At the beginning of the first taxable year in which a current rate election ceases to be in effect, an owner's net accumulated unrecognized section 987 loss and deferred section 987 loss are converted into suspended section 987 loss. See paragraph (g)(3) of this section ( Example 3 ) for an illustration of this rule.
(e) Loss-to-the-extent-of-gain rule —(1) In general. An owner of a section 987 QBU (or an original suspended loss QBU owner) only recognizes suspended section 987 loss to the extent described in this paragraph (e) (the loss-to-the-extent-of-gain rule ). See § 1.987-13(b) through (d) for rules requiring the recognition of additional suspended section 987 loss (after the application of the loss-to-the-extent-of-gain rule) in connection with certain transactions.
(2) Separate determination for each recognition grouping. The amount of suspended section 987 loss recognized is determined separately for the suspended section 987 loss in each recognition grouping. Because the recognition groupings generally are determined on the basis of the initial assignment of section 987 gain or loss under § 1.987-6(b)(2)(i), the loss-to-the-extent-of-gain rule generally is applied on the basis of the initial assignment of section 987 gain or loss.
(3) Amount of suspended section 987 loss recognized. Except as provided in paragraph (e)(5) or (6) of this section, the amount of suspended section 987 loss in each recognition grouping that an owner recognizes in a taxable year is equal to the sum (if positive) of the current year gain amount described in paragraph (e)(3)(i) of this section and the lookback gain amount described in paragraph (e)(3)(ii) of this section, but may not exceed the owner's total cumulative suspended section 987 loss in the recognition grouping. If the sum of the current year gain amount and the lookback gain amount is negative, then the amount of suspended section 987 loss recognized under this paragraph (e) is zero. See paragraphs (g)(1) and (2) of this section ( Examples 1 and 2 ) for an illustration of this rule.
(i) Current year gain amount. The current year gain amount described in this paragraph (e)(3)(i) is equal to the section 987 gain in the recognition grouping that is recognized by the owner in the taxable year, reduced (including below zero) by section 987 loss (other than suspended section 987 loss) in the recognition grouping that is recognized by the owner in the taxable year.
(ii) Lookback gain amount. The lookback gain amount described in this paragraph (e)(3)(ii) is equal to the section 987 gain in the recognition grouping that was recognized by the owner in the lookback period, reduced (including below zero) by section 987 loss (other than suspended section 987 loss described in paragraph (e)(3)(iii) of this section) in the recognition grouping that was recognized by the owner in the lookback period. The total amount of suspended section 987 loss recognized by reason of the recognition of an amount of section 987 gain cannot, in any event, exceed the amount of section 987 gain recognized.
(iii) Suspended section 987 loss not taken into account —(A) In general. For purposes of applying paragraph (e)(3)(ii) of this section in a taxable year (the current taxable year ), suspended section 987 loss recognized during the lookback period is not taken into account if it was recognized under this paragraph (e) by reason of the recognition of section 987 gain that was recognized before the lookback period for the current taxable year.
(B) Ordering rule. For purposes of this paragraph (e)(3)(iii), suspended section 987 loss is treated as recognized by reason of the most recently recognized section 987 gain in the same recognition grouping. See paragraph (g)(2) of this section ( Example 2 ) for an illustration of this rule.
(iv) Lookback period —(A) In general. Except as provided in paragraph (e)(3)(iv)(B) of this section, the lookback period with respect to a taxable year of an owner means the three preceding taxable years of the owner (or, if the owner was not in existence for three preceding taxable years, each taxable year in which the owner existed), but it does not include any taxable year beginning before the transition date described in § 1.987-10(c)(1).
(B) Taxable years in which both a current rate election and an annual recognition election are in effect. In a taxable year of an owner in which both a current rate election and an annual recognition election are in effect, the lookback period includes all prior taxable years of the owner in which both a current rate election and an annual recognition election were continuously in effect.
(v) Anti-abuse rule. If an owner recognizes section 987 gain with a principal purpose of reducing the Federal income tax liability of the owner (or its U.S. shareholders or partners, as applicable), including over multiple taxable years, the section 987 gain is disregarded for purposes of this paragraph (e)(3). For example, this paragraph (e)(3)(v) may apply if an owner that is a CFC recognizes section 987 gain that is offset by a tax attribute of one of the CFC's U.S. shareholders that would not otherwise be used (such as excess foreign tax credits with respect to section 951A category income, or a tested loss). In determining whether a principal purpose described in this paragraph (e)(3)(v) exists, all relevant facts and circumstances are considered, including the extent to which the transaction giving rise to the recognition of section 987 gain resulted in a sustained economic contraction of the section 987 QBU over a period of at least twelve months.
(4) Suspended section 987 loss recognized with respect to each section 987 QBU and suspended section 987 loss QBU. The amount of suspended section 987 loss in a recognition grouping that is recognized by an owner in a taxable year is treated as attributable to each section 987 QBU or successor suspended loss QBU in proportion to the QBU's suspended section 987 loss in that recognition grouping.
(5) S ection 381(a) transactions —(i) In general. Except as provided in paragraph (e)(5)(ii) of this section (or to the extent that other limitations apply), if one corporation (acquiring corporation) acquires the assets of another corporation (transferor corporation) in a transaction described in section 381(a), section 987 gain or loss recognized by the transferor corporation during the lookback period is taken into account in determining the lookback gain amount of the acquiring corporation in taxable years ending after the transaction under paragraph (e)(3)(ii) of this section. If the lookback period for a taxable year of the acquiring corporation is determined under paragraph (e)(3)(iv)(A) of this section, the lookback period includes each taxable year of the transferor corporation ending with or within the current taxable year of the acquiring corporation or during the acquiring corporation's lookback period. If the lookback period for a taxable year of the acquiring corporation is determined under paragraph (e)(3)(iv)(B) of this section, the lookback period includes only taxable years of the transferor corporation in which both an annual recognition election and a current rate election were continuously in effect before the transaction (and only if both elections were continuously in effect from the date of the transaction through the current taxable year).
(ii) Limitation for inbound nonrecognition transactions. If a foreign corporation ceases to exist in a transaction described in § 1.987-8(c)(1)(ii) (inbound section 332 liquidation) or § 1.987-8(c)(2)(ii) (inbound reorganization), section 987 gain recognized by the foreign corporation before the transaction is disregarded for purposes of applying paragraph (e)(3) of this section in taxable years ending after the transaction.
(6) Consolidated group members —(i) In general. All members of a consolidated group are treated as a single owner for purposes of applying this paragraph (e).
(ii) Suspended section 987 losses arising in separate return limitation years. This paragraph (e)(6)(ii) applies to suspended section 987 losses arising in a separate return limitation year (SRLY, as defined in § 1.1502-1(f)) or treated as arising in a SRLY under the principles of § 1.1502-21(c) ( SRLY section 987 losses ). The aggregate of a member's SRLY section 987 losses that are included in the determination of consolidated taxable income for all consolidated return years of the group may not exceed the aggregate consolidated net income for all consolidated return years of the group determined by reference to only the member's items of section 987 gain or loss, including the member's section 987 losses actually absorbed by the group in the taxable year (whether or not absorbed by the member). For purposes of applying this paragraph (e)(6)(ii), the principles of § 1.1502-21(c) (including the SRLY subgroup principles of § 1.1502-21(c)(2)) apply with appropriate adjustments.
(f) Recognition groupings. The term recognition grouping means the section 987 gain or loss (including section 987 gain or loss that is recognized under § 1.987-5, deferred section 987 gain or loss, suspended section 987 loss, or pretransition gain or loss that is recognized under § 1.987-10(e)(5)(ii)) described in paragraph (f)(1) or (2) of this section, as applicable. If an owner has suspended section 987 loss with respect to a terminating QBU in a taxable year ending before the transition date described in § 1.987-10(c)(1), section 987 gain or loss of the owner (other than section 987 gain or loss with respect to the terminating QBU) is assigned to a recognition grouping based on the method that is used to determine the source and character of section 987 gain or loss for that taxable year.
(1) Sourcing and section 904 category. Except as provided in paragraph (f)(2) of this section, a recognition grouping includes only section 987 gain or loss that is initially assigned to one of the following statutory and residual groupings—
(i) U.S. source income; or
(ii) Foreign source income in a single section 904 category.
