52876 Federal Register / Vol. 71, No. 173 / Thursday September 7, 2006 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–208270–86] 

RIN 1545–AM12 

Income and Currency Gain or Loss 

With Respect to a Section 987 QBU 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Withdrawal of notice of 

proposed rulemaking, notice of 

proposed rulemaking and notice of 

public hearing. 

SUMMARY: This document contains 

proposed regulations that provide 

guidance under section 987 of the 

Internal Revenue Code (Code) regarding 

the determination of the items of 

income or loss of a taxpayer with 

respect to a section 987 qualified 

business unit (section 987 QBU) as well 

as the timing, amount, character and 

source of any section 987 gain or loss. 

It withdraws proposed regulations 

under section 987 that were published 

in the Federal Register on September 

25, 1991 (56 FR 48457). These 

regulations are necessary to provide 

guidance under section 987. Taxpayers 

affected by these regulations are 

corporations and individuals with 

qualified business units subject to 

section 987. 

DATES: Written or electronic comments 

must be received by December 6, 2006. 

Outlines of topics to be discussed at the 

public hearing scheduled for November 

21, 2006, must be received by October 

31, 2006. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–208270–86), 

Internal Revenue Service, PO Box 7604, 

Ben Franklin Station, Washington, DC 

20044. Submissions may be sent 

electronically, via the IRS Internet site 

at http://www.irs.gov/regs or via the 

Federal eRulemaking Portal at http:// 

www.regulations.gov (IRS REG–208270– 

86). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Sheila Ramaswamy at (202) 622–3870; 

concerning submissions of comments, 

Kelly Banks at (202) 622–7180 (not tollfree numbers). 

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act 

The collection of information 

contained in this notice of proposed 

rulemaking has been submitted to the 

Office of Management and Budget for 

review in accordance with the 

Paperwork Reduction Act of 1995 (44 

U.S.C. 3507(d)). Comments on the 

collection of information should be sent 

to the Office of Management and 

Budget, Attn: Desk Officer for the 

Department of Treasury, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503, with copies to 

the Internal Revenue Service, Attn: IRS 

Reports Clearance Officer, 

SE:W:CAR:MP:T:T:SP, Washington, DC 

20224. Comments on the collection of 

information should be received by 

November 6, 2006. 

Comments are requested specifically 

concerning: 

Whether the proposed collection of 

information is necessary for the proper 

performance of the functions of the 

Internal Revenue Service, including 

whether the information will have 

practical utility; 

The accuracy of the estimated burden 

associated with the proposed collection 

of information (see below); 

How the quality, utility, and clarity of 

the information to be collected may be 

enhanced; 

How the burden of complying with 

the proposed collection of information 

may be minimized, including through 

the application or automated collection 

techniques or other forms of information 

technology; and 

Estimates of capital or start-up costs 

and costs of operation, maintenance, 

and purchase of service to provide 

information. 

The collection of information in these 

proposed regulations is in §§ 1.987– 

1(b)(1)(ii),1.987–1(b)(2)(ii), 1.987– 

1(c)(1)(ii), 1.987–1(f), 1.987–3(b)(1), 

1.987–9, 1.987–10 and 1.987–11. 

Section 1.987–1(b)(1)(ii) allows a 

partner to make an election not to take 

section 987 gain or loss into account. 

Section 1.987–1(b)(2)(ii) allows a 

taxpayer to make an election to group 

certain QBUs with the same functional 

currency as a single QBU. Sections 

1.987–1(c)(1)(ii) and –3(b)(1) allow a 

taxpayer to make an election to use a 

convention for exchange rates. Section 

1.987–11(b) allows a taxpayer to elect to 

apply these regulations to taxable years 

beginning after the date of publication 

of a Treasury decision adopting this rule 

as a final regulation in the Federal 

Register. The preceding elections are to 

be made pursuant to § 1.987–1(f) by 

attaching a statement to the taxpayer’s 

tax return describing the election to be 

made. Section 1.987–9 contains 

recordkeeping rules to establish a 

qualified business unit’s income and 

section 987 gain or loss. This collection 

of information is required to establish 

the qualified business unit’s income, 

gain, deduction or loss and assets and 

liabilities as well as exchange rates used 

for foreign currency translation 

purposes. Section 1.987–10 provides 

rules for transitioning to the method 

provided under the new proposed 

regulations for determining section 987 

gain or loss and provides certain 

corresponding reporting rules. The 

collection of information contained in 

this regulation facilitates the 

identification of the prior method used 

by the taxpayer to determine section 987 

gain or loss. The collections of 

information are mandatory. The likely 

respondents are taxpayers with foreign 

qualified business units. 

Estimated total annual reporting 

burden: 12,000. 

Estimated average annual burden 

hours per respondent: 12. 

Estimated number of respondents: 

1,000. 

Estimated annual frequency of 

responses: annually. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number assigned by the Office of 

Management and Budget. 

Books and records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

A. Overview 

As part of the Tax Reform Act of 1986, 

Public Law 99–514, 100 Stat. 2085 

(October 22, 1986), 1986–3 CB Vol.1, 1, 

see § 601.601(d)(2), Congress enacted 

comprehensive reforms to the tax 

treatment of foreign currency 

transactions by adding new subpart J. 

Those reforms included, among other 

things, the introduction of the 

functional currency concept, which 

generally distinguishes taxpayers on the 

basis of the primary currency in which 

they keep their books and records and 

conduct their business. Reforms also 

included the addition of the qualified 

business unit (QBU) concept, which 

generally provides a basis for allowing 

a taxpayer with a separate unit that 

conducts business and keeps books and 

records in a currency other than the 

functional currency of the taxpayer to 

account for the results of operation of 

the separate unit in the unit’s own 

functional currency. Against that 

conceptual background, section 988 

provides rules for the treatment of 

transactions in a currency other than the 


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1H. Rep. No. 99–426, 99th Cong., 1st Sess. (1985); 

1986–3 CB Vol 2, 449. S. Rep. No 99–313, 99th 

Cong., 2d Sess. (1986); 1986–3 CB Vol. 3, 443. H.R. 

Conf. Rep. No. 99–841, 99th Cong., 2d Sess. (1986); 

1986–3 CB Vol. 4, 659. Later citations are to the 

Cumulative Bulletin. See § 601.601(d)(2). 

taxpayer’s functional currency. Section 

986 generally provides rules for 

translating into U.S. dollars the earnings 

and profits and foreign taxes of a foreign 

corporation whose functional currency 

is not the U.S. dollar (dollar). Section 

987, in turn, generally provides rules for 

determining and translating income and 

currency gain and loss with respect to 

operations of a branch whose functional 

currency is other than the functional 

currency of the taxpayer. As discussed 

below, an already complex area of law 

was made even more complicated when 

the entity classification rules under 

§ 301.7701–1 through 301.7701–3 (the 

‘‘check the box’’ regulations) were 

promulgated in 1997. 

On September 25, 1991, the IRS and 

the Treasury Department issued 

proposed regulations under section 987 

(the 1991 proposed regulations). See 56 

FR 48457. In light of subsequent IRS 

experience with taxpayer claims of large 

non-economic currency losses under 

section 987, the IRS and the Treasury 

Department issued Notice 2000–20 

(2000–1 CB 851). See § 601.601(d)(2). 

This notice expressed serious concern 

that the 1991 proposed regulations had 

not fully achieved the original goal of 

facilitating recognition of true economic 

foreign currency gain and loss under 

appropriate circumstances and 

requested comments on this issue and 

other matters. 

This document withdraws the 1991 

proposed regulations and provides new 

proposed regulations based on the 

‘‘foreign exchange exposure pool’’

method. The IRS and the Treasury 

Department believe that this method 

more accurately reflects foreign 

currency gain and loss than the 1991 

proposed regulations and does so in a 

manner consistent with statutory 

authority and legislative intent. These 

new proposed regulations are designed 

to prescribe more precisely foreign 

currency gain and loss that is 

economically realized, while 

minimizing or eliminating the 

realization of non-economic currency 

gain and loss. 

The following background discussion 

describes section 987, its legislative 

history, the 1991 proposed regulations, 

Notice 2000–20, and the general 

approach that provides the basis for the 

foreign exchange exposure pool method. 

B. The Statute 

Section 987 generally provides that in 

the case of a taxpayer having a QBU 

with a functional currency other than 

that of the taxpayer, the taxable income 

of the taxpayer with respect to the QBU 

is determined by computing the taxable 

income or loss of the QBU separately 

and translating such income or loss at 

the appropriate exchange rate. Section 

987 further requires the taxpayer to 

make ‘‘proper adjustments’’ (as 

prescribed by the Secretary) for transfers 

of property between QBUs having 

different functional currencies 

including treating post-1986 remittances 

from each such unit as made on a pro 

rata basis out of post-1986 accumulated 

earnings; treating section 987 gain or 

loss as ordinary income or loss; and 

sourcing such gain or loss by reference 

to the source of the income giving rise 

to post-1986 accumulated earnings. 

C. The Legislative History 

1. Prior Law 

As described in the applicable 

legislative history,1 section 987 was 

enacted against a background of, and 

partly in reaction to, perceived 

shortcomings with prevailing law. The 

prevailing law at that time was fairly 

limited. It consisted primarily of two 

revenue rulings that provided 

alternative methods for calculating 

branch taxable income. 

Rev. Rul. 75–106 (1975–1 CB 31), see 

§ 601.601(d)(2), provides for the use of 

a ‘‘net worth’’ method. Under this 

method, taxable income of a branch of 

a domestic corporation engaged in 

business in a foreign country is defined 

generally as the difference between the 

branch’s opening and closing net worth 

as reflected on the branch’s balance 

sheets for the taxable year. Under this 

method, the branch’s balance sheet is 

translated into U.S. dollars. In general, 

the values of current items (such as cash 

or cash flows denominated in foreign 

currency) are translated at the year-end 

exchange rate, and the values of 

historical items (such as equipment) are 

translated at the exchange rate for the 

period in which the item was acquired 

or incurred. The translation of an item 

at the year-end rate causes changes in 

the item’s value due to currency 

fluctuations to be taken into account 

annually, and the translation of an item 

at the historical rate generally precludes 

recognition of fluctuations in value due 

to changing exchange rates. In this way, 

the net worth method was able to 

identify items considered economically 

exposed to fluctuations in exchange 

rates. The total change in net worth 

identified by the net worth method is 

equal to the sum of the operating profit 

or loss of the branch and the exchange 

gain or loss on current items. However, 

the net worth method does not identify 

separate items of income and expense 

because it is based solely on a balance 

sheet comparison and does not use a 

profit and loss statement. 

Rev. Rul. 75–107 (1975–1 CB 32), see 

§ 601.601(d)(2), provides for the use of 

a ‘‘profit and loss’’ method. Under this 

method, the branch computes taxable 

income by translating the local currency 

profit and loss statement (adjusted for 

U.S. tax principles) into dollars. Any 

portion of the profit and loss remitted to 

the home office during the year is 

translated at the exchange rate on the 

date of the remittance, and the 

remainder is translated at the year-end 

exchange rate. No exchange gain or loss 

is recognized on a remittance. 

The net worth method of Rev. Rul. 

75–106 and the profit and loss method 

of Rev. Rul. 75–107 each suffered from 

infirmities. The net worth method 

resulted in the realization of foreign 

currency gain and loss that was not 

consistent with the general realization 

principles of the Code; it also failed to 

accurately characterize items of income, 

gain, deduction or loss of the branch. 

The profit and loss method, in turn, did 

not take into account foreign currency 

gain and loss inherent in the assets and 

liabilities on the balance sheet as part of 

such method. Both methods failed to 

account for foreign currency gain or loss 

in the event of a remittance. 

The legislative history states that 

under section 987, a taxpayer with a 

QBU whose functional currency is other 

than the functional currency of the 

taxpayer will be required to use a profit 

and loss method, rather than the net 

worth method (as this method was 

understood at the time). House Report 

(1986–3 CB Vol. 2, 479); Senate Report 

(1986–3 CB Vol. 3, 470); and Conference 

Report (1986–3 CB Vol. 4, 675). See 

§ 601.601(d)(2). However, this 

legislative history is not properly read 

as an explicit rejection of the net worth 

method in its entirety. Instead, it is 

more accurately viewed as a rejection of 

certain aspects of the law prevailing at 

that time. Importantly, the method 

provided in section 987 as enacted 

actually represents a blend of the 

separate methods, as it has aspects of 

both a net worth method and a profit 

and loss method. It also has at least one 

feature absent from each method—that 

is, section 987 includes the remittance 

recognition concept. Consistent with a 

profit and loss method, sections 987(1) 

and (2) generally determine the items of 

income or loss of a QBU based on its 

profit and loss statement as determined 

in its functional currency. Such items 

are then translated into the taxpayer’s 


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2Section 989(b)(4) provides that, ‘‘except as 

provided in regulations,’’ the appropriate exchange 

rate is the average exchange rate for the taxable year 

of the QBU. 

functional currency at the appropriate 

rate.2 Consistent with a net worth 

method, section 987(3) requires that 

exchange gain or loss be computed with 

respect to certain branch assets and 

liabilities (as prescribed by the 

Secretary). Unlike either method, 

section 987(3)(A) provides that 

exchange gain or loss is recognized 

upon a remittance. 

The blending of features of both a 

profit and loss method and of a net 

worth method in section 987 is 

significant. Together with more specific 

principles identified in the legislative 

history, this blending of methods 

informs the Congressionally stated 

preference for the profit and loss 

method. The House Report states: 

A profit and loss method can be viewed as 

being more consistent with the functional 

currency concept than a net worth method. 

Under a profit and loss method, the 

functional currency is used as the measure of 

income or loss, so that earnings determined 

for U.S. tax purposes would bear a close 

relation to taxable income computed by the 

foreign jurisdiction. In contrast, a net worth 

method takes unrealized exchange gains and 

losses into account. Further, a profit and loss 

method minimizes the accounting 

procedures that otherwise would be required 

to make the item-by-item translations under 

a net worth method. Finally, in the case of 

a branch, the net worth method as applied 

under present law fails to characterize 

accurately items of income or loss that are 

subject to special U.S. tax rules. For example, 

although there are limitations on the 

deductibility of long-term capital losses, such 

a loss incurred by a branch would be given 

tax effect because it would be reflected as an 

adjustment to the balance sheet. 

House Report at 469. 

The House and Senate reports are 

generally uniform in describing 

Congressional intent with regard to the 

computations required under section 

987 as illustrated by the Senate Report. 

Under the bill, a taxpayer with a branch 

whose functional currency is a currency 

other than the U.S. dollar will be required to 

use the profit and loss method to compute 

branch income. Thus, the net worth method 

will no longer be an acceptable method of 

computing income or loss of a foreign branch 

for tax purposes, and only realized exchange 

gains and losses on branch capital will be 

reflected in taxable income. 

For each taxable year, the taxpayer will 

compute income or loss separately for each 

qualified business unit in the business unit’s 

functional currency, converting this amount 

to U.S. dollars using the weighted average 

exchange rate for the taxable period over 

which the income or loss accrued. This 

amount will be included in income without 

reduction for remittances from the branch 

during the year. The committee anticipates 

that regulations will provide rules that will 

limit the deduction of branch losses to the 

taxpayer’s dollar basis in the branch (that is, 

the original dollar investment plus 

subsequent capital contributions and 

unremitted earnings). 

A taxpayer will recognize exchange gain or 

loss on remittances (without regard to 

whether or when the remittances are 

converted to dollars), to the extent the value 

of the currency at the time of the remittance 

differs from the value when earned. 

Remittances of foreign branch earnings (and 

interbranch transfers involving branches with 

different functional currencies) after 1986 

will be treated as paid pro rata out of post1986 accumulated earnings of the branch. 

The committee anticipates that, for purposes 

of calculating exchange gain or loss on 

remittances, the value of the currency will be 

determined by translating the currency at the 

rate in effect on the date of remittance. 

Exchange gains and losses on such 

remittances will be deemed to be ordinary 

and domestic source. 

Senate Report (1986–3 CB Vol. 3, 

470). Importantly, the Conference 

Report modifies the House and Senate 

reports by stating that a remittance by a 

QBU ‘‘will trigger exchange gain or loss 

inherent in accumulated earnings or 

branch capital.’’ Conference Report, 

1986–3 CB Vol. 4, 675. 

From section 987 and the foregoing 

legislative history, several principles emerge: 

1. A branch profit and loss computation is 

required in order to properly characterize 

items of branch income or loss, which is 

taken into account in the year earned. 

2. Exchange gain or loss is recognized upon 

a remittance, in an amount prescribed by the 

Secretary. 

3. Both branch earnings and branch capital 

can give rise to exchange gain or loss under 

section 987. 

4. Regulations under section 987 should 

seek to minimize complexity regarding itemby-item translations. 

5. The currency gain or loss taken into 

account under section 987 is only the 

economic gain or loss ‘‘inherent in’’ the 

assets and liabilities of a QBU. 

2. Relationship Between Section 986(c) 

and 987 

Comments to the IRS and the 

Treasury Department have suggested 

that the computation under section 987 

of exchange gain or loss for a branch is 

intended to operate in the same manner 

as the computation under section 986(c) 

of certain exchange gain or loss of a 

foreign corporation. In general, section 

986(c) provides for the recognition of 

exchange gain or loss only with respect 

to distributions of previously taxed 

earnings and profits (as described in 

section 959 or 1293(c)). The Conference 

Report includes the following general 

statement about the translation rules: 

The same translation rule applies to the 

earnings and profits of a foreign corporation 

and the income or loss of a branch or other 

QBU. An entity that uses a nonfunctional 

currency to measure the results of operation 

is required to use a profit and loss method 

to translate income or loss into functional 

currency. * * * These translation rules 

apply without regard to the form of 

enterprise through which the taxpayer 

conducts business (e.g., sole proprietorship, 

partnership, or corporation) as long as such 

form of enterprise rises to the level of a QBU. 

Conference Report, 1986–3 CB Vol. 4, 

670. See § 601.601(d)(2). The suggestion 

in comments is to apply this general 

principle such that section 987 would 

require the recognition of exchange gain 

or loss only with respect to branch 

earnings and not with respect to 

contributed capital. 

Despite the broad statements of 

principle quoted above, Congress 

provided more specific guidance 

regarding the treatment of branches in 

this regard. The Conference Report 

states that a remittance by a QBU ‘‘will 

trigger exchange gain or loss inherent in 

accumulated earnings or branch 

capital.’’ Conference Report, 1986–3 CB 

Vol. 4, 675. See § 601.601(d)(2). 

Similarly, despite the stated 

requirement that QBUs must use a 

notional profit and loss method to 

determine branch taxable income, the 

specific method actually provided in 

section 987 and described in the 

legislative history represents a blend of 

a net worth method and a profit and loss 

method. Accordingly, the IRS and the 

Treasury Department believe that the 

more specific statements made by 

Congress regarding the treatment of 

branch exchange gain or loss reflect an 

intention that the methodologies of 

section 986(c) and section 987 not be 

identical. 