(2) Statutory and residual groupings for CFC owners. In the case of an owner that is a controlled foreign corporation, a recognition grouping includes only section 987 gain or loss that is initially assigned to one of the statutory and residual groupings described in paragraph (f)(1) of this section and that is also initially assigned to one of the following statutory and residual groupings—
(i) Tentative tested income;
(ii) Each separate subpart F income group (as defined in § 1.960-1(d)(2)(ii)(B));
(iii) Income described in section 952(b) (ECI that is excluded from subpart F income); or
(iv) Income not described in paragraphs (f)(2)(i) through (iii) of this section.
(g) Examples. The following examples illustrate the application of this section.
(1) Example 1: Suspension of section 987 loss and recognition of suspended section 987 loss —(i) Facts. CFC is a controlled foreign corporation that has the U.S. dollar as its functional currency. CFC owns three section 987 QBUs, QBU1, QBU2, and QBU3. QBU1 has the euro as its functional currency, QBU2 has the pound as its functional currency, and QBU3 has the yen as its functional currency. CFC is subject to a current rate election but not an annual recognition election. CFC is also subject to an election under § 1.987-6(b)(2)(i)(C) (treating section 987 gain or loss relating to passive foreign personal holding company income as attributable to section 988 transactions). An election has not been made under § 1.951A-2(c)(7)(viii) (GILTI high-tax exclusion) with respect to CFC. In year 1, CFC did not have cumulative suspended section 987 loss with respect to any of its QBUs and did not have outstanding deferred section 987 gain or loss. In the three years before year 2, CFC did not recognize any section 987 gain or loss. In year 2, CFC has net unrecognized section 987 loss of $200 with respect to QBU1, net unrecognized section 987 loss of $1,000 with respect to QBU2, and net unrecognized section 987 gain of $1,000 with respect to QBU3. In year 2, each QBU makes a remittance, and CFC's remittance proportion (determined under § 1.987-5(b)(1)) is 25% with respect to QBU1, 15% with respect to QBU2, and 10% with respect to QBU3. For purposes of § 1.987-6(b)(2)(i), all of QBU1's assets generate foreign source passive category income that corresponds to one or more subpart F income groups described in § 1.960-1(d)(2)(ii)(B)( 2 )( i ) through ( v ), and all of QBU2's and QBU3's assets generate foreign source general category tested income. Another member of CFC's controlled group owns a section 987 QBU with respect to which $10 million of net unrecognized section 987 loss becomes suspended section 987 loss under paragraph (c)(1) of this section in year 2.
(ii) Analysis —(A) Application of §§ 1.987-5 and 1.987-6 and paragraph (c) of this section. In year 2, CFC recognizes $100 of section 987 gain with respect to QBU3 (10% of $1,000) under § 1.987-5(a). Under § 1.987-6(b)(2)(i)(A), (B), and (D), the section 987 gain is initially characterized as foreign source general category tentative tested income. If a current rate election was not in effect, in year 2 CFC would recognize $50 of section 987 loss with respect to QBU1 (25% of $200) and $150 of section 987 loss with respect to QBU2 (15% of $1,000). However, under paragraph (c) of this section, these amounts instead become suspended section 987 loss. The de minimis rule under paragraph (c)(2) of this section does not apply because a member of CFC's controlled group has more than $3 million of section 987 loss that is suspended in year 2 under paragraph (c)(1) of this section. Under § 1.987-6(b)(2)(i)(A) and (B), the $50 of suspended section 987 loss with respect to QBU1 is initially characterized as foreign source passive category income assigned to a subpart F income group described in § 1.960-1(d)(2)(ii)(B)( 2 )( i ) through ( v ), and is treated as foreign currency loss of the CFC attributable to section 988 transactions not directly related to the business needs of the CFC because an election under § 1.987-6(b)(2)(i)(C) is in effect. Under § 1.987-6(b)(2)(i)(A), (B), and (D), the $150 of suspended section 987 loss with respect to QBU2 is initially characterized as foreign source general category tentative tested income.
(B) Cumulative suspended section 987 loss. Under paragraph (b) of this section, in year 2, CFC's cumulative suspended section 987 loss in the recognition grouping of foreign source passive category income in a separate subpart F income group for foreign currency gains of CFC with respect to QBU1 is $50, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC's total cumulative suspended section 987 loss in that recognition grouping is $50. Similarly, CFC's cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income with respect to QBU2 is $150, the amount that became suspended section 987 loss in the recognition grouping in year 2. In addition, CFC's total cumulative suspended section 987 loss in that recognition grouping is $150.
(C) Current year gain amount and lookback gain amount. Under paragraph (e)(3) of this section, in year 2, CFC recognizes suspended section 987 loss in a recognition grouping to the extent of the sum of the current year gain amount described in paragraph (e)(3)(i) of this section and the lookback gain amount described in paragraph (e)(3)(ii) of this section. In the recognition grouping of foreign source general category tentative tested income, the current year gain amount described in paragraph (e)(3)(i) of this section is equal to the section 987 gain of $100 recognized by CFC in year 2 with respect to QBU3. The current year gain amount for all other recognition groupings is zero. During the lookback period (the three years before year 2), CFC did not recognize any section 987 gain or loss. Therefore, the lookback gain amount described in paragraph (e)(3)(ii) of this section is zero for all recognition groupings.
(D) Recognition of suspended section 987 loss. In year 2, CFC has $50 of total cumulative suspended section 987 loss in the recognition grouping of foreign source passive category income in a separate subpart F income group for foreign currency gains of CFC and $150 of total cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. In the recognition grouping of foreign source general category tentative tested income, CFC has a current year gain amount of $100 and a lookback gain amount of zero ($100 in total). Therefore, CFC recognizes $100 of suspended section 987 loss in that recognition grouping. Under paragraph (e)(4) of this section, the cumulative suspended section 987 loss that is recognized by CFC is attributable to QBU2, because QBU2 is CFC's only QBU with cumulative suspended section 987 loss in the recognition grouping of foreign source general category tentative tested income. Because no election under § 1.951A-2(c)(7) applies in year 2, both the $100 of recognized section 987 gain and the $100 of recognized section 987 loss are allocated to foreign source general category tested income. See § 1.987-6(b)(2)(ii). The amounts of suspended section 987 loss not recognized (that is, $50 of suspended section 987 loss assigned to foreign source passive category income in the subpart F income group for foreign currency gains of CFC with respect to QBU1 and $50 of suspended section 987 loss assigned to foreign source general category tentative tested income with respect to QBU2) remain suspended.
(2) Example 2: Recognition of suspended section 987 loss by reason of gain recognized during the lookback period —(i) Facts. CFC is a controlled foreign corporation that has the U.S. dollar as its functional currency. CFC owns QBU1, a section 987 QBU with the euro as its functional currency, and CFC has no other QBUs. Assume that all section 987 gain or loss (including suspended section 987 loss) is assigned to the same recognition grouping. CFC is subject to a current rate election but not an annual recognition election. Before year 1, QBU1 does not have cumulative suspended section 987 loss. In year 1, CFC recognizes section 987 gain of $10 million with respect to QBU1. In year 3, CFC recognizes section 987 gain of $15 million with respect to QBU1. In year 4, QBU1 has net unrecognized section 987 loss, and $10 million of the net unrecognized section 987 loss becomes suspended section 987 loss under paragraph (c) of this section. In year 6, an additional $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section.
(ii) Analysis —(A) Recognition of suspended section 987 loss in year 4. In year 4, CFC's total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 4). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 4. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 1 through 3). The lookback gain amount under paragraph (e)(3)(ii) of this section is $25 million (the sum of the $10 million of section 987 gain recognized in year 1 and the $15 million of section 987 gain recognized in year 3). Therefore, under paragraph (e)(3) of this section, CFC recognizes suspended section 987 loss of $10 million. Under paragraph (e)(3)(iii)(B) of this section, the suspended section 987 loss is considered to be recognized by reason of the section 987 gain recognized in year 3, which is the most recent taxable year in which section 987 gain was recognized.
(B) Recognition of suspended section 987 loss in year 6. In year 6, CFC's total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 6). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 6. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 3 through 5). The lookback gain amount under paragraph (e)(3)(ii) of this section is $5 million (the sum of the section 987 gain of $15 million recognized in year 3 and the suspended section 987 loss of $10 million recognized in year 4 by reason of the section 987 gain recognized in year 3). Therefore, under paragraph (e)(3) of this section, CFC recognizes $5 million of suspended section 987 loss in year 6.
(iii) Alternative facts. Assume the facts are the same as described in paragraph (g)(2)(i) of this section, with the following modifications. In year 1, CFC recognizes section 987 gain of $10 million with respect to QBU1. CFC does not recognize section 987 gain in year 3. In year 4, $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section. In year 5, CFC recognizes section 987 gain of $15 million with respect to QBU1. In year 6, $10 million of net unrecognized section 987 loss with respect to QBU1 becomes suspended section 987 loss under paragraph (c) of this section.
(iv) Analysis of alternative facts —(A) Recognition of suspended section 987 loss in year 4. In year 4, CFC's total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 4). The current year gain amount under paragraph (e)(3)(i) of this section is zero, because CFC does not recognize section 987 gain in year 4. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 1 through 3). The lookback gain amount under paragraph (e)(3)(ii) of this section is $10 million (equal to the $10 million of section 987 gain recognized in year 1). Therefore, under paragraph (e)(3) of this section, CFC recognizes suspended section 987 loss of $10 million in year 4. Under paragraph (e)(3)(iii)(B) of this section, the suspended section 987 loss is considered to be recognized by reason of the section 987 gain recognized in year 1, which is the most recent taxable year in which section 987 gain was recognized.
(B) Recognition of suspended section 987 loss in year 6. In year 6, CFC's total cumulative suspended section 987 loss is $10 million (that is, the loss that becomes suspended in year 6). The current year gain amount under paragraph (e)(3)(i) of this section is zero because CFC does not recognize section 987 gain in year 6. The lookback period under paragraph (e)(3)(iv)(A) of this section is three years (years 3 through 5). The lookback gain amount under paragraph (e)(3)(ii) of this section is $15 million (equal to the section 987 gain of $15 million recognized in year 5). Under paragraph (e)(3)(iii)(A) of this section, the suspended section 987 loss recognized in year 4 is not taken into account in determining the lookback gain amount, because it was recognized by reason of the section 987 gain recognized in year 1 (before the beginning of the lookback period for year 6). Therefore, under paragraph (e)(3) of this section, CFC recognizes $10 million of suspended section 987 loss in year 6.
(3) Example 3: Suspension of section 987 loss when a current rate election is revoked —(i) Facts. U.S. Corp is a domestic corporation that owns all of the interests in DE1. DE1 owns Business A, which is a section 987 QBU of U.S. Corp. In year 1, U.S. Corp made a current rate election but not an annual recognition election. In year 9, U.S. Corp has net unrecognized section 987 loss of $2 million with respect to Business A, which is not recognized or suspended in year 9. U.S. Corp revokes its current rate election effective for year 10. In year 10, before the application of this section, U.S. Corp has net accumulated unrecognized section 987 loss of $2 million.
(ii) Analysis. Under paragraph (d)(2) of this section, U.S. Corp's net accumulated unrecognized section 987 loss of $2 million with respect to Business A is converted into suspended section 987 loss at the beginning of year 10, the first taxable year in which the current rate election ceases to be in effect.
§ 1.987-12   Deferral of section 987 gain or loss.
(a) Overview —(1) Scope. This section provides rules that defer the recognition of section 987 gain or loss and rules for recognizing (or suspending) deferred section 987 gain or loss. This paragraph (a) provides an overview of this section and certain instances when this section does not apply. Paragraph (b) of this section describes the extent to which net unrecognized section 987 gain or loss is recognized under § 1.987-5 (or in certain cases, suspended) or becomes deferred section 987 gain or loss in connection with a deferral event. Paragraph (c) of this section describes the extent to which deferred section 987 gain or loss is recognized (or in certain cases, suspended) upon the occurrence of subsequent events. Paragraph (d) of this section provides a rule relating to the treatment of a successor deferral QBU when deferred section 987 loss becomes suspended section 987 loss. Paragraph (e) of this section provides an anti-abuse rule. Paragraph (f) of this section provides rules for determining the deferred section 987 gain or loss of combined and separated QBUs. Paragraph (g) of this section provides definitions. Paragraph (h) of this section provides examples illustrating the rules of this section.
(2) Exceptions —(i) Annual recognition election. This section does not apply to a termination of a section 987 QBU in a taxable year in which an annual recognition election is in effect.
(ii) De minimis rule. This section does not apply in a taxable year if the aggregate amount of net unrecognized section 987 gain or loss of the owner with respect to all of its section 987 QBUs that would become deferred section 987 gain or loss under this section does not exceed $5 million.
(b) Treatment of section 987 gain and loss in connection with a deferral event. Notwithstanding § 1.987-5 (general rule requiring recognition of section 987 gain or loss in the taxable year of a remittance), the owner of a section 987 QBU with respect to which a deferral event occurs (an original deferral QBU ) includes in taxable income section 987 gain or loss in connection with the deferral event only to the extent provided in this paragraph (b).
(1) Gain or loss recognized (or suspended) in the taxable year of a deferral event. In the taxable year of a deferral event with respect to an original deferral QBU, the owner of the original deferral QBU recognizes section 987 gain or loss under § 1.987-5, except that, solely for purposes of applying § 1.987-5, all assets and liabilities of the original deferral QBU that, immediately after the deferral event, are reflected on the books and records of a successor deferral QBU are treated as not having been transferred and therefore as remaining on the books and records of the original deferral QBU notwithstanding the deferral event. Notwithstanding the prior sentence, any section 987 loss that would otherwise be recognized under this paragraph (b)(1) and § 1.987-5 may instead become suspended loss under § 1.987-11(c) if a current rate election is in effect, or under § 1.987-13(h) if the deferral event also constitutes an outbound loss event.
(2) Deferred section 987 gain or loss —(i) In general. In the taxable year of a deferral event with respect to an original deferral QBU, any net unrecognized section 987 gain or loss that is not recognized or suspended in the taxable year of the deferral event becomes deferred section 987 gain or loss of the original deferral QBU owner. Suspended section 987 loss does not become deferred section 987 loss under this paragraph (b)(2).
(ii) Deferred section 987 gain or loss attributable to a successor deferral QBU. A portion of the deferred section 987 gain or loss described in paragraph (b)(2)(i) of this section becomes deferred section 987 gain or loss with respect to each successor deferral QBU. Such portion is equal to the deferred section 987 gain or loss multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor deferral QBU in connection with the deferral event and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor deferral QBUs in connection with the deferral event.
(c) Recognition (or suspension) of deferred section 987 gain or loss following a deferral event. An original deferral QBU owner recognizes deferred section 987 gain or loss with respect to a successor deferral QBU in the taxable year of the deferral event and in subsequent taxable years as provided in this paragraph (c).
(1) Recognition upon a subsequent remittance —(i) In general. Except as provided in paragraph (c)(2) of this section, an original deferral QBU owner recognizes deferred section 987 gain or loss in the taxable year of the deferral event, and in subsequent taxable years, upon a remittance from a successor deferral QBU to the owner of the successor deferral QBU ( successor deferral QBU owner ) in the amount described in paragraph (c)(1)(ii) of this section. Notwithstanding the prior sentence, any deferred section 987 loss that would otherwise be recognized under this paragraph (c)(1) may instead become suspended section 987 loss under § 1.987-11(c) (if a current rate election is in effect with respect to the original deferral QBU owner) or under § 1.987-7(d)(1)(ii) (in the case of a partnership).
(ii) Amount. The amount of deferred section 987 gain or loss that is recognized (or suspended) pursuant to this paragraph (c)(1) in a taxable year of the original deferral QBU owner is the original deferral QBU owner's outstanding deferred section 987 gain or loss (that is, the amount of deferred section 987 gain or loss not previously recognized or suspended) with respect to the successor deferral QBU multiplied by the remittance proportion of the successor deferral QBU owner with respect to the successor deferral QBU for the taxable year ending with or within the taxable year of the original deferral QBU owner, as determined under § 1.987-5(b) without regard to any annual recognition election of the successor deferral QBU owner. See paragraph (h)(4) of this section ( Example 4 ) for an illustration of this rule.