D. The 1991 Proposed Regulations 

The 1991 proposed regulations 

provide generally that the net income of 

a QBU having a functional currency 

different than the taxpayer is 

determined annually. Such 

determination is based on the profit and 

loss appearing on the QBU’s books and 

records, adjusted to conform to U.S. tax 

principles, and translated into the 

functional currency of the taxpayer 

using the weighted average exchange 

rate for the taxable year. The 1991 

proposed regulations also provide for 

the recognition of exchange gain or loss 

upon a remittance from the QBU’s 

equity pool. In general, the equity pool 

consists of the undistributed capital and 

earnings of the QBU, determined in the 

QBU’s functional currency. The 1991 

proposed regulations also provide for a 

basis pool, which consists of the basis 


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of the capital and earnings in the equity 

pool, expressed in the functional 

currency of the taxpayer. The portion of 

the basis pool, expressed in the 

functional currency of the taxpayer, that 

is attributable to a remittance is 

generally determined according to the 

following formula: 

Amount remitted in the

QBU’s functional currency

Equity pool in the QBU’s

functional currency reduced

by prior remittances

 in the taxpayer’s× functional currency red

Basis pool

uced by

prior remittances

Section 987 gain or loss is the 

difference between the value of the 

remittance from the QBU translated into 

the taxpayer’s functional currency at the 

spot rate on the date the remittance is 

made, less the basis associated with the 

remittance as determined above. One 

important consequence of the equity 

pool paradigm is that all branch equity 

gives rise to exchange gain or loss, 

regardless of whether or not that equity 

is held in a form that actually exposes 

the QBU’s owner to currency 

fluctuations (compare assets such as 

cash or indebtedness to assets such as 

equipment). 

Under the 1991 proposed regulations, 

a taxpayer must determine the source 

and character of section 987 gain or loss 

for all purposes of the Code, including 

sections 904(d), 907, and 954, by using 

the same method the taxpayer uses to 

allocate and apportion its interest 

expense under section 861, with certain 

modifications. 

E. Concerns Regarding the 1991 

Proposed Regulations; Notice 2000–20 

Effective January 1, 1997, the IRS and 

the Treasury Department issued the 

check the box regulations implementing 

new elective entity-classification rules. 

These regulations made it possible for 

certain entities with a single owner to be 

treated for federal income tax purposes 

as an entity disregarded as separate from 

its owner (a disregarded entity or DE). 

As a result, businesses that had 

previously operated through 

subsidiaries could operate through 

structures treated for tax purposes as 

branches. The effect of the check the 

box regulations was a dramatic increase 

in the number of branches resulting 

from DE elections that are subject to 

section 987. This increase has greatly 

exacerbated the already existing 

problems of the 1991 proposed 

regulations, especially the ability of 

taxpayers to trigger non-economic losses 

(and the corresponding trap for the 

unwary taxpayer with non-economic 

gains). 

As indicated above, the equity pool 

paradigm in the 1991 proposed 

regulations imputes currency gain or 

loss to all equity of a QBU whether or 

not the assets of the QBU are 

economically exposed to changes in the 

value of the functional currency of the 

QBU. The IRS has faced many cases in 

which taxpayers have claimed 

substantial non-economic exchange 

losses largely on the basis of the 1991 

proposed regulations. An example may 

be instructive. Assume that a domestic 

corporation (US Corp) with the dollar as 

its functional currency forms a foreign 

corporation in Country X and then 

elects under the check the box 

regulations to treat that corporation as a 

DE. The DE conducts mineral extraction 

and owns all the necessary equipment. 

The equipment owned by the DE was 

contributed by US Corp. The DE has no 

employees and contracts with a 

subsidiary of US Corp for the employees 

needed in the business of extraction. US 

Corp, as the entity’s sole owner, claims 

that the DE is a QBU for purposes of 

section 987. The DE has minimal 

financial assets and conducts no 

activities other than mineral extraction. 

US Corp claims that the DE’s functional 

currency is Country X currency. A 

decline in the value of Country X 

currency relative to the dollar does not 

produce any economic loss for US Corp 

because the assets of the DE are not 

financial assets subject to currency 

fluctuation. Nevertheless, US Corp 

claims under the 1991 proposed 

regulations that the equity of the DE, 

which consists almost exclusively of 

equipment, gives rise to a substantial 

non-economic exchange loss and that 

terminating the DE (for example, by 

another check the box election) triggers 

recognition of such loss. Taxpayers have 

claimed similar results under other fact 

patterns. The IRS and the Treasury 

Department have serious concerns about 

these types of transactions. 

Although the foregoing example 

concerns the claiming of non-economic 

losses, the equity pool approach in the 

1991 proposed regulations can also give 

rise to non-economic gains. Recently, 

the value of the US dollar has declined 

against many foreign currencies. It is 

likely that under these circumstances, 

taxpayers subject to section 987 may 

have large non-economic gains built 

into the equity pool. The IRS and the 

Treasury Department believe that 

Congress did not intend for section 987 

to generate non-economic foreign 

currency gains or losses. 

In light of the entity-classification 

rules and the potential for the equity 

pool paradigm to generate noneconomic currency gains and losses, the 

IRS and the Treasury Department issued 

Notice 2000–20, 2000–1 CB 851. See 

§ 601.601(d)(2). Among other things, the 

notice indicated that the IRS and the 

Treasury Department were concerned 

that the proposed regulations may not 

have achieved their original goal of 

recognizing economic exchange gains 

and losses under appropriate 

circumstances. The notice requested 

comments on this and other issues. 

Several comments were received in 

response to the notice and raised a 

number of important points. Two of 

those comments suggested replacing the 

equity pool paradigm in the 1991 

proposed regulations with a paradigm 

that recognizes exchange gain or loss 

only on the earnings of a QBU and not 

its capital. As described above, the IRS 

and the Treasury Department believe 

that such an approach is inconsistent 

with Congressional intent as expressed 

in the legislative history to section 987. 

An earnings-only approach also would 

fail to address the core problem of 

distinguishing between items that 

economically give rise to exchange gain 

and loss and those that do not. 

Additionally, an earnings-only approach 

would produce different results for 

QBUs with the same net assets, 

depending upon whether the net assets 

were funded with capital or earnings. 

Finally, an earnings-only approach fails 

to take into account any foreign 

currency exposure on capital and so 

could disadvantage banks and other 

financial institutions, much of whose 

QBUs’ capital may be subject to such 

exposure. 

F. The Foreign Exchange Exposure Pool 

Method 

The IRS and the Treasury Department 

believe that Congress did not intend 


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section 987 to permit the largely 

uninhibited recognition of noneconomic exchange gain or loss. The 

1991 proposed regulations, together 

with the check the box regulations, have 

combined to permit taxpayers to trigger 

non-economic losses with relative ease. 

Accordingly, the 1991 proposed 

regulations are withdrawn and are 

replaced with new proposed regulations 

that adopt the ‘‘foreign exchange 

exposure pool method.’’ In general, the 

foreign exchange exposure pool method 

provides that the income of a QBU that 

is subject to section 987 (‘‘section 987 

QBU’’) is determined by reference to the 

items of income, gain, deduction and 

loss booked to the QBU in its functional 

currency, adjusted to reflect US tax 

principles. With certain exceptions, 

items of income, gain, deduction and 

loss of a section 987 QBU are translated 

into the functional currency of the 

QBU’s owner at the average exchange 

rate for the year. However, the basis of 

historic assets and deductions for 

depreciation, depletion, and 

amortization of such assets are 

translated at the historic exchange rate. 

Translating these items at the historic 

exchange rate differs from the approach 

taken in the 1991 proposed regulations, 

which instead uses the average 

exchange rate. Although using the 

average exchange rate for translating 

such items might be simpler than using 

the historic exchange rate, it leads to the 

generation of non-economic foreign 

currency gains or losses described in 

this preamble. 

The foreign exchange exposure pool 

method uses a balance sheet approach 

to determine exchange gain or loss, 

which is then recognized upon a 

remittance. Use of a balance sheet 

approach allows taxpayers and the IRS 

to distinguish between those items 

whose value fluctuates with respect to 

changes in the functional currency of 

the owner and those which do not. 

Under this method, exchange gain or 

loss with respect to ‘‘marked items’’ is 

identified annually but is pooled and 

deferred until a remittance is made. The 

IRS and the Treasury Department 

believe that section 988(c) identifies the 

items that should be treated as giving 

rise to exchange gain or loss for 

purposes of section 987. Accordingly, a 

marked item is generally defined as an 

asset or liability that would generate 

section 988 gain or loss if such asset or 

liability were held or entered into 

directly by the owner of the section 987 

QBU. 

When a section 987 QBU makes a 

remittance, a portion of the pooled and 

deferred exchange gain or loss is 

recognized. In general, the amount taken 

into account is an amount equal to the 

product of the owner’s portion of the 

section 987 QBU’s net unrecognized 

exchange gain or loss, multiplied by the 

owner’s remittance proportion. The 

owner’s remittance proportion generally 

is equal to the quotient of the amount 

of the remittance, divided by the 

aggregate basis of the section 987 QBU’s 

gross assets (as reflected on its year-end 

balance sheet), without reduction for the 

remittance. 

The source and character of exchange 

gain or loss recognized under section 

987 for all purposes of the Code, 

including sections 904(d), 907 and 954, 

is determined by reference to the source 

and character of the income derived 

from the section 987 QBU’s assets. 

The IRS and the Treasury Department 

believe that the foreign exchange 

exposure pool method is consistent with 

section 987 and legislative intent for 

several reasons. First, the foreign 

exchange exposure pool method uses a 

profit and loss statement to determine 

the items of income, gain, deduction 

and loss of a section 987 QBU in its 

functional currency. This allows proper 

characterization of items of income, 

gain, deduction and loss. Second, 

exchange gain or loss must be taken into 

account only with respect to items of 

branch capital and earnings whose 

value fluctuates with changes in 

exchange rates by reference to the 

owner’s functional currency. This 

comports both with Congressional 

intent that taxpayers recognize exchange 

gain or loss (but only economic 

exchange gain or loss) inherent in 

branch capital and branch earnings and 

with authority granted under section 

987(3) to identify appropriate 

translation rates. Third, exchange gain 

or loss is recognized under section 987 

only upon a remittance. Finally, the 

foreign exchange exposure pool method 

is an appropriate interpretation of the 

‘‘blended’’ approach of section 987—

that is, it incorporates certain aspects of 

the profit and loss method and the net 

worth method. 

Explanation of Provisions 

A. Section 1.987 1 Scope, Definitions 

and Special Rules 

1. Scope in General 

The proposed regulations provide 

rules for determining the section 987 

taxable income or loss of a taxpayer 

with respect to a section 987 QBU as 

well as the timing, amount, character, 

and source of section 987 gain or loss 

recognized with respect to such QBU. 

The proposed regulations do not apply 

to banks, insurance companies, and 

similar financial entities (including, 

solely for this purpose, leasing 

companies, finance coordination 

centers, regulated investment 

companies, and real estate investment 

trusts). The IRS and the Treasury 

Department plan to apply the foreign 

exchange exposure pool method 

adopted in the proposed regulations to 

such entities in subsequent guidance 

but believe it is appropriate to request 

comments regarding how the rules of 

the proposed regulations need to be 

precisely tailored to address issues 

unique to financial entities. Financial 

entities are urged to make necessary 

comments to help tailor the planned 

extension of the foreign exchange 

exposure pool method to such entities. 

Specifically, in the context of banks, 

the IRS and the Treasury Department 

request comments on whether special 

rules are needed for the global dealing 

of currencies and securities. Comments 

are also requested on the relationship of 

sections 987 and 988 for banks. Finally, 

comments are requested on whether the 

use of exchange rate conventions is 

appropriate for banks and finance 

entities and, if so, how such 

conventions should be determined. In 

the context of insurance companies, the 

IRS and the Treasury Department 

request comments on the proper 

treatment of insurance reserves, surplus, 

and investment assets held by the 

separate trades or business of an 

insurance company. In particular, 

comments are requested on the proper 

treatment of stock held in separate 

accounts of a section 987 QBU of a life 

insurance company and the related 

insurance reserves established for those 

separate accounts. In the context of 

leasing companies, comments are 

requested regarding the treatment of 

stock in other leasing companies 

recorded on the books and records of a 

section 987 QBU and how the rules of 

sections 986 and 987 can be reconciled 

if stock is treated as a ‘‘marked asset’’ in 

this setting. Until regulations are issued 

applying the foreign exchange exposure 

pool method to financial entities, such 

entities must comply with section 987 

under a reasonable method, consistently 

applied. For this purpose, reasonable 

methods include using the method 

described in the 1991 proposed 

regulations and a method that imputes 

section 987 gain or loss to earnings but 

not capital. 

The proposed regulations also do not 

apply to trusts, estates and S 

corporations. The IRS and the Treasury 

Department plan to apply the foreign 

exchange exposure pool method 

adopted in the proposed regulations to 

such entities but believe it is 

appropriate to request comments 


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regarding how the rules of the proposed 

regulations should be applied to such 

entities. The IRS and the Treasury 

Department request comments regarding 

whether principles similar to those 

applied to partnerships should apply to 

these entities. 

2. Taxpayers Subject to Section 987 and 

Related Definitions 

The IRS and the Treasury Department 

believe that section 987 should only 

apply where an individual or 

corporation (whether foreign or 

domestic) has activities that constitute a 

trade or business under § 1.989(a)–1(c) 

and the trade or business has a 

functional currency different from the 

individual or corporation. In such cases, 

the individual or corporation will be 

subject to the rules of the proposed 

regulations if the individual or 

corporation is the owner of a section 

987 QBU. A section 987 QBU is defined 

in § 1.987–1(b)(2) as an eligible QBU 

that has a functional currency different 

from its owner. 

An eligible QBU is defined in § 1.987–

1(b)(3) of the proposed regulations. 

Generally, an eligible QBU is an activity 

of an individual, corporation, 

partnership or DE that is a trade or 

business as defined in § 1.989(a)–1(c); 

maintains separate books and records as 

defined in § 1.989(a)–1(d) and assets 

and liabilities used in conducting such 

activities are reflected on such books 

and records; and the activities are not 

subject to the dollar approximate 

separate transaction (DASTM) rules of 

§ 1.985–3. A corporation is not an 

eligible QBU. An individual is not a 

QBU under § 1.989(a)–1(b)(2)(i) and 

therefore cannot be an eligible QBU. In 

addition, and as discussed in this 

preamble, neither a partnership nor a 

DE is an eligible QBU. 

In the case of ownership other than 

through a partnership (that is, direct 

ownership), the individual or 

corporation is treated as the owner of an 

eligible QBU if the individual or 

corporation is the tax owner of the 

assets and liabilities of the eligible QBU. 

For purposes of determining direct 

ownership, an individual or corporation 

will be treated as a direct owner of the 

assets and liabilities of an eligible QBU 

if it owns a DE that holds an eligible 

QBU. In such case, because the DE is 

not recognized as a separate entity, it 

cannot be a QBU under section 989 and, 

therefore, is not treated as an eligible 

QBU under the proposed regulations. 

However, the activities of the DE, which 

are treated for purposes of the Code as 

carried on directly by its owner, can 

qualify as an eligible QBU of the DE’s 

owner. 

With respect to partnerships, the IRS 

and the Treasury Department recognize 

that issues often arise as to whether the 

international tax provisions of the Code 

operate on an aggregate or an entity 

basis. The legislative history of 

subchapter K of chapter 1 of the Code 

provides that, for purposes of 

interpreting Code provisions outside of 

that subchapter, a partnership may be 

treated as either an entity separate from 

its partners or an aggregate of its 

partners, depending on which 

characterization is more appropriate to 

carry out the purpose of the particular 

section under consideration. H.R. Conf. 

Rep. No. 2543, 83rd Cong. 2d. Sess. 59 

(1954). 

In the case of section 987, the 

calculations under the foreign exchange 

exposure pool method would differ 

dramatically based on whether an 

aggregate or an entity approach is 

adopted. For example, if the foreign 

exchange exposure pool method is 

applied at the entity level, the 

partnership will make the method’s 

calculations by reference to the 

partnership’s functional currency. 

Under this approach, any foreign 

currency gain or loss will be an item of 

the partnership and will be allocated 

among the partners in accordance with 

the partnership agreement, to the extent 

such allocation is consistent with the 

provisions of subchapter K. If, in the 

alternative, the foreign exchange 

exposure pool method is applied under 

an aggregate approach, each partner will 

make its own foreign exchange exposure 

pool calculations by reference to the 

partner’s functional currency and such 

amounts will not be subject to separate 

allocation under subchapter K. 

The IRS and the Treasury Department 

believe that, on balance, an aggregate 

approach is more appropriate for section 

987 purposes. Applying the foreign 

exchange exposure pool method directly 

at the partner level will more 

appropriately preserve the correct 

amounts of exchange gain or loss. In 

addition, such approach will measure 

the foreign currency exposure by 

reference to the functional currencies of 

the persons who generally bear the 

economic risk from such exposure. As a 

result, the proposed regulations provide 

that for purposes of applying the foreign 

exchange exposure pool method each 

individual or corporation that is a 

partner in a partnership will be 

considered to own indirectly an eligible 

QBU consisting of a portion of the assets 

and liabilities of the partnership 

allocated to it under § 1.987–7. If such 

eligible QBU has a different functional 

currency from the partner and therefore 

is a section 987 QBU, the foreign 

exchange exposure pool method is 

applied with respect to those assets and 

liabilities. In addition, the proposed 

regulations provide rules for converting 

the items of section 987 taxable income 

or loss of a section 987 QBU into the 

functional currency of the partner 

(when necessary), and rules 

coordinating this aggregate approach 

with other provisions of subchapter K. 

Section 1.987–1(b)(2)(ii) allows an 

owner to elect to treat certain section 

987 QBUs with the same functional 

currency as a single section 987 QBU. 

The purpose of this rule is to simplify 

section 987 calculations by reducing the 

number of interbranch transactions that 

would be considered as ‘‘transfers’’ of 

assets and liabilities. This election 

applies only to certain section 987 

QBUs of the owner. The IRS and the 

Treasury Department request comments 

regarding whether such election should 

be available to treat section 987 QBUs 

of owners that are members of a 

consolidated group as a single section 

987 QBU and how this should be 

technically effectuated. 

Section 1.987–1(b)(5) provides that 

the term ‘‘owner’’ for section 987 

purposes does not include an eligible 

QBU or section 987 QBU of an owner. 

Under this rule, a tiered ownership 

structure of eligible QBUs and/or 

section 987 QBUs will not be respected 

as distinct tiers of QBUs for purposes of 

section 987. Rather, tiers of eligible and/ 

or section 987 QBUs will be treated as 

a ‘‘flat’’ structure, with each QBU in the 

tier considered as owned directly by the 

ultimate non-QBU owner. For example, 

if a domestic corporation is the holder 

of the interests in a section 987 DE 

(section 987 DE1) and that DE owns the 

interests in another section 987 DE 

(section 987 DE2) for purposes other 

than U.S. tax law, the structure will not 

be treated as a tier of QBUs for purposes 

of section 987. Rather, the domestic 

corporation will be considered the 

direct holder of the interests in the 

section 987 branches of section 987 DE1 

and DE2. This flat structure, which is 

consistent with the general approach 

taken in the proposed dual consolidated 

loss regulations (70 FR 29868–29907), is 

expected to be easier to administer for 

both taxpayers and the IRS and to 

provide more appropriate results under 

the section 987 rules. 