(iii) Deemed remittance by a successor deferral QBU. For purposes of this paragraph (c)(1), in a taxable year of the original deferral QBU owner in which a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the successor deferral QBU is treated as having a remittance proportion of one. Accordingly, if a successor deferral QBU ceases to be owned by a member of the controlled group that includes the original deferral QBU owner, the original deferral QBU owner's outstanding deferred section 987 gain or loss with respect to that successor deferral QBU will be recognized (or suspended). For purposes of this paragraph (c)(1), if the original deferral QBU owner goes out of existence and there is no qualified successor, in the last taxable year of the original deferral QBU owner, each successor deferral QBU is treated as having a remittance proportion of one. This paragraph (c)(1)(iii) does not affect the application of the section 987 regulations to the successor deferral QBU owner with respect to its ownership of the successor deferral QBU.
(2) Deferral events and outbound loss events with respect to a successor deferral QBU. Notwithstanding paragraph (c)(1) of this section, if assets of the successor deferral QBU ( transferred assets ) are transferred (or deemed transferred) in a transaction that would constitute a deferral event or an outbound loss event if the original deferral QBU owner owned the successor deferral QBU directly and the original deferral QBU owner had net unrecognized section 987 gain or loss with respect to the successor deferral QBU equal to its outstanding deferred section 987 gain or loss with respect to the successor deferral QBU (the deemed transaction ), then, in accordance with the rules of this section and § 1.987-13(h)—
(i) The original deferral QBU owner recognizes its outstanding deferred section 987 gain or loss, or suspends its outstanding deferred section 987 loss, to the extent it would have recognized or suspended net unrecognized section 987 gain or loss as a result of the deemed transaction; and
(ii) Each section 987 QBU is a successor deferral QBU to the extent it would have been after the deemed transaction and the original deferral QBU owner has deferred section 987 gain or loss with respect to the successor deferral QBU to the extent it would have after the deemed transaction;
(iii) Each eligible QBU is a successor suspended loss QBU to the extent it would have been after the deemed transaction and the original deferral QBU owner has suspended section 987 loss with respect to the suspended loss QBU to the extent it would have after the deemed transaction.
(d) Successor deferral QBU becomes a successor suspended loss QBU. A successor deferral QBU becomes a successor suspended loss QBU, and an original deferral QBU owner becomes an original suspended loss QBU owner, if any of the original deferral QBU owner's deferred section 987 loss with respect to the successor deferral QBU becomes suspended section 987 loss. An eligible QBU may be both a successor deferral QBU and a successor suspended loss QBU and the original deferral QBU owner may also be an original suspended loss QBU owner.
(e) Anti-abuse rule. No section 987 loss is recognized under this section, § 1.987-5 or § 1.987-13 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section.
(f) Combinations and separations of successor deferral QBUs. A combined QBU is a successor deferral QBU if either combining QBU was a successor deferral QBU. A separated QBU is a successor deferral QBU if the separating QBU was a successor deferral QBU.
(1) Combined QBU. The outstanding deferred section 987 gain or loss of a combined QBU in each recognition grouping for a taxable year is equal to the sum of the combining QBUs' outstanding deferred section 987 gain or loss in that recognition grouping.
(2) Separated QBU. The outstanding deferred section 987 gain or loss of a separated QBU in each recognition grouping for a taxable year is equal to the separating QBU's outstanding deferred section 987 gain or loss in each recognition grouping multiplied by the separation fraction.
(g) Definitions. The following definitions apply for purposes of this section.
(1) Deferral event. A deferral event with respect to a section 987 QBU means any transaction or series of transactions that satisfy the conditions described in both paragraphs (g)(1)(i) and (ii) of this section.
(i) Events. The transaction or series of transactions constitutes:
(A) A termination of the section 987 QBU under § 1.987-8(b)(2) (substantially all the assets transferred to the owner), § 1.987-8(b)(5) (section 987 QBU ceases to be a section 987 QBU), or § 1.987-8(b)(6) (individual or corporation ceases to be a direct owner of a section 987 QBU); or
(B) [Reserved]
(ii) Assets on books of successor deferral QBU. Immediately after the transaction or series of transactions, assets of the section 987 QBU are reflected on the books and records of a successor deferral QBU.
(2) Successor deferral QBU. A section 987 QBU ( potential successor deferral QBU ) is a successor deferral QBU with respect to a section 987 QBU referred to in paragraph (g)(1)(i) of this section if, immediately after the transaction or series of transactions described in that paragraph, the potential successor deferral QBU satisfies all of the conditions described in paragraphs (g)(2)(i) through (iii) of this section.
(i) The books and records of the potential successor deferral QBU reflect assets that, immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section, were reflected on the books and records of the section 987 QBU referred to in paragraph (g)(1)(i) of this section.
(ii) The owner of the potential successor deferral QBU and the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section are members of the same controlled group.
(iii) If the owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this section immediately before the transaction or series of transactions described in paragraph (g)(1)(i) of this section was a U.S. person, the potential successor deferral QBU is owned by a U.S. person.
(3) Original deferral QBU owner. An original deferral QBU owner means, with respect to an original deferral QBU, the owner of the original deferral QBU immediately before the deferral event, or the owner's qualified successor.
(4) Qualified successor. A qualified successor with respect to a corporation ( transferor corporation ) means another corporation that acquires the assets of the transferor corporation in a transaction described in section 381(a) ( acquiring corporation ), provided that the acquiring corporation is a domestic corporation and the transferor corporation was a domestic corporation, or the acquiring corporation is a controlled foreign corporation and the transferor corporation was a controlled foreign corporation. A qualified successor of a person includes the qualified successor of a qualified successor.
(h) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the stock of DC2, which is also a domestic corporation, and CFC1, a controlled foreign corporation. In addition, DC1, DC2, and CFC1 are members of a controlled group, and the de minimis rule of paragraph (a)(2)(ii) of this section is not applicable. Finally, except as otherwise provided, Business A is a section 987 QBU with the euro as its functional currency, there are no transfers between Business A and its owner, and Business A's assets are not depreciable or amortizable.
(1) Example 1: Contribution of a section 987 QBU with net unrecognized section 987 gain to a member of the controlled group —(i) Facts. DC1 owns Business A. The adjusted balance sheet of Business A reflects assets with an aggregate adjusted basis of €1,000x and no liabilities. DC1 contributes €900x of Business A's assets to DC2 in exchange for DC2 stock in a transaction to which section 351 applies. Immediately after the contribution, the remaining €100x of Business A's assets are no longer reflected on the books and records of a section 987 QBU (but are instead reflected on the books and records of DC1's home office). DC2, which has the U.S. dollar as its functional currency, uses the Business A assets in a business ( Business B ) that constitutes a section 987 QBU. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x.
(ii) Analysis —(A) Under § 1.987-2(c)(2)(ii), DC1's contribution of €900x of Business A's assets to DC2 is treated as a transfer of all of the assets of Business A to DC1, immediately followed by DC1's contribution of €900x of Business A's assets to DC2. The contribution of Business A's assets is a deferral event within the meaning of paragraph (g)(1) of this section because:
( 1 ) The transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, resulting in a termination of the Business A QBU under § 1.987-8(b)(2); and
( 2 ) Immediately after the transaction, assets of Business A are reflected on the books and records of Business B, a section 987 QBU owned by a member of DC1's controlled group and a successor deferral QBU within the meaning of paragraph (g)(2) of this section. Accordingly, Business A is an original deferral QBU within the meaning of paragraph (b) of this section, and DC1 is an original deferral QBU owner of Business A within the meaning of paragraph (g)(3) of this section.