3. De Minimis Rule for Certain 

Indirectly Owned Section 987 QBUs 

The IRS and the Treasury Department 

recognize that it may be 

administratively burdensome for 

taxpayers to apply certain aspects of the 

proposed regulations to section 987 

QBUs indirectly owned through 


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relatively small interests in 

partnerships. As a result, the proposed 

regulations provide a de minimis 

election for certain indirectly owned 

section 987 QBUs. Under this rule, an 

individual or corporation that owns a 

section 987 QBU indirectly through a 

partnership may elect not to take into 

account the section 987 gain or loss of 

such section 987 QBU, provided such 

individual or corporation owns, directly 

or indirectly, less than five percent of 

the section 987 partnership. 

Constructive ownership rules apply for 

purposes of determining whether the 

less than five percent ownership 

threshold is satisfied. 

This de minimis exception only 

applies to recognition of section 987 

gain or loss with respect to a section 987 

QBU. Thus, owners of section 987 QBUs 

that qualify under the de minimis 

exception must comply with all other 

aspects of the proposed regulations, 

including the requirement to take into 

account the section 987 taxable income 

or loss with respect to such section 987 

QBUs. 

An individual or corporation that 

qualifies for the election (that is, 

because they owned less than five 

percent of a section 987 partnership) 

subsequently may fail to qualify as a 

result of an increase in their interest in 

a section 987 partnership. In such a 

case, taxpayers must begin taking into 

account the section 987 gain or loss 

with respect to section 987 QBUs owned 

through such partnerships. Similarly, 

taxpayers that were required to take into 

account section 987 gain or loss with 

respect to an indirectly owned section 

987 QBU may reduce their ownership 

such that they become eligible for the de 

minimis exception and, as a result, may 

elect to no longer take into account 

section 987 gain or loss. The IRS and the 

Treasury Department recognize that 

transition issues will arise when 

interests in section 987 partnerships 

change such that individuals or 

corporations no longer qualify (or are 

able to qualify) for the de minimis 

exception. The IRS and the Treasury 

Department are considering such 

transition rules and request comments 

as to their application. 

4. Exchange Rates 

Section 1.987–1(c)(1)(i) defines the 

spot rate as the rate determined under 

the principles of § 1.988–1(d)(1), (2) and 

(4) on the relevant day. Section 1.987–

1(c)(1)(ii) allows taxpayers to elect to 

use spot rate conventions that 

reasonably approximate the spot rate on 

a particular day. It is anticipated that 

taxpayers will be able to conform the 

spot rate convention for section 987 to 

the spot rate conventions used under 

FAS 52 for financial accounting 

purposes. This is intended to simplify 

the calculations required under section 

987. 

In a similar attempt to simplify 

calculations, § 1.987–1(c)(2) defines the 

yearly average exchange rate as an 

average exchange rate for the taxable 

year computed under any reasonable 

method that is consistently applied. 

Finally, § 1.987–1(c)(3) defines the 

historic exchange rate by reference to 

the spot rate on the day that assets are 

transferred to (or acquired by) the 

section 987 QBU, or on the day that 

liabilities are assumed (or entered into) 

by the section 987 QBU. The reference 

to the spot rate as defined in § 1.987–

1(c)(1)(i) and (ii) allows taxpayers to 

elect to use spot rate conventions for 

these purposes. 

5. Definitions of a Section 987 Marked 

Item and a Section 987 Historic Item 

The definitions of a section 987 

marked item and a section 987 historic 

item are central to the foreign exchange 

exposure pool method. When taken into 

account in the context of the calculation 

of net unrecognized section 987 gain or 

loss under § 1.987–4, the definitions 

distinguish those items that generate 

section 987 gain or loss from those that 

do not. The IRS and the Treasury 

Department believe that section 988 

identifies those items properly treated 

as giving rise to exchange gain or loss 

for purposes of section 987. Thus, a 

marked item as defined in § 1.987–1(d) 

is an asset or liability reflected on the 

books and records of the section 987 

QBU that both (1) Would generate 

section 988 gain or loss if held or 

entered into directly by the owner of the 

section 987 QBU and (2) is not a section 

988 transaction to the section 987 QBU. 

It is important to exclude section 988 

transactions of a section 987 QBU 

because section 988 already requires the 

section 987 QBU to recognize gain or 

loss from such transactions. Thus, 

treating such transactions as marked 

items for purposes of section 987 would 

result in double counting. Marked items 

give rise to exchange gain or loss under 

section 987. Historic items, which are 

defined in § 1.987–1(e) as items other 

than marked items, do not give rise to 

exchange gain or loss under section 987. 

6. Elections Under Section 987 

Section 1.987–1(f) provides rules for 

making elections under section 987. In 

general, the elections made under 

section 987 must be made by the owner 

of the section 987 QBU. The elections 

must be made with respect to a section 

987 QBU for the first taxable year in 

which the election is relevant, and must 

be made by attaching a statement to a 

timely filed tax return for such taxable 

year. Elections under section 987 are 

treated as methods of accounting and 

are governed by the general rules 

regarding changes in methods of 

accounting. 

The IRS and the Treasury Department 

believe that a reasonable cause standard 

should be applied to determine whether 

taxpayers that fail to make a timely 

election are eligible for an extension of 

time to file elections pursuant to 

§ 1.987–1(f) of the proposed regulations. 

As a result, extensions of time under 

§§ 301.9100–1 through 301.9100–3 will 

not be granted for filings under the 

proposed regulations. See § 301.9100–

1(d). 

Under the reasonable cause standard, 

if an owner that is permitted to file an 

election under the proposed regulations 

fails to make such a filing in a timely 

manner, the owner is considered to have 

satisfied the timeliness requirement 

with respect to such filing if it 

demonstrates, to the satisfaction of the 

Area Director, Field Examination, Small 

Business/Self Employed or the Director, 

Field Operations, Large and Mid-Size 

Business (Director) having jurisdiction 

of the taxpayer’s return for the taxable 

year, that such failure was due to 

reasonable cause and not willful 

neglect. Once the owner becomes aware 

of the failure, the owner must 

demonstrate reasonable cause and must 

satisfy the filing requirement by 

attaching the election to an amended tax 

return (that amends the tax return to 

which the election should have been 

attached). A written statement must be 

included that explains the reasons for 

the failure to comply. 

In determining whether the taxpayer 

has reasonable cause, the Director shall 

consider whether the taxpayer acted 

reasonably and in good faith. Whether 

the taxpayer acted reasonably and in 

good faith will be determined after 

considering all the facts and 

circumstances. The Director shall notify 

the person in writing within 120 days of 

the filing if it is determined that the 

failure to comply was not due to 

reasonable cause or if additional time 

will be needed to make such 

determination. If the Director fails to 

notify the owner within 120 days of the 

filing, the owner shall be considered to 

have demonstrated to the Director that 

such failure was due to reasonable cause 

and not willful neglect. 

The proposed regulations provide that 

elections under section 987 cannot be 

revoked without the consent of the 

Commissioner. In addition, the 

proposed regulations provide that the 


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Commissioner will consider allowing 

revocation of such an election if the 

taxpayer demonstrates significantly 

changed circumstances, or other 

circumstances that demonstrate a 

substantial non-tax business reason for 

such revocation. Finally, the IRS and 

the Treasury Department are 

considering an exception to the general 

revocation rule where a section 987 

QBU is acquired in certain transactions 

that do not result in the termination of 

such QBU. Comments are requested as 

to whether such an exception is 

warranted and, if so, the appropriate 

scope of such an exception. 

B. Section 1.987–2 Attribution of Items 

to an Eligible QBU; the Definition of a 

Transfer, and Related Rules 

1. Attribution of Items to an Eligible 

QBU 

i. Overview 

A section 987 QBU is not itself a 

taxpayer and does not have its own 

taxable income. Items of income, gain, 

deduction and loss must nonetheless be 

attributed to such section 987 QBU for 

purposes of determining the owner’s 

taxable income. The items of income, 

gain, deduction and loss attributed to a 

section 987 QBU are generally 

determined in the functional currency 

of the section 987 QBU and then 

translated into the functional currency 

of the owner. The aggregate translated 

amount is the section 987 taxable 

income or loss of the section 987 QBU. 

Thus, attribution rules are necessary to 

determine which items of income, gain, 

deduction and loss are attributed to the 

section 987 QBU. 

Under section 987(3), assets and 

liabilities must be attributed to a section 

987 QBU in order to determine the 

amount of section 987 gain or loss of 

such QBU. In some cases, a section 987 

QBU of a taxpayer will not be held 

through an entity separate from the 

taxpayer that can legally own assets and 

incur liabilities. In addition, not all the 

assets and liabilities of an entity that is 

separate from the taxpayer may be 

attributable to a section 987 QBU for 

purposes of section 987. Moreover, 

assets and liabilities may constitute a 

section 987 QBU of a taxpayer even 

when such assets and liabilities are 

owned or incurred by separate legal 

entities. As a result, assets and liabilities 

of the taxpayer (or of entities owned by 

the taxpayer that are not themselves 

taxpayers) must be attributed to the 

section 987 QBU. 

Neither section 987 nor the 

underlying legislative history provides 

explicit rules for attributing a taxpayer’s 

items of income, gain, deduction, or loss 

to a section 987 QBU to determine the 

QBU’s section 987 taxable income or 

loss. Similarly, no explicit rules are 

provided in the statute or legislative 

history for attributing a taxpayer’s assets 

or liabilities to a section 987 QBU to 

determine the section 987 gain or loss 

of such QBU. 

Other provisions of the Code provide 

various methods for attributing or 

allocating a taxpayer’s assets and 

liabilities, or items of income, gain, 

deduction and loss (items) for particular 

purposes. These provisions provide 

complex rules for making such 

determinations and, in many cases, 

require a detailed analysis of various 

factors and relationships involving 

income, assets, and activities of the 

taxpayer. For example, section 864(c) 

and the regulations thereunder provide 

rules for determining the income, gain, 

deduction, or loss of a nonresident alien 

individual or foreign corporation which 

are treated as effectively connected with 

the conduct of a trade or business 

within the United States. Other 

examples are §§ 1.882–5, 1.861–8 and 

1.861–9T through 1.861–13T. These 

regulations provide rules for the 

allocation and apportionment of 

expenses, losses, and other deductions 

of a taxpayer. Finally, section 884(c)(2) 

and § 1.884–1(d) and (e) provide rules 

for determining U.S. assets and U.S. 

liabilities of a foreign corporation for 

purposes of the branch profits tax. As 

discussed below, the IRS and the 

Treasury Department do not believe 

these complex methodologies are 

appropriate for purposes of section 987. 

ii. Books and Records Method—General 

Rule 

The IRS and the Treasury Department 

believe that items should be attributed 

to an eligible QBU (and, if all or a 

portion of such eligible QBU has a 

different functional currency than its 

owner, to a section 987 QBU of such 

owner) to the extent they are reflected 

on the books and records of the eligible 

QBU (books and records method). The 

IRS and the Treasury Department 

believe that using a books and records 

method for attributing items under 

section 987 is consistent with other 

provisions of the Code involving foreign 

currency transactions. For example, it is 

consistent with the requirement under 

section 989(a) that a QBU maintain 

books and records separate from the 

taxpayer. It is also consistent with the 

requirement under section 985(b)(1) 

that, in order to have a functional 

currency other than the dollar, a QBU 

must keep its books and records in such 

currency. Moreover, the IRS and the 

Treasury Department believe the books 

and records method is administrable for 

both taxpayers and the Commissioner. 

This is the case because the books and 

records method should be consistent 

with the taxpayer’s accounting 

treatment of the items and, unlike the 

methods discussed above, it does not 

require a complex and factually 

intensive analysis of the circumstances 

and activities of the eligible QBU. 

For the reasons described above, the 

proposed regulations adopt a books and 

records method for allocating items to 

an eligible QBU. The proposed 

regulations provide that, subject to 

certain exceptions, items are attributable 

to an eligible QBU to the extent they are 

reflected on the separate set of books 

and records of such eligible QBU, as 

defined in § 1.989(a)–1(d). The proposed 

regulations make clear that these rules 

apply solely for purposes of section 987. 

Thus, for example, the attribution rules 

contained in the proposed regulations 

do not apply for purposes of allocating 

and apportioning interest expense under 

section 864(e). 

iii. Exception for Non-Portfolio Stock, 

Interests in Partnerships and Certain 

Acquisition Indebtedness 

As discussed above, the IRS and the 

Treasury Department believe that the 

assets and liabilities reflected on the 

books and records of an eligible QBU 

are a reasonable approximation of the 

assets and liabilities that are used in the 

trade or business of the eligible QBU 

and, therefore, should be taken into 

account for purposes of section 987. 

However, the IRS and the Treasury 

Department believe that certain assets 

and liabilities should not be attributed 

to an eligible QBU, even if such assets 

and liabilities are reflected on the books 

and records of such QBU. The IRS and 

the Treasury Department believe that 

non-portfolio stock and interests in 

partnerships (and liabilities to acquire 

such assets), even if reflected on the 

books and records of the eligible QBU, 

should not be attributed to such QBU 

for purposes of section 987. This is 

consistent with the principle stated 

above that a section 987 QBU cannot be 

an owner of another section 987 QBU. 

Excluding non-portfolio stock is also 

consistent with the principle that nonportfolio stock cannot be used in, or 

held for the use in, the conduct of a 

trade or business in the United States. 

See § 1.864–4(c)(2)(iii). 

As a result, the proposed regulations 

provide that stock of a corporation 

(whether domestic or foreign) and an 

interest in a partnership (whether 

domestic or foreign) are not considered 

to be on the books and records of an 

eligible QBU. The proposed regulations 


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provide an exception, however, for 

portfolio stock where the owner of the 

eligible QBU owns (directly or 

constructively) less than ten percent of 

the total voting power or value of the 

stock of such corporation. The proposed 

regulations also provide that 

indebtedness incurred to acquire stock 

or a partnership interest that is not 

treated as being reflected on the books 

and records of an eligible QBU should 

similarly be excluded from the books 

and records. Finally, the proposed 

regulations provide that items of 

income, gain, deduction and loss arising 

from ownership of stock, a partnership 

interest, or related acquisition 

indebtedness that is excluded from the 

general books and records rule, shall 

similarly not be treated as being on the 

books and records of the eligible QBU. 

iv. Coordination With Source Rules 

Under Section 988 

Section 988(a)(3) provides that the 

source of gain or loss recognized under 

section 988(a)(1) is determined by 

reference to the residence of the 

taxpayer or the QBU of the taxpayer on 

whose books the asset, liability, or item 

of income or expense is properly 

reflected. Section 1.988–4(b)(2) provides 

that, in general, the determination of 

whether an asset, liability, or item of 

income or expense is properly reflected 

on the books of a QBU is a question of 

fact. The regulations under section 988 

further provide that such items are 

presumed not to be properly reflected 

on the books and records for this 

purpose if inconsistent booking 

practices are employed with respect to 

the same or similar items. Finally, the 

regulations provide that if such items 

are not properly reflected on the books 

of the QBU, the Commissioner may 

allocate the item between or among the 

taxpayer and its QBUs to properly 

reflect the source (or realization) of 

exchange gain or loss. 

The IRS and the Treasury Department 

believe that rules for determining 

whether items are properly reflected on 

the books of a QBU for purposes of 

sourcing section 988 gain or loss should 

be consistent with the rules for 

attributing items to an eligible QBU 

under section 987. As a result, the 

proposed regulations modify the 

sourcing rules in the section 988 

regulations to provide that the 

principles of § 1.987–2(b) apply in 

determining whether an asset, liability, 

or item of income or expense is properly 

reflected on the books of a QBU. 

2. Certain Assets and Liabilities of 

Partnerships and DEs Not Attributable 

to an Eligible QBU 

Section 988 applies to certain 

transactions described in section 988(c) 

if the transaction is denominated (or 

determined by reference to) a currency 

that is not the functional currency of the 

taxpayer or QBU of the taxpayer. Thus, 

in order to determine if a transaction is 

subject to section 988, it must be 

determined whether a transaction is 

attributable to the taxpayer or a QBU of 

the taxpayer. 

Under the current section 989 

regulations, a partnership is a QBU even 

if it does not have activities that 

constitute a trade or business (‘‘per se 

QBU’’). As a result, a partnership may 

have a functional currency different 

than its partners and section 988 is 

applied at the partnership level with 

respect to section 988 transactions 

properly attributable to the partnership. 

These regulations propose to amend 

section 989 to provide that a partnership 

is no longer a per se QBU of its partners, 

but instead the activities of such 

partnership may be treated as a QBU. 

As discussed above, the IRS and the 

Treasury Department will generally 

apply either an entity or an aggregate 

approach with respect to partnerships 

depending on which approach more 

appropriately carries out the purpose of 

the particular Code section under 

consideration. Following the 

amendments made by the proposed 

regulations, and because only certain 

activities of a partnership (and not the 

partnership itself) can qualify as a 

section 987 QBU, the IRS and the 

Treasury Department believe that it is 

appropriate, in cases where an asset or 

liability of a partnership is not reflected 

on the books and records of an eligible 

QBU of the partnership, to determine 

whether section 988 applies by 

reference to the functional currencies of 

the partners. The IRS and the Treasury 

Department believe that this rule will 

have limited application and will apply, 

for example, where the only activity of 

a partnership is the incurrence of a 

liability used to acquire stock that is 

held by the partnership. The proposed 

regulations provide examples 

illustrating the application of this rule. 

As discussed above, the proposed 

regulations provide that a DE itself is 

not an eligible QBU and, instead, certain 

activities of the DE will be treated as an 

eligible QBU of the owner to the extent 

a separate set of books and records with 

respect to such activities are 

maintained. Thus, an issue similar to 

that discussed above with respect to 

partnerships will arise where the DE is 

the local law owner of certain assets or 

the local law obligor on certain 

liabilities, which are not reflected on the 

books and records of an eligible QBU 

held by the DE. The proposed 

regulations provide that the 

determination of whether section 988 

(rather than section 987) applies with 

respect to transactions involving assets 

and liabilities of a DE that are not 

attributable to an eligible QBU is 

determined by reference to the 

functional currency of the owner of 

such DE. 

3. Definition of a Transfer 

i. Overview 

Section 987(3) provides, in part, that 

taxable income of a taxpayer shall be 

determined by making proper 

adjustments (as prescribed by the 

Secretary) for transfers of property 

between qualified business units of the 

taxpayer having different functional 

currencies. Similarly, the legislative 

history to section 987 refers to 

contributions to, and remittances from, 

QBUs. See, H.R. Conf. Rep. No. 841, 

99th Cong. 2d. Sess. II 673–76 (1986). 

However, neither the statute nor the 

legislative history defines the terms 

‘‘transfer,’’ ‘‘contribution,’’ or 

‘‘remittance.’’