(B) Under paragraph (b)(1) of this section, DC1's taxable income in the taxable year of the deferral event includes DC1's section 987 gain or loss determined with respect to Business A under § 1.987-5, except that, for purposes of applying § 1.987-5, all assets of Business A that are reflected on the books and records of Business B immediately after Business A's termination are treated as not having been transferred and therefore as though they remained on Business A's books and records (notwithstanding the deemed transfer of those assets under § 1.987-8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of €100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the €100x remittance by the sum of the remittance and the €900x aggregate adjusted basis of the gross assets deemed to remain on Business A's books and records at the end of the taxable year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year of the deferral event. DC1's deferred section 987 gain equals $90x, which is the amount of its net unrecognized section 987 gain (which is $100x) less the amount of section 987 gain recognized by DC1 under § 1.987-5 and this section (which is $10x).
(2) Example 2: Contribution of a section 987 QBU with net unrecognized section 987 loss to a member of the controlled group when a current rate election is in effect —(i) Facts. The facts are the same as in paragraph (h)(1) of this section ( Example 1 ) except that a current rate election is in effect for the taxable year (and an annual recognition election is not in effect) and, at the time of the contribution, Business A has net unrecognized section 987 loss of $100x. Business A is engaged in the business of manufacturing Product X before the contribution, and Business B is engaged in the same business after the contribution. After the contribution, the €100x of assets that are reflected on the books and records of DC1's home office are not used in the business of manufacturing Product X.
(ii) Analysis —(A) For the reasons described in paragraph (h)(1) of this section ( Example 1 ), the contribution results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; and DC2 is a successor deferral QBU owner.
(B) Under paragraph (b)(1) of this section, for purposes of applying § 1.987-5, all the assets of Business A that are reflected on the books and records of Business B immediately after Business A's termination are treated as not having been transferred and therefore as though they remained on Business A's books and records (notwithstanding the deemed transfer of those assets under § 1.987-8(e)). Accordingly, in the taxable year of the deferral event, Business A is treated as making a remittance of €100x, corresponding to the assets of Business A that are no longer reflected on the books and records of a section 987 QBU, and DC1 is treated as having a remittance proportion with respect to Business A of 0.1, determined by dividing the €100x remittance by the sum of the remittance and the €900x aggregate adjusted basis of the gross assets deemed to remain on Business A's books and records at the end of the taxable year. Thus, but for the application of § 1.987-11(c), DC1 would recognize $10x of section 987 loss in the taxable year of the deferral event. Under § 1.987-11(c), because a current rate election is in effect (and an annual recognition election is not in effect), the loss is instead treated as suspended section 987 loss. DC1's deferred section 987 loss equals $90x, which is the amount of its net unrecognized section 987 loss less the amount of section 987 loss suspended under § 1.987-11(c) (which is $10x).
(C) Under § 1.987-13(b)(1)(i), Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, a significant portion of the assets of Business A was reflected on the books and records of Business B (an eligible QBU), Business B continued to carry on the trade or business of Business A, and Business B was owned by DC2, a member of the same controlled group as DC1 (which is the original suspended loss QBU owner under § 1.987-13(l)(1)). Therefore, under § 1.987-13(b)(1)(ii), all of Business A's cumulative suspended section 987 loss (including the suspended section 987 loss resulting from the termination of Business A) becomes suspended section 987 loss with respect to Business B. After the transaction, DC1 may recognize its suspended section 987 loss with respect to Business B under § 1.987-11(e) or § 1.987-13(b) through (d), as applicable.
(3) Example 3: Election to be classified as a corporation —(i) Facts. DC1 owns all of the interests in Entity A, a DE. Entity A conducts Business A, which has net unrecognized section 987 gain of $500x. Entity A elects to be classified as a corporation under § 301.7701-3(c) of this chapter. As a result of the election and pursuant to § 301.7701-3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the assets and liabilities of Business A to newly-formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1's books and records.
(ii) Analysis. Under § 1.987-2(c)(2)(ii), DC1's deemed contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1's contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, the Business A QBU terminates under § 1.987-8(b)(2). The contribution of Business A's assets is not a deferral event within the meaning of paragraph (b) of this section because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of paragraph (g)(2) of this section due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination. In addition, the requirement of paragraph (g)(2)(iii) of this section is not met because Business A was owned by a U.S. person and the potential successor deferral QBU, which is owned by CFC1, is not owned by a U.S. person. Accordingly, DC1 recognizes section 987 gain of $500x with respect to Business A under § 1.987-5 without regard to this section. Because the requirement of paragraph (g)(2)(iii) of this section is not met, the result would be the same even if the assets of Business A were transferred in a section 351 exchange to an existing foreign corporation that had a different functional currency than Business A.
(4) Example 4: Partial recognition of deferred gain or loss —(i) Facts. DC1 owns all of the interests in Entity A, a DE that conducts Business A in Country X. During year 1, DC1 contributes all of its interests in Entity A to DC2 in an exchange to which section 351 applies. At the time of the contribution, Business A has net unrecognized section 987 gain of $100x and cumulative suspended section 987 loss of $50x. After the contribution, Entity A continues to conduct the same trade or business in Country X ( Business B ). In year 3, as a result of a net transfer of property from Business B to DC2, DC2's remittance proportion with respect to Business B, as determined under § 1.987-5, is 0.25.
(ii) Analysis —(A) For the reasons described in paragraph (h)(1) of this section (Example 1 ), the contribution of all the interests in Entity A by DC1 to DC2 results in a termination of the Business A QBU and a deferral event with respect to the Business A QBU, an original deferral QBU; DC1 is an original deferral QBU owner within the meaning of paragraph (g)(3) of this section; Business B is a successor deferral QBU with respect to Business A; DC2 is a successor deferral QBU owner; and the $100x of net unrecognized section 987 gain with respect to Business A becomes deferred section 987 gain as a result of the deferral event.
(B) Under § 1.987-13(b)(1)(i), Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, a significant portion of the assets of Business A was reflected on the books and records of Business B (an eligible QBU), Business B continued to carry on the trade or business of Business A, and Business B was owned by DC2, a member of the same controlled group as DC1 (which is the original suspended loss QBU owner under § 1.987-13(l)(1)). Therefore, under § 1.987-13(b)(1)(ii), all of DC1's cumulative suspended section 987 loss with respect to Business A becomes suspended section 987 loss of DC1 with respect to Business B.
(C) Under paragraph (c)(1)(i) of this section, DC1 recognizes deferred section 987 gain in year 3 as a result of the remittance from Business B to DC2. Under paragraph (c)(1)(ii) of this section, the amount of deferred section 987 gain that DC1 recognizes is $25x, which is DC1's outstanding deferred section 987 gain of $100x with respect to Business A multiplied by the remittance proportion of 0.25 of DC2 with respect to Business B for the taxable year as determined under § 1.987-5(b). In addition, under § 1.987-11(e), DC1 recognizes its cumulative suspended section 987 loss to the extent of the deferred section 987 gain recognized in the same recognition grouping.
§ 1.987-13   Suspended section 987 loss upon terminations.
(a) Overview —(1) In general. This section provides rules relating to suspended section 987 loss of an owner with respect to a section 987 QBU or successor suspended loss QBU that terminates. Paragraph (b) of this section provides rules treating suspended section 987 loss as recognized or attributable to a successor when a section 987 QBU terminates. Paragraph (c) of this section provides rules treating suspended section 987 loss as recognized or attributable to a subsequent successor when a successor suspended loss QBU terminates. Paragraph (d) of this section provides rules regarding the recognition of suspended section 987 loss when interests in a successor suspended loss QBU owner are transferred. Paragraph (e) of this section provides rules that apply when interests in an original suspended loss QBU owner are transferred. Paragraph (f) of this section provides rules that apply when an original suspended loss QBU owner ceases to exist. Paragraph (g) of this section provides rules preventing the carryover of suspended section 987 loss in connection with certain inbound transactions. Paragraph (h) of this section provides rules that suspend section 987 loss in connection with certain outbound transactions. Paragraph (i) of this section is reserved. Paragraph (j) of this section provides rules relating to the termination of a successor suspended loss QBU. Paragraph (k) of this section provides an anti-abuse rule. Paragraph (l) of this section provides definitions that apply for purposes of this section. Paragraph (m) of this section provides examples illustrating the rules of this section.
(2) Ordering rule. Paragraphs (b) through (d) of this section are applied after the application of § 1.987-11(e) (loss-to-the-extent-of-gain rule).
(b) Termination of a section 987 QBU with suspended loss. If a section 987 QBU terminates, and at the time of termination, the owner has suspended section 987 loss with respect to the section 987 QBU (including because the termination was an outbound loss event or because net unrecognized section 987 loss became suspended section 987 loss upon termination as a result of a current rate election), then either paragraph (b)(1) or (2) of this section applies. However, this paragraph (b) does not apply to a termination that occurs in connection with a transaction described in paragraph (f) or (g) of this section.
(1) Suspended section 987 loss becomes suspended section 987 loss with respect to a successor suspended loss QBU —(i) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating section 987 QBU are reflected on the books and records of an eligible QBU that carries on a trade or business of the section 987 QBU and is owned by the owner of the section 987 QBU or a member of its controlled group (determined immediately after the transaction), then the eligible QBU is a successor suspended loss QBU and the rules provided in paragraph (b)(1)(ii) of this section apply.
(ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the terminating section 987 QBU that is not recognized in the taxable year of the termination under § 1.987-11(e) becomes suspended section 987 loss with respect to each successor suspended loss QBU. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the successor suspended loss QBU in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all successor suspended loss QBUs in connection with the termination.
(2) Recognition of suspended section 987 loss. If, immediately after the termination of the section 987 QBU, there is no successor suspended loss QBU under paragraph (b)(1) of this section, then the owner recognizes the cumulative suspended section 987 loss with respect to the section 987 QBU that is not recognized in the taxable year of the termination under § 1.987-11(e).
(c) Termination of a successor suspended loss QBU. If a successor suspended loss QBU terminates (as described in paragraph (j) of this section), then either paragraph (c)(1) or (2) of this section applies. However, this paragraph (c) does not apply to a termination that occurs in connection with a transaction described in paragraph (e), (f), or (g) of this section.
(1) Successor to the successor suspended loss QBU —(i) Successor suspended loss QBU. If, immediately after the termination, a significant portion of the assets of the terminating successor suspended loss QBU ( initial successor ) are reflected on the books and records of an eligible QBU ( subsequent successor ) that carries on a trade or business of the initial successor and is owned by the original suspended loss QBU owner or a member of its controlled group (determined immediately after the transaction), then the subsequent successor is a successor suspended loss QBU and the rules provided in paragraph (c)(1)(ii) of this section apply.
(ii) Attribution of suspended section 987 loss to successor suspended loss QBU. A portion of the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under § 1.987-11(e) becomes suspended section 987 loss with respect to each subsequent successor. Such portion is equal to the suspended section 987 loss described in the preceding sentence, multiplied by a fraction, the numerator of which is the aggregate adjusted basis of the gross assets transferred to the subsequent successor in connection with the termination, and the denominator of which is the aggregate adjusted basis of the gross assets transferred to all subsequent successors in connection with the termination.
(2) Recognition of suspended section 987 loss. If, immediately after the termination of the initial successor, there is no subsequent successor that is a successor suspended loss QBU under paragraph (c)(1) of this section, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the initial successor that is not recognized in the taxable year of the termination under § 1.987-11(e).
(d) Transfer of successor suspended loss QBU owner. If a successor suspended loss QBU ceases to be owned by a member of the original suspended loss QBU owner's controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the successor suspended loss QBU owner, then the original suspended loss QBU owner recognizes the cumulative suspended section 987 loss with respect to the successor suspended loss QBU that is not recognized in the taxable year under § 1.987-11(e).
(e) Transfer of original suspended loss QBU owner. If an original suspended loss QBU owner ceases to be a member of the successor suspended loss QBU owner's controlled group as a result of a direct or indirect transfer, or an issuance or redemption, of an ownership interest in the original suspended loss QBU owner, the original suspended loss QBU owner's suspended section 987 loss ceases to be attributable to any successor suspended loss QBU (but it continues to be suspended section 987 loss of the original suspended loss QBU owner). As a result, the suspended section 987 loss can be recognized by the original suspended loss QBU owner under § 1.987-11(e) but cannot be recognized under paragraph (b)(2), (c)(2), or (d) of this section.
(f) Owner ceases to exist. If the owner of a section 987 QBU with suspended section 987 loss or an original suspended loss QBU owner ceases to exist and there is no successor under paragraph (l)(1)(ii) of this section (for example, as a result of a section 331 liquidation), then any suspended section 987 loss of the owner that is not recognized after application of the loss-to-the-extent-of-gain rule in § 1.987-11(e) is eliminated and cannot be recognized.
(g) Inbound nonrecognition transactions — no carryover of suspended section 987 loss. If an owner of a section 987 QBU with suspended section 987 loss, or an original suspended loss QBU owner, ceases to exist in a transaction described in § 1.987-8(c)(1)(ii) (inbound section 332 liquidation) or § 1.987-8(c)(2)(ii) (inbound reorganization), then any suspended section 987 loss of the owner or original suspended loss QBU owner that is not recognized after application of the loss-to-the-extent-of-gain rule in § 1.987-11(e) is eliminated and cannot be recognized. As a result, the distributee or acquiring corporation does not succeed to or take into account any suspended section 987 loss of the owner or original suspended loss QBU owner under section 381.
(h) Outbound transactions — recognition or suspension of net unrecognized section 987 loss. This paragraph (h) applies to taxable years in which neither a current rate election nor an annual recognition election is in effect.
(1) In general. Notwithstanding § 1.987-5, if an outbound loss event occurs with respect to a section 987 QBU (an outbound loss QBU ), the original owner of the section 987 QBU includes in taxable income in the taxable year of the outbound loss event section 987 loss with respect to the outbound loss QBU only to the extent provided in paragraph (h)(3) of this section.
(2) Outbound loss event. An outbound loss event means, with respect to a section 987 QBU:
(i) Any termination of the section 987 QBU as a result of a transfer by a U.S. person of assets of the section 987 QBU to a foreign person that is a member of the same controlled group as the U.S. person immediately before the transaction or, if the transferee did not exist immediately before the transaction, immediately after the transaction ( related foreign person ), provided that the termination would result in the recognition of section 987 loss with respect to the section 987 QBU under § 1.987-5 but for this paragraph (h); or
(ii) [Reserved]
(3) Loss recognition upon an outbound loss event. In the taxable year of an outbound loss event with respect to an outbound loss QBU, the owner of the outbound loss QBU recognizes section 987 loss as determined under §§ 1.987-5 and 1.987-12(b), except that, solely for purposes of applying § 1.987-5, assets and liabilities of the outbound loss QBU that, immediately after the outbound loss event, are reflected on the books and records of an eligible QBU owned by the related foreign person described in paragraph (h)(2) of this section are treated as not having been transferred and therefore as remaining on the books and records of the outbound loss QBU notwithstanding the outbound loss event.
(4) Loss suspension upon outbound loss event. Net unrecognized section 987 loss or deferred section 987 loss that, as a result of this paragraph (h), is not recognized in the taxable year of the outbound loss event ( outbound section 987 loss ) under § 1.987-5 becomes suspended section 987 loss.
(i) [Reserved]
(j) Termination of a successor suspended loss QBU. For purposes of applying paragraph (c) of this section, a successor suspended loss QBU terminates if it ceases to be an eligible QBU of its owner.
(k) Anti-abuse. No section 987 loss is recognized under this section, § 1.987-5, or § 1.987-12 in connection with a transaction or series of transactions that are undertaken with a principal purpose of avoiding the purposes of this section.
(l) Definitions. The following definitions apply for purposes of this section.
(1) Original suspended loss QBU owner —(i) In general. An original suspended loss QBU owner is the person that was the owner of a section 987 QBU before its termination in a transaction to which paragraph (b)(1) of this section applies.
(ii) Successors. If an original suspended loss QBU owner is a corporation ( transferor corporation ) and another corporation acquires the assets of the transferor corporation in a transaction described in section 381(a), then the acquiring corporation becomes the original suspended loss QBU owner.
(2) Successor suspended loss QBU. See paragraphs (b)(1) and (c)(1) of this section and § 1.987-12(d) for rules regarding when an eligible QBU is a successor suspended loss QBU.