As noted above, section 987 QBUs can 

be divisions of an owner that have no 

legal distinction separate from their 

owner. Section 987 QBUs can also be 

owned indirectly through partnerships, 

where they have legal distinction 

separate from their owners. Moreover, 

as a result of the entity classification 

regulations, a section 987 QBU held 

through a DE can have legal distinction 

separate from its owner, even though 

the section 987 QBU is treated as a 

division of the owner for federal income 

tax purposes. As a result, assets and 

liabilities can be transferred between an 

owner and a section 987 QBU in a 

manner that has legal significance (that 

is, a distribution from a section 987 

partnership), or in a manner that has no 

legal significance because the transfers 

are simply between divisions of the 

same legal entity (that is, a transfer 

involving divisions of a taxpayer that is 

reflected through accounting entries). 

ii. Disregarded Transactions 

The definition of a transfer under the 

proposed regulations includes 

transactions that are regarded for both 

legal and tax purposes, and transactions 

that are regarded for legal purposes, but 

disregarded as transactions for tax 

purposes (‘‘disregarded transactions’’). 

For this purpose, the term disregarded 

transaction is treated as including the 


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recording of an asset or liability on one 

set of books and records, if the recording 

is the result of such asset or liability 

being removed from another set of books 

and records of the same person or entity 

(including a DE or partnership). 

The proposed regulations provide that 

an asset or liability is treated as 

transferred to or from a section 987 QBU 

if, as a result of a disregarded 

transaction, such asset or liability is 

reflected, or is not reflected, 

respectively, on the books and records 

of the section 987 QBU. For example, if 

an owner of a section 987 DE loans cash 

to the section 987 QBU held by the 

section 987 DE, the loan is disregarded 

for Federal income tax purposes. 

However, as a result of such disregarded 

transaction, the loaned cash is reflected 

on the books and records of the section 

987 QBU and, therefore, is treated as 

transferred to such section 987 QBU. 

iii. Certain Contributions to, and 

Distributions From, Partnerships 

The proposed regulations also provide 

that transfers to and from section 987 

QBUs include certain contributions of 

assets to, or distributions of assets from, 

a section 987 partnership. For example, 

an asset contributed by a partner to a 

section 987 partnership is treated as 

transferred to an indirectly owned 

section 987 QBU of the partner if the 

asset is reflected on the section 987 

QBU’s books and records following such 

contribution. The proposed regulations 

provide similar rules for assumptions of 

liabilities between a section 987 

partnership and its partners. 

iv. Certain Acquisitions and 

Dispositions of Interests in DEs and 

Partnerships 

The proposed regulations also provide 

that transfers to or from a section 987 

QBU may occur as a result of certain 

acquisitions (including by contribution) 

and dispositions of interests in DEs and 

partnerships. For example, if a partner 

in a section 987 partnership sells a 

portion of its interest in such 

partnership, the sale results in a transfer 

from the partner’s indirectly owned 

section 987 QBU to the extent assets and 

liabilities are not reflected on the books 

and records of such QBU as a result of 

such sale. 

v. Change in Form of Ownership 

The owner of a section 987 QBU can 

change its form of ownership in all or 

a portion of such section 987 QBU. Such 

changes in form of ownership often 

occur in a manner that does not affect 

the operation of the eligible QBU (or its 

status as an eligible QBU), but rather 

only changes the owner’s interest in its 

section 987 QBU. For example, a direct 

owner of a section 987 QBU that is 

owned through a section 987 DE can 

change to being an indirect owner of all 

or a portion of such section 987 QBU, 

if the interests in the section 987 DE are 

transferred to a partnership. 

Changes in form of ownership of a 

section 987 QBU can occur through 

actual or deemed transactions involving 

the section 987 QBU itself, or actual or 

deemed transactions involving interests 

in a section 987 DE or section 987 

partnership that owns such QBU. For 

example, certain conversions of DEs to 

partnerships, or partnerships to DEs, 

result in deemed transactions pursuant 

to Rev. Ruls. 99–5, 1999–1 CB 434, and 

99–6, 1999–1 CB 432. See 

§ 601.601(d)(2). Deemed transactions 

with respect to partnerships also occur 

pursuant to section 708(b) and the 

regulations thereunder. 

The IRS and the Treasury Department 

believe that changes in form of 

ownership should result in a transfer 

only to the extent such change affects 

the assets and liabilities attributable to 

the section 987 QBU of the owner. As 

a result, the proposed regulations 

provide that a mere change in form of 

ownership of a section 987 QBU does 

not result in a transfer to or from the 

section 987 QBU. Instead, the proposed 

regulations provide that the 

determination of whether a transfer has 

occurred in such cases should be made 

under the general transfer rules, 

discussed above. Moreover, the 

proposed regulations clarify that 

deemed transactions (for example, 

pursuant to Rev. Ruls. 99–5 and 99–6) 

shall not be taken into account for 

purposes of determining whether there 

is a transfer. 

vi. General Tax Law Principles 

The proposed regulations clarify that 

general tax law principles, including the 

circular cash flow, step-transaction, and 

substance-over-form doctrines apply for 

purposes of determining whether there 

is a transfer of an asset or liability to or 

from a QBU. For example, if a 

shareholder of a corporation that 

directly owns a section 987 QBU 

transfers property to the corporation and 

the property is recorded on the books 

and records of the corporation’s section 

987 QBU, the shareholder is first treated 

as transferring the property to the 

corporation, and then the corporation is 

treated as transferring the property to 

the section 987 QBU in a disregarded 

transaction. 

4. Adjustments to Items Reflected on the 

Books and Records 

As noted above, a section 987 QBU of 

a taxpayer may not be an entity separate 

from the taxpayer that can legally own 

assets and incur liabilities. As a result, 

recording (or failing to record) an asset 

or liability on the books and records 

may, other than for purposes of section 

987, have little significance for tax or 

legal purposes. In addition, transfers 

between section 987 QBUs of the same 

owner that are divisions of the same 

legal entity may have no legal 

significance and are accomplished only 

through journal entries on the books and 

records of such section 987 QBUs. As a 

result, the IRS and the Treasury 

Department are concerned that, in 

certain circumstances, transfers to or 

from a section 987 QBU may be 

structured solely to achieve advantages 

under section 987, especially given that 

such transfers may have little or no 

significance from a legal or business 

perspective. 

In Notice 2000–20, the IRS and the 

Treasury Department expressed similar 

concerns in connection with taxpayers 

taking positions that certain 

contributions and distributions triggered 

foreign currency losses prematurely 

with respect to transactions that were 

undertaken for tax purposes, but lacked 

meaningful non-tax economic 

consequences. The notice provided that 

the IRS and the Treasury Department 

believe that circular cash flows and 

similar transactions lacking economic 

substance will not result in recognition 

of foreign currency losses under general 

tax principles because such transactions 

are not properly treated as transfers or 

remittances under section 987. 

The IRS and the Treasury Department 

continue to be concerned about 

transactions that are undertaken for tax 

purposes and lack meaningful non-tax 

economic consequences. As a result, the 

proposed regulations provide the 

Commissioner the ability to allocate 

assets and liabilities, and items of 

income, gain, deduction and loss, where 

a principal purpose of recording (or 

failing to record) an item on the books 

and records of an eligible QBU 

(including an eligible QBU owned 

indirectly through a partnership) is the 

avoidance of U.S. tax under section 987. 

The proposed regulations also provide 

various factors that indicate whether 

recording (or failing to record) an item 

on books and records has as a principal 

purpose the avoidance of U.S. tax under 

section 987. For example, factors 

indicating that such tax avoidance was 

not a principal purpose of recording (or 

not recording) an item include doing so 


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for a substantial and bona fide business 

purpose, or in a manner that is 

consistent with the economics of the 

underlying transaction. 

5. Translation of Items Transferred to a 

Section 987 QBU 

The proposed regulations provide 

translation rules for the transfer of assets 

and liabilities to a section 987 QBU. 

Under the proposed regulations, if an 

asset or a liability is transferred to a 

section 987 QBU, such items are 

translated into the QBU’s functional 

currency at the spot rate on the day of 

transfer. No translation is required for 

assets or liabilities denominated in the 

functional currency of the section 987 

QBU. 

The proposed regulations provide 

special rules for items transferred to a 

section 987 QBU where such items are 

denominated in (or determined by 

reference to) the owner’s functional 

currency. Such items are not translated 

and instead are carried on the balance 

sheet in the owner’s functional currency 

since no foreign currency exposure with 

respect to the owner is created by such 

items. 

6. Interaction With Other Foreign 

Currency Provisions 

The IRS and the Treasury Department 

are considering whether the attribution 

and transfer rules provided under the 

proposed regulations should apply with 

respect to other foreign currency 

provisions in the Code. For example, the 

IRS and the Treasury Department are 

considering whether the attribution 

rules under the proposed regulations 

should apply to determine the 

functional currency of a QBU under 

section 985. As a result, comments are 

requested on the interaction of these 

rules with other foreign currency 

provisions. 

C. Section 1.987–3 Determination of 

the Items of Aection 987 Taxable 

Income or Loss of an Owner of a Section 

987 QBU 

In general, the term ‘‘section 987 

taxable income’’ refers to the items of 

income, gain, deduction or loss 

attributed to the section 987 QBU under 

§ 1.987–2(b), translated into the 

functional currency of the owner. The 

allocation of expenses such as interest 

under other provisions are not taken 

into account for this purpose. Section 

987 taxable income is calculated by 

determining each item of income, gain, 

deduction or loss in the section 987 

QBU’s functional currency under 

§ 1.987–3(a), and then translating those 

items into the owner’s functional 

currency using the exchange rates 

provided in § 1.987–3(b). Items of 

income, gain, deduction or loss of a 

section 987 QBU that are denominated 

in (or determined by reference to) the 

functional currency of the owner are not 

translated and are not treated as section 

988 transactions to the section 987 QBU. 

Transactions denominated in (or 

determined by reference to) a currency 

that is neither the functional currency of 

the owner nor of the section 987 QBU 

are subject to the generally applicable 

rules under section 988 determined 

with respect to the functional currency 

of the section 987 QBU. 

When basis recovery is required with 

respect to an historic asset, either in 

computing gain or loss on the sale or 

exchange of such asset, or in 

determining cost recovery deductions 

(such as depreciation or depletion), the 

proposed regulations require the use of 

the historical exchange rate associated 

with the particular asset. Thus, for 

example, where a section 987 QBU sells 

an historic asset, the amount realized 

will be translated into the owner’s 

functional currency using the yearly 

average exchange rate (or, if properly 

elected, the spot rate), but the adjusted 

basis will be translated using the 

historic exchange rate associated with 

that asset. The use of different exchange 

rates for amount realized and adjusted 

basis is designed to more closely reflect 

the economic gain or loss to the owner 

of the section 987 QBU than the 1991 

proposed regulations. The same is true 

for depreciation or other cost recovery 

deductions that are claimed with 

respect to historic assets of a section 987 

QBU. 

Special translation rules are provided 

with respect to the disposition of 

marked assets (other than functional 

currency cash of the section 987 QBU). 

Generally, the amount realized and 

basis are translated at the same 

exchange rates. The purpose of these 

special rules is to assure that foreign 

currency gain or loss (as opposed to gain 

or loss not related to movements in 

exchange rates) is reflected through the 

balance sheet calculations of § 1.987–4 

and not through the profit and loss 

calculations of § 1.987–3. Cash is not 

included in these special rules because 

the disposition of cash cannot generate 

profit or loss to the section 987 QBU for 

purposes of § 1.987–3. 

D. Section 1.987–4 Determination of 

Net Unrecognized Section 987 Gain or 

Loss of a Section 987 QBU 

Section 1.987–4 provides the 

mechanics for determining ‘‘net 

unrecognized section 987 gain or loss’’

and, when combined with § 1.987–5, 

form the mathematical core of the 

foreign exchange exposure pool method. 

In summary, § 1.987–4 uses a balance 

sheet to distinguish the items of a 

section 987 QBU that give rise to section 

987 gain or loss (section 987 marked 

items) from those that do not (section 

987 historic items). This approach 

avoids the distortions caused by the 

1991 proposed regulations that impute 

section 987 gain or loss to all assets of 

a section 987 QBU, even those assets the 

value of which does not fluctuate with 

currency movements. Generally, annual 

comparison of the change in the value 

of section 987 marked items on the 

opening and closing balance sheets due 

to changes in exchange rates gives rise 

to unrecognized section 987 gain or loss. 

This unrecognized section 987 gain or 

loss is aggregated with similar amounts 

determined for prior years (to the extent 

not previously taken into account) and 

is taken into account by the owner 

under the rules of § 1.987–5 upon a 

remittance by the section 987 QBU. 

Under § 1.987–4(a) and (b), net 

unrecognized section 987 gain or loss is 

computed annually and is equal to the 

sum of the ‘‘unrecognized section 987 

gain or loss for the current taxable year’’

and the ‘‘net accumulated unrecognized 

section 987 gain or loss for all prior 

taxable years.’’ A section 987 QBU’s net 

accumulated unrecognized section 987 

gain or loss for all prior taxable years is 

the aggregate of the unrecognized 

section 987 gain or loss determined 

under § 1.987–4(d) for all prior taxable 

years (to which these regulations apply) 

reduced by the amounts taken into 

account under § 1.987–5 upon a 

remittance for all such taxable years. For 

section 987 QBUs in existence prior to 

the effective date of these regulations, a 

section 987 QBU’s net accumulated 

unrecognized section 987 gain or loss 

includes amounts taken into account 

under the transition rules of § 1.987–10. 

Unrecognized section 987 gain or loss 

is determined under a seven step 

calculation. Under the first step in 

§ 1.987–4(d)(1), the ‘‘owner functional 

currency net value’’ of the section 987 

QBU is determined under § 1.987–1(e) 

at the close of the taxable year in the 

functional currency of the owner. This 

is a balance sheet calculation under 

which the basis (or amount, in the case 

of a liability) of each section 987 marked 

item is translated into the owner’s 

functional currency at the spot rate on 

the last day of the taxable year. Section 

987 historic items are translated into the 

owner’s functional currency at the 

historic exchange rate and, therefore, do 

not give rise to exchange gain or loss. 

The amount of liabilities determined in 

the owner’s functional currency is 

subtracted from the value of the assets 


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determined in the owner’s functional 

currency to result in the owner 

functional currency net value of the 

section 987 QBU at the close of the 

taxable year. The owner functional 

currency net value of the section 987 

QBU at the close of the preceding 

taxable year is subtracted from the 

owner functional currency net value of 

the section 987 QBU at the close of the 

current taxable year to yield the change 

in owner functional currency net value 

of the section 987 QBU for the taxable 

year expressed in the owner’s functional 

currency. 

Generally, three components are 

reflected in the change in owner 

functional currency net value of the 

section 987 QBU for a taxable year. 

First, taxable income or loss of the 

section 987 QBU will result in increases 

or decreases in net assets, and will 

therefore affect net value. Second, 

transfers of assets or liabilities to or 

from the section 987 QBU will affect net 

value. Finally, any remaining change in 

net value (as measured in the owner’s 

functional currency) results from 

changes in the value of the section 987 

QBU’s marked assets and liabilities. In 

order to isolate the change in value due 

to foreign currency movements with 

respect to section 987 marked assets and 

liabilities, the other changes must be 

reversed out. That is the function of 

steps 2 through 7 of § 1.987–4(d). 

The unrecognized section 987 gain or 

loss when aggregated with similar 

amounts for prior years (that were not 

previously taken into account) yields a 

pool of ‘‘net unrecognized section 987 

gain or loss’’ all or part of which is to 

be triggered upon a remittance or 

termination. 

E. Section 1.987–5 Recognition of 

Section 987 Gain or Loss 

Section 1.987–5 of the proposed 

regulations provides the method for 

determining the amount of section 987 

gain or loss a taxpayer must recognize 

in a taxable year. Generally, the amount 

of section 987 gain or loss recognized in 

a taxable year equals the net 

unrecognized section 987 gain or loss of 

the section 987 QBU determined under 

§ 1.987–4 on the last day of such taxable 

year, multiplied by the owner’s 

remittance proportion. The pool of net 

unrecognized section 987 gain or loss 

includes both unrecognized section 987 

gain or loss on marked items for the 

current year and unrecognized section 

987 gain or loss on marked items for 

prior years (that has not yet been taken 

into account). A portion of the § 1.987–

4 pool of unrecognized section 987 gain 

or loss is triggered by a net transfer or 

‘‘remittance’’ to the owner by a section 

987 QBU during the owner’s taxable 

year. Generally, the owner’s remittance 

proportion is equal to the quotient of the 

amount of the remittance divided by the 

aggregate adjusted basis of the section 

987 QBU’s gross assets (as reflected on 

its year end balance sheet), without 

reduction for the remittance. 

The 1991 proposed regulations define 

a remittance as the amount of any 

transfer from a QBU branch to the extent 

the amount of transfers during the year 

does not exceed the year end balance of 

the equity pool. Transfers are limited in 

the 1991 proposed regulations by a daily 

netting rule that takes into account only 

the amount of property distributed from 

the QBU branch that exceeds the 

amount of property transferred by the 

taxpayer to the QBU branch in a single 

day. The IRS and the Treasury 

Department believe that the daily 

netting rule of the 1991 proposed 

regulations is not easily administered 

and causes distortions in the amount of 

a remittance. For example, taxpayers 

have taken the position that a 

remittance followed a short time later by 

an equal contribution to a QBU branch 

can trigger recognition of section 987 

gain or loss even though there has been 

no economic change in position of the 

QBU branch. The IRS and the Treasury 

Department believe this approach is 

inappropriate and provides incentives 

for circular cash flows used to 

manipulate amounts of remittances. 

This daily netting rule is eliminated in 

the proposed regulations to reduce 

administrative burdens on both the IRS 

and taxpayers, and to eliminate both 

taxpayer favorable and taxpayer 

unfavorable distortions that it can 

create. 

Section 1.987–5(c) of the proposed 

regulations defines a remittance as the 

excess of total transfers from the section 

987 QBU to the owner determined in 

the owner’s functional currency on an 

annual basis over total transfers from 

the owner to the section 987 QBU 

determined on an annual basis. Solely 

for purposes of determining the amount 

of a remittance under § 1.987–5(c), the 

amount of liabilities transferred from 

the owner to the section 987 QBU is 

treated as a transfer of assets from the 

section 987 QBU to the owner. 

Similarly, the amount of liabilities 

transferred from the section 987 QBU to 

the owner is treated as a transfer of 

assets from the owner to the section 987 

QBU. The IRS and the Treasury 

Department recognize that section 987 

QBUs actively engaged in business may 

have a significant number of 

transactions that are treated as transfers 

to and from the owner pursuant to 

§ 1.987–2(c). It is anticipated that the 

annual netting rule will help to reduce 

complexity and administrative burden 

for taxpayers and the IRS by treating the 

net amount of transfers as a single 

annual remittance. For purposes of 

determining the annual remittance, only 

assets and liabilities considered 

transferred pursuant to § 1.987–2(c) will 

be taken into account. 

The remittance is divided by the total 

adjusted basis of section 987 gross 

assets, expressed in the functional 

currency of the owner, reflected on the 

section 987 QBU balance sheet pursuant 

to § 1.987–2 (increased by the amount of 

the remittance) to determine the 

remittance proportion. The IRS and the 

Treasury Department considered a 

number of different measures for 

determining the amount of section 987 

gain or loss triggered upon a remittance. 