(3) Successor suspended loss QBU owner. A successor suspended loss QBU owner is the owner of the assets and liabilities of a successor suspended loss QBU.
(4) Ownership interests. The term ownership interests means stock in a corporation and partnership interests in a partnership.
(5) Significant portion. With respect to the assets of an eligible QBU, the term significant portion means a significant portion of the operating assets, determined based on all the facts and circumstances, provided that more than 30 percent of the operating assets will constitute a significant portion in all cases and less than 10 percent of the operating assets will not constitute a significant portion in all cases.
(m) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns all of the interests in Entity A, a DE. Entity A conducts Business A, a section 987 QBU that is engaged in the business of selling Product X. Business A has the euro as its functional currency.
(1) Example 1: Trade or business of a section 987 QBU ceases —(i) Facts. Entity A's trade or business of selling Product X ceases, resulting in a termination of the Business A section 987 QBU under § 1.987-8(b)(1). After the trade or business is wound up, the remaining assets are transferred to DC1 and are not used in the trade or business of selling Product X immediately following the termination. Business A has cumulative suspended section 987 loss under § 1.987-11(b) of $500x.
(ii) Analysis. Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A's assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section.
(2) Example 2: Trade or business of a section 987 QBU is sold to a third party —(i) Facts. DC1 sells all the interests in Entity A to a third party for cash. Business A has cumulative suspended section 987 loss under § 1.987-11(b) of $500x.
(ii) Analysis. Under § 1.987-2(c)(2)(ii), the sale of the Business A assets and liabilities for cash that is reflected on the books of DC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1's sale of those assets and liabilities. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, the Business A section 987 QBU terminates under § 1.987-8(b)(2). Immediately after the termination of the Business A section 987 QBU, a significant portion of Business A's assets is not reflected on the books and records of an eligible QBU that carries on a trade or business of Business A and is owned by DC1 or a member of its controlled group. Therefore, Business A has no successor suspended loss QBU under paragraph (b)(1) of this section. Consequently, DC1 recognizes the cumulative suspended section 987 loss with respect to the Business A section 987 QBU under paragraph (b)(2) of this section.
(3) Example 3: Outbound loss event —(i) Facts. Entity A elects to be classified as a corporation under § 301.7701-3(c) of this chapter. As a result of the election and pursuant to § 301.7701-3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the assets and liabilities of Business A to newly formed CFC1, which has the euro as its functional currency. Immediately after the contribution, the assets and liabilities of Business A are reflected on CFC1's books and records (which are the only books and records maintained by CFC1). CFC1 continues to use those assets in the same trade or business after the contribution ( Business B ). Neither a current rate election nor an annual recognition election is in effect. Business A has net unrecognized section 987 loss of $500x.
(ii) Analysis —(A) Under § 1.987-2(c)(2)(ii), DC1's contribution of all of the assets and liabilities of Business A to CFC1 is treated as a transfer of all of the assets and liabilities of Business A to DC1, followed immediately by DC1's contribution of those assets and liabilities to CFC1. Because the deemed transfer from Business A to DC1 is a transfer of substantially all of Business A's assets to DC1, the Business A section 987 QBU terminates under § 1.987-8(b)(2). The contribution of Business A's assets to CFC1 is not a deferral event within the meaning of § 1.987-12(g)(1) because, immediately after the transaction, no assets of Business A are reflected on the books and records of a successor deferral QBU within the meaning of § 1.987-12(g)(2) due to the fact that the assets of Business A are not reflected on the books and records of a section 987 QBU immediately after the termination, as well as the fact that the requirement of § 1.987-12(g)(2)(iii) is not met because Business A was owned by a U.S. person and the potential successor deferral QBU (Business B) is not owned by a U.S. person. The termination of the Business A section 987 QBU as a result of the transfer of the assets of Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a member of DC1's controlled group is an outbound loss event described in paragraph (h)(2) of this section.
(B) Under paragraphs (h)(1) and (3) of this section, in the taxable year of the outbound loss event, DC1 includes in taxable income section 987 loss recognized with respect to Business A as determined under § 1.987-5, except that, for purposes of applying § 1.987-5, all assets and liabilities of Business A that are reflected on the books and records of CFC1, a related foreign person described in paragraph (h)(2) of this section, are treated as not having been transferred. Accordingly, DC1's remittance proportion with respect to Business A is 0, and DC1 recognizes no section 987 loss with respect to Business A. DC1's outbound section 987 loss is $500x, which is the amount of section 987 loss that DC1 would have recognized under § 1.987-5 without regard to paragraph (h) of this section ($500x), less the amount of section 987 loss recognized by DC1 under paragraph (h)(3) of this section ($0). Under paragraph (h)(4) of this section, the $500x of outbound section 987 loss becomes suspended section 987 loss.
(C) Under paragraph (b)(1)(i) of this section, Business B is a successor suspended loss QBU because, immediately after the termination of the Business A section 987 QBU, the Business A assets are reflected on the books and records of Business B (which is the only set of books and records maintained by CFC1), Business B was an eligible QBU that continued to carry on the same trade or business as Business A did before the contribution, and Business B was owned by CFC1, a member of the same controlled group as DC (which is the original suspended loss QBU owner under paragraph (l)(1) of this section). See § 1.987-1(b)(4)(ii) (providing that, if a corporation is solely engaged in activities that constitute a trade or business, and the corporation maintains only one set of books and records, the activities (but not the corporation) are a qualified business unit). Therefore, under paragraph (b)(1)(ii) of this section, all of Business A's suspended section 987 loss (including the suspended section 987 loss resulting from the termination of Business A) is treated as suspended section 987 loss of DC1 with respect to Business B.
§ 1.987-14   Section 987 hedging transactions.
(a) Overview. This section provides rules relating to section 987 hedging transactions. Paragraph (b) of this section provides the definition of a section 987 hedging transaction. Paragraph (c) of this section provides identification requirements for section 987 hedging transactions. Paragraph (d) of this section provides rules relating to the taxation of section 987 hedging transactions. Paragraph (e) of this section provides examples illustrating the rules of this section.
(b) Section 987 hedging transaction —(1) In general. A section 987 hedging transaction is a financial instrument or a combination or series of financial instruments (a hedge ), that is entered into by the owner of a section 987 QBU as part of the normal course of the owner's trade or business for the purpose of managing exchange rate risk with respect to all or part of the owner's net investment in the section 987 QBU (the hedged QBU ), provided that the requirements of paragraph (b)(2) of this section are met. If only part of a financial instrument (or combination or series of financial instruments) is described in the preceding sentence, that part is treated as a section 987 hedging transaction for purposes of this section.
(2) Requirements. A transaction is a section 987 hedging transaction described in paragraph (b)(1) of this section for a taxable year only if the following requirements are met.
(i) Identification. The hedge must be identified as a section 987 hedging transaction with respect to the hedged QBU under paragraph (c) of this section. The financial instrument or instruments that comprise the hedge must not be identified as a section 987 hedging transaction with respect to any other section 987 QBU. If only part of a financial instrument (or combination or series of financial instruments) is a section 987 hedging transaction, that part must be clearly identified.
(ii) Current rate election. A current rate election must be in effect for the taxable year.
(iii) Mark-to-market method of accounting. Section 988 gain or loss of the owner with respect to the hedge must be accounted for under a mark-to-market method of accounting (for example, under section 1256). In addition, if a member of the owner's controlled group is a party to the hedge, any section 988 gain or loss of the controlled group member with respect to the hedge must be accounted for under a mark-to-market method of accounting.
(iv) Treatment under U.S. generally accepted accounting principles. Foreign currency gain or loss on the hedge must be properly accounted for under generally accepted accounting principles as a cumulative foreign currency translation adjustment to shareholders' equity.
(v) Hedge entered into by owner of the hedged QBU. The hedge must be entered into by the owner of the hedged QBU (and not by a section 987 QBU of the owner). In the case of a hedged QBU that is owned by a member of a consolidated group, the hedge must be entered into by the member that owns the hedged QBU.
(3) Anti-abuse rule. If a taxpayer enters into a hedge or a related transaction with a principal purpose of effectively converting section 987 gain or loss into section 988 gain or loss (or another type of income or loss) of the owner or a related party, the hedge is not treated as a section 987 hedging transaction.
(4) Partial termination of a section 987 hedging transaction. If only part of a financial instrument is a section 987 hedging transaction, and a part of the financial instrument is terminated or disposed of, a proportionate part of the section 987 hedging transaction is treated as terminated or disposed of.
(c) Identification requirements —(1) In general. The owner of a hedged QBU must clearly identify the hedge as a section 987 hedging transaction with respect to the hedged QBU in its books and records on or before the close of the day on which the owner entered into the hedge. The identification must meet the requirements of § 1.1221-2(f)(4) and must include the following information—
(i) The date on which the hedge is entered into by the owner of the hedged QBU and the date on which the hedge is identified as a section 987 hedging transaction;
(ii) A description of the hedge; and
(iii) Identification of the hedged QBU.
(2) Inadvertent error. If a hedge is not identified under paragraph (c)(1) of this section, but the hedge would otherwise qualify as a section 987 hedging transaction with respect to a hedged QBU within the meaning of paragraph (b) of this section and the taxpayer can demonstrate to the satisfaction of the Commissioner that its failure to identify the hedge was due to inadvertent error, the taxpayer may treat the hedge as a section 987 hedging transaction if all of the owner's hedges described in paragraph (b) of this section in all open years are being treated on either original or, if necessary, amended returns as section 987 hedging transactions subject to the rules of paragraph (d) of this section.
(d) Taxation of section 987 hedging transactions —(1) Hedging gain or loss with respect to a hedged QBU. If the owner of a section 987 QBU has entered into a section 987 hedging transaction with respect to the section 987 QBU, the owner's hedging gain or loss with respect to the hedged QBU for a taxable year is equal to the gain or loss that the owner would (but for the application of this paragraph (d)) recognize under section 988 with respect to the section 987 hedging transaction in the taxable year under the mark-to-market method of accounting described in paragraph (b)(2)(iii) of this section (including gain or loss that would be recognized in connection with a complete or partial disposition or termination of the section 987 hedging transaction). If only part of a financial instrument is a section 987 hedging transaction, a proportionate part of the gain or loss that would (but for the application of this paragraph (d)) be recognized under section 988 with respect to the financial instrument in the taxable year is treated as hedging gain or loss with respect to the hedged QBU. See paragraph (d)(3) of this section for rules relating to the determination of hedging gain or loss in the taxable year in which the hedged QBU terminates.
(2) Adjustment to unrecognized section 987 gain or loss for the taxable year —(i) Hedging loss. In a taxable year in which an owner has hedging loss with respect to a hedged QBU and has unrecognized section 987 gain for the taxable year with respect to the hedged QBU (as determined under § 1.987-4(d), without regard to this paragraph (d)), the unrecognized section 987 gain for the taxable year is reduced (but not below zero) by the amount of the hedging loss. The amount of hedging loss that reduces unrecognized section 987 gain under this paragraph (d)(2)(i) is not recognized under section 988. Any hedging loss that does not reduce unrecognized section 987 gain under this paragraph (d)(2)(i) is recognized under section 988.
(ii) Hedging gain. In a taxable year in which an owner has hedging gain with respect to a hedged QBU and has unrecognized section 987 loss for the taxable year with respect to the hedged QBU (as determined under § 1.987-4(d), without regard to this paragraph (d)), the unrecognized section 987 loss for the taxable year is reduced (but not below zero) by the amount of the hedging gain. The amount of hedging gain that reduces unrecognized section 987 loss under this paragraph (d)(2)(ii) is not recognized under section 988. Any hedging gain that does not reduce unrecognized section 987 loss under this paragraph (d)(2)(ii) is recognized under section 988.
(3) Termination of a hedged QBU. If the owner of a section 987 QBU has entered into a section 987 hedging transaction with respect to the section 987 QBU and the hedged QBU terminates, the owner's hedging gain or loss with respect to the hedged QBU for the taxable year is equal to the hedging gain or loss that the owner would (but for the application of this paragraph (d)) recognize with respect to the section 987 hedging transaction under the mark-to-market method of accounting described in paragraph (b)(2)(iii) of this section if the taxable year ended on the termination date. Appropriate adjustments must be made to prevent the section 988 gain or loss from being taken into account again after it is applied to reduce unrecognized section 987 gain or loss under this paragraph (d).
(e) Examples. The following examples illustrate the application of this section. For purposes of the examples, DC1 is a domestic corporation that owns Business A, a section 987 QBU that has the euro as its functional currency. A current rate election is in effect for years 1 and 2, but no other elections are in effect. In year 1, DC1 had net unrecognized section 987 loss (determined under § 1.987-4(b)) of $1,000x with respect to Business A, and Business A did not make a remittance in year 1. As a result, in year 2, DC1's net accumulated unrecognized section 987 loss from prior taxable years (determined under § 1.987-4(c)) was $1,000x. In year 2, DC1 had unrecognized section 987 loss for the taxable year (determined under § 1.987-4(d) before the application of paragraph (d) of this section) of $500x.
(1) Example 1: Section 987 hedging transaction —(i) Facts. In year 2, DC1 entered into a six-month foreign currency forward contract with an unrelated bank in the normal course of DC1's trade or business for the purpose of managing exchange rate risk with respect to DC1's net investment in Business A. On the same day, DC1 identified the forward contract as a section 987 hedging transaction with respect to Business A under paragraph (c) of this section. Under generally accepted accounting principles, currency gain or loss from the forward contract is accounted for as a cumulative translation adjustment to shareholder's equity. For Federal income tax purposes, DC1 accounts for section 988 gain or loss with respect to the forward contract under a mark-to-market method of accounting. But for the application of paragraph (d) of this section, DC1 would recognize $400x of section 988 gain with respect to the forward contract.
(ii) Analysis —(A) Qualification of the hedge as a section 987 hedging transaction. The forward contract qualifies as a section 987 hedging transaction under paragraph (b) of this section because it is a financial instrument that manages DC1's exchange rate risk with respect to Business A (the hedged QBU) as part of the normal course of DC1's trade or business, and the hedge meets the requirements of paragraph (b)(2) of this section.
(B) Treatment of the section 987 hedging transaction. But for the application of paragraph (d) of this section, DC1 would recognize $400x of section 988 gain with respect to the forward contract in year 2. Therefore, DC1 has $400x of hedging gain in year 2. In year 2, DC1 had unrecognized section 987 loss of $500x for the taxable year (determined under § 1.987-4(d) before the application of paragraph (d) of this section). Therefore, under paragraph (d)(2)(ii) of this section, DC1's unrecognized section 987 loss for the taxable year of $500x is reduced by the $400x of hedging gain. Accordingly, DC1 has unrecognized section 987 loss of $100x for the taxable year with respect to Business A. Under § 1.987-4(b), DC1 has $1,100x of net unrecognized section 987 loss in year 2 (equal to the sum of its net accumulated section 987 loss of $1,000x from prior taxable years and its unrecognized section 987 loss for the taxable year of $100x). DC1 does not recognize its hedging gain under section 988 because all of the hedging gain reduces unrecognized section 987 loss for the taxable year.
(2) Example 2: Excess hedging gain from a section 987 hedging transaction —(i) Facts. The facts are the same as in paragraph (e)(1) of this section ( Example 1 ) except that, but for the application of paragraph (d) of this section, DC1 would recognize $600x of section 988 gain with respect to the forward contract.
(ii) Analysis. Under paragraph (d)(2)(ii) of this section, DC1's unrecognized section 987 loss for the taxable year of $500x is reduced by the hedging gain, but not below zero. Accordingly, $500x of the hedging gain is applied to reduce DC1's unrecognized section 987 loss for the taxable year to zero. DC1 has $1,000x of net unrecognized section 987 loss in year 2 under § 1.987-4(b) (equal to its net accumulated section 987 loss of $1,000x from prior taxable years). The $500x hedging gain that reduces unrecognized section 987 loss for the taxable year is not recognized under section 988. The excess amount of hedging gain ($100x) is recognized by DC1 under section 988.