The adjusted basis of gross section 987 

QBU assets was selected as the measure 

because it avoids administrative 

concerns raised by alternative methods 

and limits the potential volatility 

associated with the recognition of 

section 987 gain or loss. In particular, 

the adjusted basis of gross section 987 

QBU assets measure avoids the 

significant administrative burdens 

associated with a section 987 QBU 

accumulated earnings approach that 

would require taxpayers to maintain 

post-1986 accumulated earnings pools 

for each section 987 QBU. The IRS and 

the Treasury Department also 

considered the use of net section 987 

QBU assets as a potential measure. 

Although the net section 987 QBU 

assets measure does not raise the same 

administrative burdens as an earnings 

based approach, the IRS and the 

Treasury Department were concerned 

about the volatility of recognizing 

section 987 gain or loss using a net asset 

measure. For example, if a section 987 

QBU’s gross assets are equal to its 

liabilities, section 987 gain or loss 

would be deferred. On the other hand, 

a small amount of income could 

increase section 987 QBU net assets 

slightly above zero and all accumulated 

section 987 gains or losses could be 

triggered with a very small remittance. 

The IRS and the Treasury Department 

believe that gross assets is a reasonable 

proxy for post-1986 accumulated 

earnings in this context, can be 

administered relatively easily, and will 

reduce the volatility and potential for 

distortion described in this preamble. 

F. Section 1.987–6 Character and 

Source 

Section 987(3)(B) requires that a 

taxpayer make proper adjustments (as 

prescribed by the Secretary) for certain 

transfers of property between QBUs of 


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3Notably, because section 987 gain or loss may 

be derived from assets acquired with earnings and 

capital of a section 987 QBU (or from liabilities 

entered into by the QBU), using post-1986 

accumulated earnings to characterize exchange gain 

or loss under section 987 may not reflect all items 

giving rise to such gain or loss. 

the taxpayer, including treating section 

987 gain or loss as ordinary income or 

loss and sourcing such gain or loss by 

reference to the source of income giving 

rise to post-1986 accumulated earnings. 

Section 987 is silent on the method of 

characterizing section 987 gain or loss 

for purposes of the Code. Nevertheless, 

the IRS and the Treasury Department 

believe that it is necessary to 

characterize section 987 gain or loss for 

the proper operation of certain other 

sections of the Code. For example, the 

character of section 987 gain must be 

determined for purposes of determining 

whether all or a portion of such gain 

qualifies as subpart F income under 

section 954. This characterization is 

necessary to prevent section 987 from 

being used as a vehicle to avoid the 

rules of section 954(c)(1)(D) with respect 

to certain section 988 transactions. In 

addition, section 987 gain or loss must 

be characterized for purposes of 

determining the foreign tax credit 

limitation under section 904(d). As a 

result, and pursuant to sections 987(3) 

and 989(c)(5), the proposed regulations 

characterize section 987 gain or loss for 

all purposes of the Code, including for 

purposes of sections 904(d), 907 and 

954. 

In accordance with section 987(3)(B), 

§ 1.987–6(a) provides that section 987 

gain or loss is ordinary income or loss. 

Moreover, the IRS and the Treasury 

Department believe that rules governing 

the source and character of section 987 

gain or loss for other Code sections 

should be consistent. The IRS and the 

Treasury Department are concerned, 

however, that sourcing and 

characterizing section 987 gain or loss 

by reference to post-1986 accumulated 

earnings would give rise to substantial 

complexity by requiring taxpayers to 

track the earnings of section 987 QBUs 

in section 904(d) categories over 

prolonged periods. The compliance 

burden would be considerable for 

taxpayers with large numbers of section 

987 QBUs. Accordingly, the IRS and the 

Treasury Department believe that it is 

appropriate to use the average tax book 

value of assets in the year of remittance 

as determined under § 1.861–9T(g) as a 

proxy for post-1986 accumulated 

earnings in the context of section 987.3

In the context of section 987, use of a 

single year’s assets should generally 

reflect the activities of a section 987 

QBU that give rise to a section 987 

QBU’s accumulated earnings and will 

significantly minimize complexity. The 

tax book value method set forth in 

§ 1.861–9T(g) as applied to section 987 

QBUs has been amended to provide 

greater consistency with the proposed 

regulations. The modified gross income 

method described in § 1.861–9T(j) 

cannot be used to characterize section 

987 gain or loss as the IRS and the 

Treasury Department believe that gross 

income earned in a single year is not a 

sufficient proxy for accumulated 

earnings. 

The IRS and the Treasury Department 

recognize that the characterization rule 

contained in the proposed regulations 

applies to provisions other than the 

international tax rules. In addition, the 

IRS and the Treasury Department 

recognize that special considerations 

may arise in connection with applying 

this characterization rule to various 

domestic provisions. For example, 

special considerations may arise when 

characterizing section 987 gain or loss 

for rules that apply to regulated 

investment companies (RICs) and real 

estate investment trusts (REITs). The 

IRS and the Treasury Department are 

studying the application of the 

characterization rules to these other 

provisions and request comments. As a 

result, the proposed regulations reserve 

on the method for characterizing and 

sourcing section 987 gain or loss for 

purposes of RICs and REITs. 

G. Section 1.987–7 Partnership Rules 

1. Scope 

Section 1.987–7 provides rules for 

determining a partner’s share of the 

assets and liabilities of an eligible QBU 

held indirectly through a section 987 

partnership. It also provides rules 

coordinating the application of section 

987 with subchapter K of chapter 1 of 

the Code. 

2. Allocation of Assets and Liabilities 

In order to apply the foreign exchange 

exposure pool method at the partner 

level, as discussed above, each partner 

must determine its share of the assets 

and liabilities of an eligible QBU and, to 

the extent applicable, a section 987 QBU 

owned indirectly through the section 

987 partnership. Section 1.987–7 

provides a general rule that requires the 

allocation of the assets and liabilities of 

the partnership’s eligible QBUs to the 

partners in a manner that is consistent 

with the manner in which the partners 

have agreed to share the economic 

benefits and burdens corresponding to 

such assets and liabilities, taking into 

account the rules and principles of 

sections 701 through 761 and the 

regulations thereunder, including 

section 704(b) and § 1.701–2. 

The IRS and the Treasury Department 

believe that this general rule is 

appropriate because it will allocate the 

assets and liabilities consistent with the 

partners’ economic arrangement. The 

IRS and the Treasury Department 

recognize that any rule which attempted 

to allocate the assets and liabilities 

without regard to such economic 

arrangement would have the effect of 

distorting each partner’s section 987 

gain or loss attributable to its section 

987 QBU and, as a result, would be 

inappropriate. Moreover, the IRS and 

the Treasury Department are concerned 

that taxpayers could attempt to 

inappropriately shift a partner’s share of 

the underlying assets and liabilities of a 

section 987 QBU owned indirectly 

through a section 987 partnership to 

distort the partner’s section 987 gain or 

loss. As a result, the Commissioner may 

review such allocations to ensure that 

they are consistent with the economic 

arrangement of the partners and the 

principles of subchapter K of Chapter 1 

of the Code and the applicable 

regulations, including section 704(b) 

and § 1.701–2. 

Moreover, the IRS and the Treasury 

Department are considering whether it 

would be appropriate, when these 

regulations are finalized, to provide a 

safe harbor. Under such a safe harbor, 

the assets and liabilities of an eligible 

QBU would be deemed to be allocated 

in a manner which appropriately 

reflects each partner’s share of the 

economic benefits and burdens if 

certain conditions are satisfied. For 

example, the safe harbor could provide 

that the assets and liabilities are deemed 

to be allocated in a manner consistent 

with each partner’s share of the 

underlying economic benefits and 

burdens provided the assets, to the 

extent of a partner’s share of partnership 

capital, are allocated in accordance with 

such capital and any excess assets 

(assets in excess of partnership capital) 

are allocated consistent with the manner 

in which the partners have agreed to 

share the economic burden of the 

liabilities incurred to acquire such 

assets. The IRS and the Treasury 

Department request comments as to 

whether a safe harbor should be 

included and, if so, what form such safe 

harbor should take. 

3. Coordination with subchapter K 

A partner must take into account its 

share of the items of income, gain, 

deduction, or loss of its section 987 

QBU owned indirectly through a 

partnership and, under § 1.987–3, must 

convert such items into its functional 


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currency. In addition, a partner must 

take into account any section 987 gain 

or loss of the section 987 QBU 

determined in the partner’s functional 

currency. In both situations, the 

partner’s adjusted basis in its 

partnership interest must be adjusted in 

order to avoid the duplication of income 

or loss attributable to the section 987 

QBU. Section 1.987–7 provides a rule 

regarding the appropriate adjustments 

which must be made to the partner’s 

adjusted basis in the section 987 

partnership to ensure that no such 

duplication occurs. 

A partner is also required under 

section 752 to adjust its basis in its 

interest in the section 987 partnership to 

take into account liabilities of the 

section 987 partnership. As a result, the 

proposed regulations provide rules for 

determining the appropriate 

adjustments to such basis required 

under section 752 in the case of an 

increase or a decrease in such partner’s 

share of the liabilities of the partnership 

reflected on the books and records of a 

section 987 QBU. In addition, the 

proposed regulations provide rules for 

determining the amount of such 

liability, as determined in the partner’s 

functional currency, which must be 

taken into account on the sale or 

exchange of a partnership interest under 

section 752(d). 

The proposed regulations also clarify, 

consistent with section 985(a), that a 

partner’s adjusted basis in its 

partnership interest is determined in the 

functional currency of the partner. 

Moreover, the proposed regulations 

provide that the fluctuations between 

the partner’s functional currency and 

the functional currency of the section 

987 QBU do not affect such partner’s 

adjusted basis in its partnership interest. 

Instead, such fluctuations are taken into 

account under the foreign exchange 

exposure pool method of § 1.987–4. 

4. Comments 

The proposed regulations do not 

address the adjustments which would 

occur under section 752 when there is 

an assumption by a partnership of a 

partner’s liability that is denominated in 

a functional currency different from the 

partner and which, as a result, is subject 

to section 988 in the hands of the 

partner. In such cases, the partner will 

be deemed to receive a distribution of 

money, under section 752(b), regardless 

of whether, following the assumption, 

the liability is reflected on the books 

and records of the partnership’s 

qualified business unit. In such cases, it 

is unclear whether the amount of the 

distribution should be determined by 

reference to the spot rate (on the date of 

assumption) or the historic exchange 

rate (on the date the liability was 

originally incurred by the partner). In 

addition, this issue raises concerns as to 

how section 988 would operate upon 

such assumption. The IRS and Treasury 

Department request comments on this 

issue and whether provisions should be 

included in section 988 to better 

coordinate the operation of section 987 

and section 988 in this context. In 

addition, comments are requested on 

whether provisions should be included 

in section 988 in order to coordinate the 

aggregate approach, adopted in these 

proposed regulations, with respect to 

certain assets and liabilities that are not 

reflected on an eligible QBU of the 

partnership. 

In addition to the issues specifically 

addressed in the proposed regulations, 

the IRS and the Treasury Department 

request comments on additional 

provisions which should be included to 

coordinate the provisions of section 987 

with subchapter K of chapter 1 of the 

Code. Specifically, comments are 

requested as to how capital accounts 

maintained under section 704 should be 

adjusted to take into account section 

987 gain or loss. In addition, comments 

are requested as to whether section 987 

loss should be subject to the limitation 

provided under section 704(d) and, if 

so, how such limitation might be 

applied. Finally, comments are 

requested as to any other provisions of 

subchapter K of chapter 1 of the Code 

on which guidance should be provided. 

H. Section 1.987–8 Termination of a 

Section 987 QBU 

1. General termination rules 

The proposed regulations set forth 

circumstances in which a section 987 

QBU will terminate. For purposes of 

§ 1.987–5, a termination of a section 987 

QBU is treated as a remittance of all the 

gross assets of the section 987 QBU to 

its owner. The termination rules 

recognize that an owner carries on a 

trade or business through its section 987 

QBU and when the owner stops 

conducting that trade or business 

through its section 987 QBU, any 

section 987 gain or loss should be 

recognized in full. Thus, a termination 

generally occurs when: (1) The activities 

of the section 987 QBU cease; (2) 

substantially all of the assets (as defined 

in section 368(a)(1)(C)) of the section 

987 QBU are transferred to its owner; or 

(3) the owner of the section 987 QBU 

ceases to exist. 

In addition, a termination occurs 

when a foreign corporation that is a 

controlled foreign corporation (CFC) 

that is the owner of a section 987 QBU 

ceases to be a CFC because at that point 

any section 987 gain or loss cannot be 

subpart F income and may be deferred 

indefinitely. 

2. Exceptions for Certain Section 381 

Transactions 

Section 987 gain or loss generally 

arises during the period that an owner 

has a section 987 QBU. The section 987 

gain or loss is analogous in some 

respects to a tax attribute under section 

381. As a result, the proposed 

regulations provide that a termination 

does not generally occur when other tax 

attributes under section 381 are carried 

over in a liquidation under section 332 

or an asset reorganization under section 

368(a). However, inbound and outbound 

liquidations and reorganizations 

terminate a section 987 QBU because 

these transactions materially change the 

circumstances in which section 987 gain 

or loss is taken into account. 

3. Treatment of Inbound Liquidations 

and Inbound Asset Reorganizations 

Although the proposed regulations 

treat inbound liquidations under section 

332 and inbound asset reorganizations 

under section 368(a) as terminations, 

the IRS and the Treasury Department 

are considering whether such treatment 

is appropriate in all cases. 

The IRS and the Treasury Department 

believe that the better view, taking into 

account various policies, is to support 

the treatment of inbound transactions as 

terminations. For example, such 

treatment may prevent the importation 

of a tax attribute that was generated 

offshore. Concerns over such attribute 

importation are similar to those that 

were addressed in § 1.367(b)–3(e) and (f) 

and section 362(e). In addition, treating 

inbound asset transactions as 

terminations is consistent with the 

results that would obtain if the foreign 

currency gain or loss attributable to the 

QBU were taken into account under 

section 988, rather than section 987. 

The IRS and the Treasury Department 

acknowledge, however, that other 

policies may support the position that 

such inbound transactions should not 

be terminations. One of the reasons the 

proposed regulations treat certain 

section 381 transactions as terminations 

is because amounts taken into account 

under section 987 (that is, section 987 

taxable income or loss, and section 987 

gain or loss) generally become subject to 

a lesser degree of U.S. taxation after the 

section 381 transaction than was the 

case before the transaction (that is, 

when the section 987 QBU goes from 

being owned by a domestic corporation 

to being owned by a foreign 

corporation). This is not the case in 


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certain inbound transactions because 

amounts taken into account under 

section 987 are generally subject to a 

greater degree of U.S. taxation after the 

inbound transaction (when the section 

987 QBU is owned by a domestic 

corporation) than was the case before 

the transaction (when the section 987 

QBU was owned by a foreign 

corporation). 

The IRS and the Treasury Department 

request comments on whether it is 

appropriate to treat these inbound asset 

transactions as terminations. Such 

comments should take into account the 

policy concerns discussed in this 

preamble. 

4. Section 351 Exchanges and 

Transactions Within a Consolidated 

Group 

The proposed regulations provide that 

a termination occurs when the owner of 

a section 987 QBU transfers the QBU to 

another corporation in exchange for 

stock in a transaction qualifying under 

section 351. The termination occurs 

because the owner no longer has a 

section 987 QBU. 

The IRS and the Treasury Department 

are studying ways to apply the 

intercompany transaction rules of 

§ 1.1502–13 to section 987 transactions 

within a consolidated group. For 

example, the IRS and the Treasury 

Department are considering whether 

transfers qualifying under section 351 

which would trigger a remittance or 

termination under the proposed 

regulations should qualify for deferral 

under § 1.1502–13. The IRS and the 

Treasury Department request comments 

on the interplay between § 1.1502–13 

and the proposed regulations and the 

timing of the inclusion of the deferred 

section 987 gain or loss. 

I. Section 1.987–9 Recordkeeping 

Rules 

Given the detailed nature of the 

calculations required under these 

regulations, § 1.987–9 articulates the 

records that taxpayers must keep. A 

taxpayer must keep such records as are 

sufficient to establish the section 987 

QBU’s section 987 taxable income or 

loss, its section 987 gain or loss, and the 

transition method used for section 987 

QBUs under § 1.987–10. Section 1.987–

9(b) lists supplemental records that 

must be maintained. 

J. Section 1.987–10 Transition Rules 

The transition rules of § 1.987–10 

apply to a taxpayer that is the owner of 

a section 987 QBU on the transition 

date. Such a taxpayer must transition to 

the foreign exchange exposure pool 

method of these regulations whether or 

not such taxpayer made determinations 

required under section 987 in prior 

years. A taxpayer that failed to make 

required determinations under section 

987 in prior years or that used an 

unreasonable method in prior years can 

only use the fresh start transition 

method of § 1.987–10(c)(4) as described 

in this preamble. Generally, use of the 

1991 proposed section 987 regulations 

method (see, Examples 1 and 3 of 

§ 1.987–10(d)) or an ‘‘earnings only’’

section 987 method (see, Example 2 of 

§ 1.987–10(d)) will be considered a 

reasonable method for purposes of 

§ 1.987–10. However, for example, the 

recognition of section 987 gain or loss 

with respect to stock under any method, 

where the gain or loss does not reflect 

economic gain or loss derived from the 

movements in exchange rates, will be 

carefully scrutinized by the IRS and 

may be considered unreasonable based 

on the facts and circumstances of the 

particular case. 

The transition date is the first day of 

the first taxable year to which these 

section 987 regulations apply. 

Comments are requested on the 

application of these transition rules to 

partnerships which were, under the 

current proposed regulations, treated as 

qualified business units for purposes of 

section 987. Comments are also 

requested on the treatment of qualified 

business units of such partnerships. 

Generally, § 1.987–10(c) allows a 

taxpayer to transition to the foreign 

exchange exposure pool method set 

forth in these regulations under one of 

two methods (the ‘‘deferral transition 

method’’ or the ‘‘fresh start transition 

method’’). Under the conformity rules of 

§ 1.987–10(c)(2), this election must be 

applied with respect to all members that 

file a consolidated return with the 

taxpayer and any controlled foreign 

corporation as defined in section 957 in 

which the taxpayer owns more than 50 

percent of the voting power or stock (as 

determined in section 957(a)). This 

conformity rule is necessary to prevent 

taxpayers and certain related entities 

from taking inconsistent positions with 

respect to qualified business units 

which have unrecognized section 987 

gains and losses. The IRS and the 

Treasury Department request comments 

on concerns that may arise by the 

inclusion of certain controlled foreign 

corporations in the conformity rule. 

Under the deferral transition method 

of § 1.987–10(c)(3), section 987 gain or 

loss is determined under the taxpayer’s 

prior section 987 method on the 

transition date as if all qualified 

business units of the taxpayer 

terminated on the last day of the taxable 

year preceding the transition date. The 

deemed termination is solely for 

purposes of measuring section 987 gain 

or loss in order to transition to the 

foreign exchange exposure pool method 

and does not apply for any other 

purpose. Section 987 gain or loss 

determined on the deemed termination 

is not immediately recognized. Rather, it 

is deferred by treating it as net 

unrecognized section 987 gain or loss of 

the relevant section 987 QBU. Such gain 

or loss will be recognized under the 

remittance rules of § 1.987–5 for periods 

after the transition date. The owner of 

a qualified business unit that is deemed 

to terminate under these rules is treated 

as having transferred all of the assets 

and liabilities attributable to the 

qualified business unit to a new section 

987 QBU on the transition date. In order 

to avoid double counting, § 1.987–

10(c)(3)(ii) provides that the exchange 

rates used to determine the amount of 

an asset or liability transferred from the 

owner to the new section 987 QBU on 

the transition date (that is, for purposes 

of making later calculations under 

§ 1.987–4) is determined with reference 

to the historic exchange rates on the day 

the asset was acquired or liability 

entered into by the qualified business 

unit deemed terminated. That exchange 

rate is then adjusted to take into account 

an allocation of section 987 gain or loss 

determined under the deferral transition 

method. If the taxpayer is not able to 

trace an historic exchange rate to a 

particular asset or liability, then the 

exchange rate must be determined 

under a reasonable allocation method, 

consistently applied, that takes into 

account an allocation of the aggregate 

basis and an allocation of the deferred 

section 987 gain or loss. 

Under the fresh start transition 

method of § 1.987–10(c)(4), on the 

transition date all qualified business 

units of the taxpayer subject to section 

987 are deemed terminated on the last 

day of the taxable year preceding the 

transition date. As under the deferral 

transition method, this deemed 

termination is solely for purposes of 

transitioning to the foreign exchange 

exposure pool method under section 

987 and does not apply for any other 

purpose. Under the fresh start transition 

method, no section 987 gain or loss is 

determined or recognized on such 

deemed termination. Rather, the 

exchange rates used to determine the 

total amount of assets and liabilities 

deemed transferred from the owner to 

the section 987 QBU for the section 987 

QBU’s first taxable year are determined 

solely with reference to the historic 

exchange rates on the day the assets 

were acquired or liabilities entered into 


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by the qualified business unit that was 

deemed terminated. Like the deferral 

transition method, if the taxpayer is not 

able to trace an exchange rate to a 

particular asset or liability, then the 

exchange rate must be determined 

under a reasonable allocation method, 

consistently applied, that takes into 

account the aggregate basis of the QBU’s 

assets (and amount of liabilities). The 

fresh start method is designed to 

prevent recognition of non-economic 

currency gain or loss with respect to 

unremitted assets that are attributable to 

the qualified business unit. In the first 

taxable year when the foreign exchange 

exposure pool method applies, the 

deemed contribution of marked assets to 

a section 987 QBU at the historic 

exchange rate when originally acquired 

potentially gives rise to section 987 gain 

or loss while the historic assets (also 

translated at the historic exchange rate) 

will not. 

The transition method adopted by the 

taxpayer must be disclosed in 

accordance with the rules provided in 

§ 1.987–10(c)(6). 

Proposed Effective Date 

These regulations are proposed to be 

effective as follows. These regulations 

shall generally apply to taxable years 

beginning one year after the first day of 

the first taxable year following the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. A taxpayer may 

elect to apply these regulations to 

taxable years beginning after the date of 

publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. Such election is 

binding on all members that file a 

consolidated return with the taxpayer 

and any controlled foreign corporation, 

as defined in section 957, in which the 

taxpayer owns more than 50 percent of 

the voting power or stock (as 

determined in section 957(a)). Pending 

finalization, the IRS and the Treasury 

Department would consider positions 

consistent with these proposed 

regulations to be reasonable 

constructions of the statute. 

Special Analyses 

It has been determined that this notice 

of proposed rulemaking is not a 

significant regulatory action as defined 

in Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

has also been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations. It is hereby 

certified that the collection of 

information contained in this regulation 

will not have a significant economic 

impact on a substantial number of small 

entities. Accordingly, a regulatory 

flexibility analysis is not required. The 

proposed section 987 regulations will 

generally only affect large United States 

corporations with business units 

operating in foreign jurisdictions. Thus, 

the number of affected small entities 

will not be substantial and any 

economic impact on those entities in 

complying with the collection of 

information would be minimal. 

Pursuant to section 7805(f) of the 

Internal Revenue Code, this notice of 

proposed rulemaking will be submitted 

to the Chief Counsel for Advocacy of the 

Small Business Administration for 

comment on its impact on small 

businesses. 

Comments and Public Hearing 

Before the proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. The IRS 

and the Treasury Department request 

comments on the clarity of the proposed 

rules and how they can be made easier 

to understand. All comments will be 

available for public inspection and 

copying. 

A public hearing has been scheduled 

for November 21, 2006, beginning at 10 

a.m. in the Auditorium, Internal 

Revenue Service, New Carrollton 

Federal Building, 5000 Ellin Road, 

Lanham, MD 20706. In addition, all 

visitors must present photo 

identification to enter the building. 

Because of access restrictions, visitors 

will not be admitted beyond the 

immediate entrance area more than 30 

minutes before the hearing starts. For 

information about having your name 

placed on the building access list to 

attend the hearing, see the FOR FURTHER

INFORMATION CONTACT section of this 

preamble. 

The rules of 26 CFR 601.601(a)(3) 

apply to the hearing. Persons who wish 

to present oral comments must submit 

electronic or written comments by 

December 6, 2006 and an outline of the 

topics to be discussed and time to be 

devoted on each topic (a signed original 

and eight (8) copies) by October 31, 

2006. A period of 10 minutes will be 

allotted to each person for making 

comments. An agenda showing the 

scheduling of the speakers will be 

prepared after the deadline for receiving 

outlines has passed. Copies of the 

agenda will be available free of charge 

at the hearing. 

Drafting Information 

The principal authors of the proposed 

regulations are Jeffrey Dorfman and 

Theodore Setzer of the Office of 

Associate Chief Counsel (International). 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Withdrawal of Notice of Proposed 

Rulemaking 

Accordingly, under the authority of 

26 U.S.C. 7805, the notice of proposed 

rulemaking (REG–208270–86) that was 

published in the Federal Register on 

September 25, 1991 (56 FR 48457) is 

withdrawn. 

Proposed Amendment to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 987, 989(c), 6601 and 

7805 * * * 

Par. 2. Section 1.861–9T is amended 

as follows: 

1. Paragraph (g)(2)(ii)(A)(1) is revised. 

2. Paragraph (g)(2)(vi) is added. 

The revisions read as follows: 

§ 1.861–9T Allocation and apportionment 

of interest expense (temporary). 

* * * * * 

(g) * * * 

(2) * * * 

(ii) * * * (A) * * * 

(1) Section 987 QBU. In the case of a 

section 987 QBU, the tax book value 

shall be determined by applying the 

rules of paragraphs (g)(2)(i) and (3) of 

this section to the beginning of year and 

end of year functional currency amount 

of assets. The beginning of year 

functional currency amount of assets 

shall be determined by reference to the 

functional currency amount of assets 

computed under § 1.987–4(d)(1)(i)(B) 

and (e) on the last day of the preceding 

taxable year. The end of year functional 

currency amount of assets shall be 

determined by reference to the 

functional currency amount of assets 

computed under § 1.987–4(d)(1)(i)(A) 

and (e) on the last day of the current 

taxable year. The beginning of year and 

end of year functional currency amount 

of assets, as so determined within each 

grouping must then be averaged as 

provided in paragraph (g)(2)(i) of this 

section. 

* * * * * 


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(vi) Effective date. Generally, 

paragraph (g)(2)(ii)(A)(1) of this section 

shall apply to taxable years beginning 

one year after the first day of the first 

taxable year following the date of 

publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. If a taxpayer 

makes an election under § 1.987–11(b), 

then the effective date of paragraph 

(g)(2)(ii)(A)(1) of this section with 

respect to the taxpayer shall be 

consistent with such election. 

* * * * * 

Par. 3. Section 1.985–1 is amended as 

follows: 

1. Paragraph (d)(2), second sentence; 

and paragraph (f), Example 9 and 

Example 10(i), ninth sentence are 

revised. 

2. Paragraph (f), Example 11 is 

removed. 

3. Paragraph (f), Example 12 is 

redesignated as Example 11. 

4. Paragraph (g) is added. 

The revisions and addition read as 

follows: 

§ 1.985–1 Functional currency. 

* * * * * 

(d) * * * 

(2) * * * The amount of income or 

loss or earnings and profits (or deficit in 

earnings and profits) of each QBU in its 

functional currency shall then be 

translated into the foreign corporation’s 

functional currency under the 

principles of section 987. 

* * * * * 

(f) Examples. * * * 

Example (9). (i) The facts are the same as 

in Example (7). In addition, assume that in 

1987 branch A has items of earnings of 100 

FC and branch B has items of earnings of 100 

LC as determined under section 987. S 

translates branch A’s and branch B’s items of 

earnings and profits into its functional 

currency under the principles of section 987. 

Example (10). (i) * * * Assume that B’s 

items of income of 200 DCs when properly 

translated under the principles of section 987 

is equal to 100 LCs. * * * 

* * * * * 

(g) Effective date. Generally, the 

revisions to the second sentence of 

paragraph (d)(2), Example 9, and 

Example 10 shall apply to taxable years 

beginning one year after the first day of 

the first taxable year following the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. If a taxpayer 

makes an election under § 1.987–11(b), 

then the effective date of these revisions 

with respect to the taxpayer shall be 

consistent with such election. 

Par 4. Section 1.985–5 is revised to 

read as follows: 

§ 1.985–5 Adjustments required upon 

change in functional currency. 

(a) In general. This section applies in 

the case of a taxpayer, qualified 

business unit (QBU) or section 987 QBU 

as defined in § 1.987–1(b)(2) changing 

from one functional currency (old 

functional currency) to another 

functional currency (new functional 

currency). A taxpayer, QBU, or section 

987 QBU subject to the rules of this 

section shall make the adjustments set 

forth in the 3-step procedure described 

in paragraphs (b) through (e) of this 

section. Except as otherwise provided in 

this section, the adjustments shall be 

made on the last day of the taxable year 

ending before the year of change as 

defined in § 1.481–1(a)(1). Gain or loss 

required to be recognized under 

paragraphs (b), (d)(2), (e)(2), and 

(e)(4)(iii) of this section is not subject to 

section 481 and, therefore, the full 

amount of the gain or loss must be 

included in income or earnings and 

profits on the last day of the taxable year 

ending before the year of change. Except 

as provided in § 1.985–6, a QBU or 

section 987 QBU with a functional 

currency for its first taxable year 

beginning in 1987 that is different from 

the currency in which it had kept its 

books and records for United States 

accounting and tax accounting purposes 

for its prior taxable year shall apply the 

principles of this section for purposes of 

computing the relevant functional 

currency items, such as earnings and 

profits, basis of an asset, and amount of 

a liability, as of the first day of a 

taxpayer’s first taxable year beginning in 

1987. However, a QBU that changes to 

the dollar pursuant to § 1.985–1(b)(2) 

after 1987 shall apply § 1.985–7. 

(b) Step 1 Taking into account 

exchange gain or loss on certain section 

988 transactions. The taxpayer, QBU or 

section 987 QBU shall recognize or 

otherwise take into account for all 

purposes of the Internal Revenue Code 

the amount of any unrealized exchange 

gain or loss attributable to a section 988 

transaction (as defined in section 

988(c)(1)(A), (B), and (C)) that, after 

applying section 988(d), is denominated 

in terms of or determined by reference 

to the new functional currency. The 

amount of such gain or loss shall be 

determined without regard to the 

limitations of section 988(b) (that is, 

whether any gain or loss would be 

realized on the transaction as a whole). 

The character and source of such gain 

or loss shall be determined under 

section 988. 

(c) Step 2 Determining the new 

functional currency basis of property 

and the new functional currency 

amount of liabilities and any other 

relevant items. Except as otherwise 

provided in this section, the new 

functional currency adjusted basis of 

property and the new functional 

currency amount of liabilities and any 

other relevant items (for example, items 

described in section 988(c)(1)(B)(iii)) 

shall equal the product of the amount of 

the old functional currency adjusted 

basis or amount multiplied by the new 

functional currency/old functional 

currency spot exchange rate on the last 

day of the taxable year ending before the 

year of change (spot rate). 

(d) Step 3A Additional adjustments 

that are necessary when a QBU or 

section 987 QBU changes functional 

currency—(1) QBU changing to a 

functional currency other than the 

owner’s functional currency—(i) Rule. If 

a QBU or section 987 QBU changes to 

a functional currency other than the 

owner’s functional currency, the owner 

and section 987 QBU shall make the 

adjustments set forth in either paragraph 

(d)(1)(ii) or (d)(1)(iii) of this section for 

purposes of section 987. 

(ii) Where prior to the change the 

section 987 QBU and owner had 

different functional currencies. If the 

section 987 QBU and the owner had 

different functional currencies prior to 

the change, the owner and section 987 

QBU shall make the following 

adjustments in the year of change. 

(A) Determining the owner functional 

currency net value of the section 987 

QBU under § 1.987–4(d)(1)(i)(B)—(1) 

Historic items. For purposes of 

determining the owner functional 

currency net value of the section 987 

QBU for the year of change under 

§ 1.987–4(d)(1)(i)(B), the owner or 

section 987 QBU shall first translate the 

section 987 historic items from the 

QBU’s old functional currency into its 

owner’s functional currency using the 

historic exchange rate as defined in 

§ 1.987–1(c)(3). The owner or section 

987 QBU shall then translate the section 

987 historic items as defined in § 1.987–

1(e) from the owner’s functional 

currency into the QBU’s new functional 

currency using the spot exchange rate 

between the section 987 QBU’s new 

functional currency and the owner’s 

functional currency on the last day of 

the taxable year ending before the year 

of change. 

(2) Marked items. For purposes of 

determining the owner functional 

currency net value of the section 987 

QBU for the year of change under 

§ 1.987–4(d)(1)(i)(B), the owner or 

section 987 QBU shall translate the 

section 987 QBU’s section 987 marked 

items as defined in § 1.987–1(d) from 

the section 987 QBU’s old functional 

currency into the QBU’s new functional 


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currency using the new functional 

currency/old functional currency spot 

exchange rate on the last day of the 

taxable year ending before the year of 

change. 

(B) Net unrecognized section 987 gain 

or loss. No adjustment to the owner’s 

net unrecognized section 987 gain or 

loss is necessary. 

(iii) Where prior to the change the 

QBU and the taxpayer had the same 

functional currency. If a QBU with the 

same functional currency of the 

taxpayer is changing to a new functional 

currency different from the taxpayer, 

and as a result of the change the 

taxpayer will be an owner of a section 

987 QBU (see § 1.987–1), the taxpayer 

and section 987 QBU shall become 

subject to section 987 for the year of 

change and subsequent years. 

(2) Section 987 QBU changing to the 

owner’s functional currency. If a section 

987 QBU changes its functional 

currency to its owner’s functional 

currency, the section 987 QBU shall be 

treated as if it terminated on the last day 

of the taxable year ending before the 

year of change. See §§ 1.987–5 and 

1.987–8 for the effect of a termination. 

(e) Step 3B Additional adjustments 

that are necessary when a taxpayer/ 

owner changes functional currency (1) 

Corporations. The amount of a 

corporation’s new functional currency 

earnings and profits and the amount of 

its new functional currency paid-in 

capital shall equal the product of the old 

functional currency amounts of such 

items multiplied by the spot rate. The 

foreign income taxes and accumulated 

profits or deficits in accumulated profits 

of a foreign corporation that were 

maintained in foreign currency for 

purposes of section 902 and that are 

attributable to taxable years of the 

foreign corporation beginning before 

January 1, 1987, also shall be translated 

into the new functional currency at the 

spot rate. 

(2) Collateral consequences to a 

United States shareholder of a 

corporation changing to the United 

States dollar as its functional currency. 

A United States shareholder (within the 

meaning of section 951(b) or section 

953(c)(1)(A)) of a controlled foreign 

corporation (within the meaning of 

section 957 or section 953(c)(1)(B)) 

changing its functional currency to the 

dollar shall recognize foreign currency 

gain or loss computed under section 

986(c) as if all previously taxed earnings 

and profits, if any, (including amounts 

attributable to pre-1987 taxable years 

that were translated from dollars into 

functional currency in the foreign 

corporation’s first post-1986 taxable 

year) were distributed immediately 

prior to the change. Such a shareholder 

shall also recognize gain or loss 

attributable to the corporation’s paid-in 

capital to the same extent, if any, that 

such gain or loss would be recognized 

under the regulations under section 

367(b) if the corporation was liquidated 

completely. 

(3) Taxpayers that are not 

corporations. [Reserved]. 

(4) Adjustments to a section 987 

QBU’s balance sheet and net 

accumulated unrecognized section 987 

gain or loss when an owner changes 

functional currency—(i) Owner 

changing to a functional currency other 

than the section 987 QBU’s functional 

currency. If an owner changes to a 

functional currency that differs from the 

functional currency of its section 987 

QBU, the owner shall make the 

following adjustments in the year of 

change. 

(A) Determining the owner functional 

currency net value of the section 987 

QBU under § 1.987–4(d)(1)(i)(B)—(1) 

Historic items. For purposes of 

determining the owner functional 

currency net value of the section 987 

QBU for the year of change under 

§ 1.987–4(d)(1)(i)(B), the owner shall 

first translate the QBU’s section 987 

historic items into the owner’s old 

functional currency at the historic 

exchange rate as defined in § 1.987–

1(c)(3). The owner shall then translate 

the section 987 historic items into its 

new functional currency using the new 

functional currency/old functional 

currency spot rate on the last day of the 

taxable year ending before the year of 

change. 

(2) Marked items. For purposes of 

determining the owner functional 

currency net value of the section 987 

QBU for the year of change under 

§ 1.987–4(d)(1)(i)(B), the owner or 

section 987 QBU shall translate the 

QBU’s section 987 marked items from 

the owner’s old functional currency into 

the owner’s new functional currency 

using the new functional currency/old 

functional currency spot exchange rate 

on the last day of the taxable year 

ending before the year of change. 

(B) Translation of net unrecognized 

section 987 gain or loss. The owner 

shall translate any net unrecognized 

section 987 gain or loss determined 

under § 1.987–4 from its old functional 

currency into its new functional 

currency using the new functional 

currency/old functional currency spot 

exchange rate on the last day of the 

taxable year ending before the year of 

change. 

(ii) Taxpayer with the same functional 

currency as its QBU changing to a 

different functional currency. If a 

taxpayer with the same functional 

currency as its QBU changes to a new 

functional currency and as a result of 

the change the taxpayer will be an 

owner of a section 987 QBU (see 

§ 1.987–1), the taxpayer and section 987 

QBU shall become subject to section 987 

for the year of change and subsequent 

years. 

(iii) Owner changing to the same 

functional currency as the section 987 

QBU. If an owner changes to the same 

functional currency as its section 987 

QBU, such section 987 QBU shall be 

treated as if it terminated on last day of 

the taxable year ending before the year 

of change. See §§ 1.987–5 and 1.987–8 

for the effect of a termination. 

(f) Examples. The provisions of this 

section are illustrated by the following 

example: 

Example. S, a calendar year foreign 

corporation, is wholly owned by domestic 

corporation P. The Commissioner granted 

permission to change S’s functional currency 

from the LC to the FC beginning January 1, 

1993. The LC/FC exchange rate on December 

31, 1992, is 1 LC/2 FC. The following shows 

how S must convert the items on its balance 

sheet from the LC to the FC. 

LC 1 2 FC 

Assets: 

Cash on hand ................................................................................................................................................... 40,000 80,000 

Accounts Receivable ........................................................................................................................................ 10,000 20,000 

Inventory ........................................................................................................................................................... 100,000 200,000 

100,000 FC Bond (100,000 LC historical basis) .............................................................................................. 1 50,000 100,000 

Fixed assets: 

Property ............................................................................................................................................................ 200,000 400,000 

Plant .................................................................................................................................................................. 500,000 1,000,000 

Accumulated Depreciation ........................................................................................................................ (200,000) (400,000) 

Equipment ......................................................................................................................................................... 1,000,000 2,000,000 


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LC 1 2 FC 

Accumulated Depreciation ........................................................................................................................ (400,000) (800,000) 

Total Assets ....................................................................................................................................... 1,300,000 2,600,000 

Liabilities: 

Accounts Payable ............................................................................................................................................. 50,000 100,000 

Long-term Liabilities ......................................................................................................................................... 400,000 800,000 

Paid-in-Capital .................................................................................................................................................. 800,000 1,600,000 

Retained Earnings ............................................................................................................................................ 2 50,000 100,000 

Total Liabilities and Equity ................................................................................................................. 1,300,000 2,600,000 

1 Under paragraph (b) of this section, S will recognize a 50,000 LC loss (100,000 LC basis—50,000 LC value) on the bond resulting from the 

change in functional currency. Thus, immediately before the change, S’s basis in the FC bond (taking into account the loss) is 50,000 LC. 2The amount of S’s LC retained earnings reflects the 50,000 LC loss on the bond. 

(g) Effective date. Generally, this 

regulation shall apply to taxable years 

beginning one year after the first day of 

the first taxable year following the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. If a taxpayer 

makes an election under § 1.987–11(b), 

then the effective date of this regulation 

with respect to the taxpayer shall be 

consistent with such election. 

Par. 5. Sections 1.987–1 through 

1.987–4 and §§ 1.987–6 through 1.987–

11 are added and § 1.987–5 is revised to 

read as follows: 

§ 1.987–1 Scope, definitions and special 

rules. 

(a) In general. These regulations 

provide rules for determining the 

taxable income or loss of a taxpayer 

with respect to a section 987 qualified 

business unit (section 987 QBU) as 

defined in paragraph (b)(2) of this 

section. Further, these regulations 

provide rules for determining the 

timing, amount, character and source of 

section 987 gain or loss recognized with 

respect to a section 987 QBU. This 

section addresses the scope of these 

regulations and provides certain 

definitions and special rules. Section 

1.987–2 provides rules for attributing 

assets and liabilities and items of 

income, gain, deduction, and loss to an 

eligible QBU and a section 987 QBU. It 

also provides rules regarding transfers 

and the translation of items transferred 

to a section 987 QBU. Section 1.987–3 

provides rules for determining and 

translating the section 987 taxable 

income or loss of a taxpayer with 

respect to a section 987 QBU. Section 

1.987–4 provides rules for determining 

net unrecognized section 987 gain or 

loss. Section 1.987–5 provides rules 

regarding the recognition of section 987 

gain or loss. Section 1.987–6 provides 

rules regarding the character and source 

of section 987 gain or loss. Section 

1.987–7 provides rules with respect to 

partnerships and rules necessary to 

coordinate the provisions of section 987 

with subchapter K. Section 1.987–8 

provides rules regarding the termination 

of a section 987 QBU. Section 1.987–9 

provides rules regarding the 

recordkeeping required under section 

987. Section 1.987–10 provides 

transition rules. Section 1.987–11 

provides the effective date of these 

regulations. 

(b) Scope of section 987 and 

definitions—(1) Taxpayers subject to 

section 987—(i) In general. Except as 

provided in paragraphs (b)(1)(ii) and 

(iii) of this section, an individual or 

corporation is subject to section 987 if 

such person is an owner (as defined in 

paragraphs (b)(4) and (5) of this section) 

of an eligible QBU (as defined in 

paragraph (b)(3) of this section) that is 

a section 987 QBU (as defined in 

paragraph (b)(2) of this section). Such 

individual or corporation, and any 

section 987 QBU owned by such person, 

must comply with these regulations. 

(ii) De minimis rule for certain 

indirectly owned section 987 QBUs. An 

individual or corporation that owns a 

section 987 QBU indirectly through a 

section 987 partnership may elect not to 

apply these regulations for purposes of 

taking into account the section 987 gain 

or loss of such section 987 QBU if the 

individual or corporation owns, directly 

or indirectly, less than five percent of 

either the total capital or the total profits 

interest in the section 987 partnership 

as determined on the date of acquisition 

of such interest or on the date such 

interest is increased or decreased. For 

purposes of this paragraph (b)(1)(ii), 

ownership of a capital or profits interest 

in a partnership shall be determined in 

accordance with the rules for 

constructive ownership of stock 

provided in section 267(c), other than 

section 267(c)(3). See § 1.987–3 for 

purposes of determining the section 987 

taxable income or loss attributable to 

such section 987 QBU. 

(iii) Inapplicability to certain entities. 

These regulations do not apply to banks, 

insurance companies and similar 

financial entities (including, solely for 

purposes of section 987, leasing 

companies, finance coordination 

centers, regulated investment 

companies and real estate investment 

trusts). Further, these rules do not apply 

to trusts, estates and S corporations. 

(2) Definition of a section 987 QBU—

(i) In general. A section 987 QBU is an 

eligible QBU, as defined in paragraph 

(b)(3) of this section, that has a 

functional currency different from its 

owner. The functional currency of an 

eligible QBU shall be determined under 

§ 1.985–1, taking into account all of the 

QBU’s activities before the application 

of § 1.987–7. 

(ii) Section 987 QBU grouping 

election—(A) In general. Except as 

provided in paragraphs (b)(2)(ii)(B)(1) 

through (3) of this section, an owner 

may elect pursuant to paragraph (f) of 

this section to treat, solely for purposes 

of section 987, all section 987 QBUs 

with the same functional currency as a 

single section 987 QBU. 

(B) Special grouping rules for section 

987 QBUs owned indirectly through a 

partnership—(1) In general. An owner 

may elect to treat all section 987 QBUs 

with the same functional currency 

owned indirectly though a single 

section 987 partnership as a single 

section 987 QBU. 

(2) Election not available to group 

section 987 QBUs owned indirectly 

through different partnerships. An 

owner cannot elect to treat multiple 

section 987 QBUs with the same 

functional currency as a single section 

987 QBU if such QBUs are owned 

indirectly through different section 987 

partnerships. 

(3) Election not available to group 

section 987 QBUs owned directly and 

indirectly. An owner cannot elect to 

treat multiple section 987 QBUs with 

the same functional currency owned 

directly, and indirectly through a 

section 987 partnership, as a single 

section 987 QBU. 

(3) Definition of an eligible QBU—(i) 

In general. The term eligible QBU means 

activities of an individual, corporation, 


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partnership, or an entity disregarded as 

an entity separate from its owner for 

U.S. Federal income tax purposes (DE), 

if—

(A) The activities constitute a trade or 

business as defined in § 1.989(a)–1(c); 

(B) A separate set of books and 

records is maintained as defined in 

§ 1.989(a)–1(d) with respect to the 

activities, and assets and liabilities used 

in conducting such activities are 

reflected on such books and records 

under § 1.987–2(b); and 

(C) The activities are not subject to the 

Dollar Approximate Separate 

Transactions Method (DASTM) rules of 

§ 1.985–3. 

(ii) Exclusion of DEs and certain 

QBUs. A DE itself is not an eligible QBU 

(even though a DE may have activities 

that qualify as an eligible QBU). In 

addition, an eligible QBU shall include 

a QBU defined in § 1.989(a)–1(b) only if 

the requirements contained in 

paragraphs (b)(3)(i)(A) through (C) of 

this section are satisfied with respect to 

such QBU. Thus, for example, neither a 

corporation nor a partnership itself is an 

eligible QBU (even though a corporation 

and a partnership may have activities 

that qualify as an eligible QBU). 

(4) Definition of the term ‘‘owner’’. 

For purposes of section 987, only an 

individual or corporation may be an 

owner of an eligible QBU. An individual 

or corporation is an owner of an eligible 

QBU if—

(i) Direct ownership. The individual 

or corporation is the tax owner of the 

assets and liabilities of an eligible QBU 

as defined in paragraph (b)(3) of this 

section; or 

(ii) Indirect ownership. In the case of 

an individual or corporation that is a 

partner in a partnership, the individual 

or corporation is allocated, under 

§ 1.987–7, all or a portion of the assets 

and liabilities of an eligible QBU of such 

partnership. 

(5) Exception with respect to an 

eligible QBU or section 987 QBU of an 

owner. The term owner for section 987 

purposes does not include an eligible 

QBU or a section 987 QBU of an owner. 

For example, a section 987 branch, as 

defined in paragraph (b)(6)(i) of this 

section is not an owner of another 

section 987 branch, regardless of its 

functional currency. 

(6) Other definitions. Solely for 

purposes of section 987, the following 

definitions shall apply. 

(i) Section 987 branch. A section 987 

branch is an eligible QBU of an 

individual, partnership, DE, or 

corporation, all or a portion of which is 

a section 987 QBU. Assets and liabilities 

of an eligible QBU of a partnership that 

are allocated to a partner under § 1.987–

7 are considered to be a section 987 

QBU of such partner, provided such 

partner has a functional currency 

different from that of such eligible QBU. 

(ii) Section 987 partnership. A section 

987 partnership is a partnership that has 

one or more section 987 branches. 

(iii) Section 987 DE. A section 987 DE 

is a DE that has one or more section 987 

branches. 

(7) Examples. The following examples 

illustrate the principles of paragraph (b) 

of this section. Except as otherwise 

provided, the following facts are 

assumed for purposes of these 

examples. X is a domestic corporation, 

has the U.S. dollar as its functional 

currency, and uses the calendar year as 

its taxable year. Business A and 

Business B are eligible QBUs, maintain 

books and records that are separate from 

the books and records of the entity that 

owns such eligible QBUs, and have the 

euro and the Japanese yen, respectively, 

as their functional currencies. Finally, 

DE1 and DE2 are entities that are 

disregarded as entities separate from 

their owner for U.S. tax purposes, have 

no assets or liabilities, and conduct no 

activities. 

Example 1. (i) Facts. X owns Business A 

and the interests in DE1. DE1 maintains a 

separate set of books and records that are 

kept in British pounds. DE1 owns British 

pounds and 100% of the stock of a foreign 

corporation, FC. DE1 is liable on a pounddenominated obligation to a lender that was 

incurred to acquire the stock of FC. The FC 

stock, the pounds, and the liability incurred 

to acquire the FC stock are recorded on DE1’s 

separate books and records. DE1 has no other 

assets or liabilities and conducts no activities 

(other than holding the FC stock and 

servicing its liability). 

(ii) Analysis. (A) Pursuant to paragraph 

(b)(4)(i) of this section, X is the direct owner 

of Business A because it is the tax owner of 

the assets and liabilities of such business. 

Because Business A is an eligible QBU with 

a functional currency that is different from 

the functional currency of its owner, X, 

Business A is a section 987 QBU, as defined 

in paragraph (b)(2) of this section. As a result, 

X and its section 987 QBU, Business A, are 

subject to section 987. 

(B) Holding the stock of FC and pounds, 

and servicing a single liability, does not 

constitute a trade or business within the 

meaning of § 1.989(a)–1(c). Because the 

activities of DE1 do not constitute a trade or 

business within the meaning of § 1.989(a)–

1(c), such activities are not an eligible QBU. 

In addition, pursuant to paragraph (b)(3)(ii) 

of this section, DE1 is not an eligible QBU. 

As a result, neither DE1 nor its activities 

qualify as a section 987 QBU of X. Therefore, 

neither the activities of DE1 nor DE2 are 

subject to section 987. For the foreign 

currency treatment of payments on DE1’s 

pound-denominated liability, see §§ 1.987–

2(b)(4) and 1.988–1(a)(4). 

Example 2. (i) Facts. X owns the interests 

in DE1. DE1 owns Business A and the 

interests in DE2. The only activities of DE1 

are Business A activities and holding the 

interests in DE2. DE2 owns Business B and 

Business C. For purposes of this example, 

Business B does not maintain books and 

records that are separate from its owner, DE2. 

Instead, the activities of Business B are 

reflected on the books and records of DE2, 

which are maintained in Japanese yen. In 

addition, Business C has the U.S. dollar as its 

functional currency, maintains books and 

records that are separate from the books and 

records of DE2, and is an eligible QBU. 

(ii) Analysis. (A) Pursuant to paragraph 

(b)(3)(ii) of this section, DE1 and DE2 are not 

eligible QBUs. Pursuant to paragraph (b)(3)(i) 

of this section, the Business B and Business 

C activities of DE2, and the Business A 

activities of DE1, are eligible QBUs. 

Moreover, pursuant to paragraph (b)(4) of this 

section, DE1 is not the owner of the Business 

A, Business B, or Business C eligible QBUs, 

and DE2 is not the owner of the Business B 

or Business C eligible QBUs. Instead, 

pursuant to paragraph (b)(4)(i) of this section, 

X is the direct owner of the Business A, 

Business B, and Business C eligible QBUs. 

(B) Because Business A and Business B are 

eligible QBUs with functional currencies that 

are different than the functional currency of 

X, Business A and Business B are section 987 

QBUs as defined in paragraph (b)(2) of this 

section. Therefore, X, and these QBUs, are 

subject to section 987. Under paragraph 

(b)(6)(iii) of this section, DE1 and DE2 are 

section 987 DEs. 

(C) The Business C eligible QBU has the 

same functional currency as X. Therefore, the 

Business C eligible QBU is not a section 987 

QBU. As a result, X is not subject to section 

987 with respect to its Business C eligible 

QBU. 

Example 3. (i) Facts. X owns DE1. DE1 

owns Business A and Business B. For 

purposes of this example, assume Business B 

has the euro as its functional currency. 

(ii) Analysis. (A) Pursuant to paragraph 

(b)(3)(ii) of this section, DE1 is not an eligible 

QBU. Moreover, pursuant to paragraph (b)(4) 

of this section, DE1 is not the owner of the 

Business A or Business B eligible QBUs. 

Instead, pursuant to paragraph (b)(4)(i) of this 

section, X is the direct owner of the Business 

A and Business B eligible QBUs. 

(B) Business A and Business B constitute 

two separate eligible QBUs with the euro as 

their respective functional currency. 

Accordingly, Business A and Business B are 

section 987 QBUs of X. X may elect to treat 

Business A and Business B as a single section 

987 QBU pursuant to paragraph (b)(2)(ii)(A) 

of this section. If such election is made, 

pursuant to paragraph (b)(4)(i) of this section, 

X is the direct owner of the Business AB 

section 987 QBU that includes the activities 

of both the Business A section 987 QBU and 

the Business B section 987 QBU. In addition, 

pursuant to paragraph (b)(4) of this section, 

DE1 is not treated as the owner of the 

Business AB section 987 QBU. X, and its AB 

section 987 QBU, are subject to section 987. 

Under paragraph (b)(6)(iii) of this section, 

DE1 is a section 987 DE. 

Example 4. (i) Facts. X is a partner in P, 

a partnership. FC, a controlled foreign 

corporation (as defined in section 957(a)) of 


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X with the Japanese yen as its functional 

currency, is the only other partner in P. P 

owns DE1 and Business A. DE1 owns 

Business B. 

(ii) Analysis. (A) Pursuant to paragraph 

(b)(3)(ii) of this section, P and DE1 are not 

eligible section 987 QBUs. Moreover, 

pursuant to paragraph (b)(4) of this section, 

neither P nor DE1 is the owner of the 

Business A eligible QBU or the Business B 

eligible QBU for section 987 purposes. 

Instead, pursuant to paragraph (b)(4)(ii) of 

this section, X and FC are indirect owners of 

the Business A eligible QBU and the 

Business B eligible QBU to the extent they 

are allocated assets and liabilities of such 

businesses under § 1.987–7. Under 

paragraphs (b)(6)(ii) and (iii) of this section, 

respectively, P is a section 987 partnership 

and DE1 is a section 987 DE. 

(B) Because Business A and Business B are 

eligible QBUs with a different functional 

currency than X, the portions of Business A 

and Business B allocated to X under § 1.987–

7 are section 987 QBUs of X. As a result, X 

and its section 987 QBUs are subject to 

section 987. 

(C) Because the Business A eligible QBU 

has a different functional currency than FC, 

the portion of the Business A eligible QBU 

that is allocated to FC under § 1.987–7 is a 

section 987 QBU, and FC and its section 987 

QBU are subject to section 987. However, the 

Business B eligible QBU has the same 

functional currency as FC. Therefore, the 

portion of the Business B eligible QBU that 

is allocated to FC, under § 1.987–7, is not a 

section 987 QBU. As a result, FC is not 

subject to section 987 with respect to its 

Business B eligible QBU. 

Example 5. (i) Facts. X owns all of the 

interests in DE1. DE1 owns Business A. DE1 

owns all of the interests in DE2. DE2 owns 

Business B. DE2 owns all of the interests in 

DE3, an entity disregarded as an entity 

separate from its owner. DE3 owns Business 

C, which is an eligible QBU with the Russian 

ruble as its functional currency. 

(ii) Analysis. Pursuant to (b)(3)(ii) of this 

section, DE1, DE2 and DE3 are not eligible 

QBUs. Pursuant to paragraph (b)(3)(i) of this 

section, the Business A, Business B and 

Business C activities are eligible QBUs. 

Moreover, pursuant to paragraph (b)(4) of this 

section, X is the direct owner of the Business 

A, Business B and Business C eligible QBUs. 

Pursuant to paragraph (b)(5) of this section, 

an eligible QBU is not an owner of another 

eligible QBU. Accordingly, the Business A 

eligible QBU is not the owner of the Business 

B eligible QBU, and the Business B eligible 

QBU is not the owner of the Business C 

eligible QBU. Since the Business A, Business 

B, and Business C eligible QBUs each has a 

different functional currency than X, such 

eligible QBUs are section 987 QBUs of X. As 

a result, X and its section 987 QBUs are 

subject to section 987. Under paragraphs 

(b)(6)(iii) of this section, DE1, DE2 and DE3 

are section 987 DEs. 

(c) Exchange rates. Solely for 

purposes of section 987, the following 

definitions shall apply. 

(1) Spot rate—(i) In general. Except as 

otherwise provided in this section, the 

spot rate means the rate determined 

under the principles of § 1.988–1(d)(1), 

(2) and (4) on the relevant day. 

(ii) Election to use a spot rate 

convention—(A) In general. In lieu of 

the spot rate determined in paragraph 

(c)(1)(i) of this section, an owner may 

elect under paragraph (f) of this section 

to use a spot rate convention that 

reasonably approximates the rate in 

paragraph (c)(1)(i) of this section. A spot 

rate convention may be determined with 

respect to a rate at the beginning of a 

reasonable period, the end of a 

reasonable period, an average of spot 

rates for a reasonable period, or by 

reference to spot and forward rates for 

a reasonable period. For example, in 

lieu of the spot rate determined in 

paragraph (c)(1)(i) of this section, the 

spot rate for all transactions during a 

monthly period can be determined 

pursuant to the following conventions: 

the spot rate at the beginning of the 

current month or at the end of the 

preceding month; the monthly average 

of daily spot rates for the current or 

preceding month; or an average of the 

beginning and ending spot rates for the 

current or preceding month. Similarly, 

in lieu of the spot rate determined in 

paragraph (c)(1)(i) of this section, the 

spot rate can be determined pursuant to 

an average of the spot rate and the 30- 

day forward rate on a day of the 

preceding month. Use of a spot rate 

convention that is consistent with the 

owner’s convention used for financial 

accounting purposes is presumed to 

reasonably approximate the rate in 

paragraph (c)(1)(i) of this section. The 

Commissioner can rebut this 

presumption if use of such a convention 

results in a significant distortion of 

income or loss under the facts and 

circumstances. 

(B) Election does not apply with 

respect to section 988 transactions. The 

election to use a spot rate convention set 

forth in paragraph (c)(1)(ii)(A) of this 

section does not apply to section 988 

transactions of a section 987 QBU. 

(2) Yearly average exchange rate. 

Notwithstanding § 1.989(b)–1, for 

purposes of section 987, the yearly 

average exchange rate is a rate 

determined by the owner that represents 

an average exchange rate for the taxable 

year (or, if the section 987 QBU is sold 

or terminated prior to the close of the 

taxable year, such portion of the taxable 

year) computed under any reasonable 

method. For example, an owner may 

determine the yearly average exchange 

rate based on a daily, monthly or 

quarterly averaging convention, whether 

weighted or unweighted, and may take 

into account forward rates for a period 

not to exceed three months. The method 

for determining the yearly average 

exchange rate must be consistently 

applied by the taxpayer. 

(3) Historic exchange rate—(i) In 

general. Except as otherwise provided 

in these regulations, the historic 

exchange rate shall be—

(A) In the case of an asset that is 

transferred to a section 987 QBU, the 

spot rate as defined in paragraphs 

(c)(1)(i) and (ii) of this section on the 

day of transfer; 

(B) In the case of an asset that is 

acquired by a section 987 QBU (other 

than by a transfer to a section 987 QBU 

described in paragraph (c)(3)(i)(A) of 

this section), the spot rate as defined in 

paragraphs (c)(1)(i) and (ii) of this 

section on the day the asset is acquired; 

(C) In the case of a liability that is 

entered into by a section 987 QBU, the 

spot rate as defined in paragraphs 

(c)(1)(i) and (ii) of this section on the 

day the liability is entered into; and 

(D) In the case of a liability that is 

transferred to a section 987 QBU, the 

spot rate as defined in paragraphs 

(c)(1)(i) and (ii) of this section on the 

day the liability is transferred. 

(ii) Changed functional currency. In 

the case of a section 987 QBU that 

previously changed its functional 

currency, § 1.985–5 shall be taken into 

account in determining the historic 

exchange rate for an item. 

(d) Section 987 marked item. A 

section 987 marked item is an asset 

(section 987 marked asset) or liability 

(section 987 marked liability) that—

(1) Is reflected on the books and 

records of a section 987 QBU under 

§ 1.987–2(b); 

(2) Would be a section 988 transaction 

if such item were held or entered into 

directly by the owner of the section 987 

QBU; and 

(3) Is not a section 988 transaction 

with respect to the section 987 QBU. 

(e) Section 987 historic item—(1) In 

general. A section 987 historic item is 

an asset (section 987 historic asset) or 

liability (section 987 historic liability) 

that—

(i) Is reflected on the books and 

records of a section 987 QBU under 

§ 1.987–2(b); and 

(ii) Is not a section 987 marked item 

as defined in paragraph (d) of this 

section. 

(2) Example. The following example 

illustrates the application of paragraphs 

(d) and (e) of this section: 

Example. X is a domestic corporation with 

the dollar as its functional currency. X owns 

all the interests in UK DE, a section 987 DE 

that owns a section 987 branch having the 

pound as its functional currency. Items 

reflected on the branch’s balance sheet 

include £100 of cash, $25 of cash, a building 


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with a basis of £1,000, a truck with a basis 

of £75, a computer with a basis of £10, a 60 

day receivable for ¥15 and a note payable of 

£500. Under paragraph (d) of this section, the 

£100 of cash and the £500 note payable are 

section 987 marked items. The other items 

are section 987 historic items under this 

paragraph (e). 

(f) Elections—(1) In general. Elections 

made under section 987 shall be treated 

as methods of accounting and, except as 

otherwise provided in this paragraph (f), 

are governed by the general rules 

concerning changes in methods of 

accounting. 

(2) Persons making the election—(i) In 

general. Except as provided in 

paragraphs (f)(2)(ii) and (iii) of this 

section, elections regarding section 987 

shall be made by the owner as defined 

in paragraph (b)(4) of this section. 

(ii) Controlled foreign corporations. 

Where a section 987 QBU is held by a 

controlled foreign corporation, elections 

shall be made in accordance with 

§§ 1.952–2(c)(2)(iv) and 1.964–1(c) by its 

controlling U.S. shareholders. 

(iii) Foreign corporations that are not 

controlled foreign corporations. Where a 

section 987 QBU is held by a foreign 

corporation that is not a controlled 

foreign corporation, elections shall be 

made in accordance with the principles 

of § 1.964–1(c) by the majority domestic 

corporate shareholders. 

(3) When elections must be made. An 

election under section 987 must be 

made with respect to a section 987 QBU 

for the first taxable year in which the 

election is relevant in determining the 

section 987 taxable income or loss, or 

section 987 gain or loss, of the section 

987 QBU. 

(4) Manner of making elections. 

Elections shall be made under section 

987 by attaching a statement to the 

timely filed tax return of the owner, or 

other applicable person, for the first 

taxable year in which the owner intends 

the election to be effective. The 

statement must be dated and titled 

‘‘Election(s) Under Section 987,’’ must 

indicate the regulation section that 

authorizes the election(s), and must 

clearly describe the election(s) being 

made. Each section 987 election must 

remain a part of the books and records 

of the taxpayer and be available to the 

IRS upon request. 

(5) Consent of the Commissioner. 

Elections made in accordance with the 

rules of this paragraph (f) shall be 

considered made with the consent of the 

Commissioner. 

(6) Failure to make election. If an 

owner is permitted to file an election 

pursuant to this paragraph (f), but fails 

to make such election in a timely 

manner, the owner shall be considered 

to have satisfied the timeliness 

requirement with respect to such 

election if the owner is able to 

demonstrate to the Area Director, Field 

Examination, Small Business/Self 

Employed or the Director, Field 

Operations, Large and Mid-Size 

Business (Director) having jurisdiction 

of the taxpayer’s return for the taxable 

year, that such failure was due to 

reasonable cause and not willful 

neglect. The previous sentence shall 

only apply if, once the owner becomes 

aware of the failure, the owner attaches 

the election, as well as a written 

statement setting forth the reasons for 

the failure to timely comply, to an 

amended income tax return that amends 

the return to which the election should 

have been attached under the rules of 

this paragraph (f). In determining 

whether the owner has reasonable 

cause, the Director shall consider 

whether the taxpayer acted reasonably 

and in good faith. Whether the taxpayer 

acted reasonably and in good faith will 

be determined after considering all the 

facts and circumstances. The Director 

shall notify the owner in writing within 

120 days of the filing if it is determined 

that the failure to comply was not due 

to reasonable cause, or if additional time 

will be needed to make such 

determination. If the Director fails to 

notify the owner within 120 days of the 

filing, the owner shall be considered to 

have demonstrated to the Director that 

such failure was due to reasonable cause 

and not willful neglect. 

(7) Revocation of election—(i) In 

general. Elections under section 987 

cannot be revoked without the consent 

of the Commissioner. The 

Commissioner will consider allowing 

the revocation of an election if the 

taxpayer can demonstrate significantly 

changed circumstance or such other 

circumstances that in the judgment of 

the Commissioner clearly demonstrates 

a substantial non-tax business reason for 

revoking the election. 

(ii) Exception in the case of certain 

acquisitions. [Reserved]. 

§ 1.987–2 Attribution of items to a section 

987 QBU; the definition of a transfer and 

related rules. 

(a) Scope and general principles. 

Paragraph (b) of this section provides 

rules for attributing assets and 

liabilities, and items of income, gain, 

deduction, and loss, to an eligible QBU 

and a section 987 QBU. Assets and 

liabilities are attributed to an eligible 

QBU, all or a portion of which is a 

section 987 QBU for purposes of section 

987. Items of income, gain, deduction, 

and loss are attributed to an eligible 

QBU all or a portion of which is a 

section 987 QBU for purposes of 

computing the section 987 taxable 

income of such section 987 QBU, and of 

the owner of such section 987 QBU. 

Paragraph (c) of this section defines a 

transfer for purposes of section 987. 

Paragraph (d) of this section provides 

translation rules for transfers to a 

section 987 QBU. 

(b) Attribution of items to an eligible 

QBU—(1) General rules. Except as 

provided in paragraphs (b)(2) and (3) of 

this section, items are attributable to an 

eligible QBU to the extent they are 

reflected on the separate set of books 

and records, as defined in § 1.989(a)–

1(d), of the eligible QBU. For purposes 

of this section, the term ‘‘item’’ refers to 

assets and liabilities, and items of 

income, gain, deduction, and loss. Items 

that are attributed to an eligible QBU 

pursuant to this section must be 

adjusted to conform to U.S. tax 

principles as provided in § 1.987–4(e). 

These attribution rules apply solely for 

purposes of section 987. For example, 

the allocation and apportionment of 

interest expense under section 864(e) is 

independent of the rules under section 

987. 

(2) Exceptions for non-portfolio stock, 

interests in partnerships, and certain 

acquisition indebtedness—(i) General 

rule. Except as provided in paragraph 

(b)(2)(ii) of this section, the following 

shall not be considered to be on the 

books and records of a an eligible QBU: 

(A) Stock of a corporation (whether 

domestic or foreign). 

(B) An interest in a partnership 

(whether domestic or foreign). 

(C) A liability that was incurred to 

acquire the stock or an interest in a 

partnership described in paragraphs 

(b)(2)(i)(A) or (B) of this section, 

respectively. 

(D) Income, gain, deduction, or loss 

arising from the items described in 

paragraphs (b)(2)(i)(A) through (C) of 

this section. For example, a section 951 

inclusion with respect to stock of a 

foreign corporation that is described in 

paragraph (b)(2)(i)(A) of this section 

shall not be considered to be on the 

books and records of the eligible QBU. 

(ii) Portfolio stock. Paragraph 

(b)(2)(i)(A) of this section shall not 

apply to stock of a corporation (whether 

domestic or foreign) reflected on the 

books and records, within the meaning 

of paragraph (b)(1) of this section, of an 

eligible QBU provided the owner of the 

eligible QBU owns less than 10 percent 

of the total voting power or value of all 

classes of stock of such corporation. For 

purposes of this paragraph (b)(2)(ii), 

section 318(a) shall be applied in 

determining ownership, except that in 

applying section 318(a)(2)(C), the phrase 


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‘‘10 percent’’ is used instead of the 

phrase ‘‘50 percent.’’

(3) Adjustments to items reflected on 

the books and records—(i) General rule. 

If a principal purpose of recording (or 

failing to record) an item on the books 

and records of an eligible QBU is the 

avoidance of U.S. tax under section 987, 

the Commissioner may allocate any item 

between or among the eligible QBU, the 

owner of such eligible QBU, and any 

other persons, entities (including 

disregarded entities), or other QBUs 

within the meaning of § 1.989(a)–1(b) 

(including eligible QBUs). A transaction 

may have such a principal purpose even 

though the tax avoidance purpose is 

outweighed by other purposes when 

taken together. For purposes of this 

paragraph (b)(3)(i), relevant factors for 

determining whether such U.S. tax 

avoidance is a principal purpose of 

recording (or failing to record) an item 

on the books and records of an eligible 

QBU shall include, but are not limited 

to, the factors set forth in paragraphs 

(b)(3)(ii) and (iii) of this section. The 

presence or absence of any factor, or of 

a particular number of factors, is not 

determinative. Moreover, the weight 

given to any factor (whether or not set 

forth in paragraphs (b)(3)(ii) and (iii) of 

this section) depends on the particular 

case. 

(ii) Factors indicating no tax 

avoidance. For purposes of paragraph 

(b)(3)(i) of this section, relevant factors 

which may indicate that the recording 

(or failing to record) an item on the 

books and records of an eligible QBU 

does not have as a principal purpose the 

avoidance of U.S. tax under section 987 

include the recording (or not recording) 

of an item: 

(A) For a significant and bona fide 

business purpose. 

(B) In a manner that is consistent with 

the economics of the underlying 

transaction. 

(C) In accordance with generally 

accepted accounting principles (or 

similar comprehensive body of 

professional accounting standards). 

(D) In a manner that is consistent with 

the treatment of similar items from year 

to year. 

(E) In accordance with accepted 

conditions or practices in the particular 

trade or business of the eligible QBU. 

(F) In a manner that is consistent with 

an explanation of existing internal 

accounting policies that is evidenced by 

documentation contemporaneous with 

the timely filing of a return for the 

taxable year. 

(G) As a result of a transaction 

between legal entities (that is, the 

transfer of an asset, or the assumption 

of a liability), even if such transaction 

is not regarded for Federal tax purposes 

(that is, a transaction between a DE and 

its owner). 

(iii) Factors indicating tax avoidance. 

For purposes of paragraph (b)(3)(i) of 

this section, relevant factors which may 

indicate that a principal purpose of 

recording (or failing to record) an item 

on the books and records of an eligible 

QBU is the avoidance of U.S. tax under 

section 987 are—

(A) The presence or absence of an 

item on the books and records that is 

disregarded as transitory due to a 

circular flow of cash or other property; 

(B) The presence or absence of an 

item on the books and records that is the 

result of one or more transactions that 

do not have economic substance; 

(C) The presence or absence of an 

item on the books and records that 

results in the taxpayer (or person related 

to the taxpayer as defined in section 

267(b) or 707(b)) having offsetting 

positions in the functional currency of 

a section 987 QBU; and 

(D) The absence of any or all of the 

factors listed in paragraphs (b)(3)(ii)(A) 

through (E) of this section. 

(4) Assets and liabilities of a 

partnership or DE that are not attributed 

to an eligible QBU. Neither a 

partnership nor a DE is an eligible QBU 

and, thus, cannot be a section 987 QBU. 

See § 1.987–1(b)(2) and (3). As a result, 

a partnership or DE may own assets and 

liabilities that are not attributed to an 

eligible QBU (or a section 987 QBU) as 

provided under this paragraph (b) and, 

therefore, are not subject to section 987. 

For the foreign currency treatment of 

such assets or liabilities, see § 1.988–

1(a)(4). 

(c) Transfers to and from section 987 

QBUs—(1) In general. The following 

rules apply for purposes of determining 

whether there is a transfer of an asset or 

a liability from the owner to a section 

987 QBU, or from such section 987 QBU 

to the owner. These rules apply solely 

for purposes of section 987. 

(2) Disregarded transactions—(i) 

General rule. Solely for purposes of 

section 987, an asset or liability shall be 

treated as transferred to a section 987 

QBU if, as a result of a disregarded 

transaction, such asset or liability is 

reflected on the books and records of the 

section 987 QBU within the meaning of 

paragraph (b) of this section. Similarly, 

an asset or liability shall be treated as 

transferred from a section 987 QBU if, 

as a result of a disregarded transaction, 

such asset or liability is not reflected on 

the books and records of the section 987 

QBU within the meaning of paragraph 

(b) of this section. 

(ii) Definition of a disregarded 

transaction. For purposes of this 

section, the term disregarded 

transaction means a transaction that is 

not regarded for U.S. Federal tax 

purposes. For purposes of this 

paragraph (c), a disregarded transaction 

shall be treated as including the 

recording of an asset or liability on one 

set of books and records, if the recording 

is the result of such asset or liability 

being removed from another set of books 

and records of the same person or entity 

(including a DE or partnership). 

(iii) Items derived from disregarded 

transactions ignored. For purposes of 

section 987, disregarded transactions 

shall not give rise to items of income, 

gain, deduction, or loss that must be 

taken into account in determining 

section 987 taxable income or loss 

under § 1.987–3. 

(3) Transfers of assets to and from 

indirectly owned section 987 QBUs—(i) 

Contributions to partnerships. Solely for 

purposes of section 987, an asset shall 

be treated as transferred to an indirectly 

owned section 987 QBU if, and to the 

extent, the asset is contributed to the 

section 987 partnership that carries on 

the section 987 QBU provided that 

immediately following such 

contribution, the asset is reflected on 

the books and records of the section 987 

QBU within the meaning of paragraph 

(b) of this section. For purposes of this 

paragraph (c)(3)(i), deemed 

contributions under section 752 shall be 

disregarded. 

(ii) Distributions from partnerships. 

Solely for purposes of section 987, an 

asset shall be treated as transferred from 

an indirectly owned section 987 QBU if, 

and to the extent, the section 987 

partnership that carries on the section 

987 QBU distributes the asset to a 

partner provided that, immediately 

prior to such distribution, the asset was 

reflected on the books and records of 

such section 987 QBU within the 

meaning of paragraph (b) of this section. 

For purposes of this paragraph (c)(3)(ii), 

deemed distributions under section 752 

shall be disregarded. 

(4) Transfers of liabilities to and from 

indirectly owned section 987 QBUs—(i) 

Assumptions of partner liabilities. 

Solely for purposes of section 987, a 

liability shall be treated as transferred to 

an indirectly owned section 987 QBU if, 

and to the extent, the section 987 

partnership assumes such liability, 

provided that immediately following 

such assumption, the liability is 

reflected on the books and records of the 

section 987 QBU within the meaning of 

paragraph (b) of this section. 

(ii) Assumptions of partnership 

liabilities. Solely for purposes of section 

987, a liability shall be treated as 

transferred from an indirectly owned 


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section 987 QBU if, and to the extent, 

the owner assumes such liability of the 

section 987 partnership provided that 

immediately prior to such assumption, 

the liability was reflected on the books 

and records of the section 987 QBU 

within the meaning of paragraph (b) of 

this section. 

(5) Acquisitions and dispositions of 

interests in DEs and partnerships. 

Solely for purposes of section 987, an 

asset or liability shall be treated as 

transferred to a section 987 QBU if, as 

a result of an acquisition (including by 

contribution) or disposition of an 

interest in a section 987 partnership or 

section 987 DE, such asset or liability is 

reflected on the books and records of the 

section 987 QBU. Similarly, an asset or 

liability shall be treated as transferred 

from a section 987 QBU if, as a result 

of an acquisition or disposition of an 

interest in a section 987 partnership or 

section 987 DE, the asset or liability is 

not reflected on the books and records 

of the section 987 QBU. 

(6) Changes in form of ownership. For 

purposes of this paragraph (c), mere 

changes in form of ownership of an 

eligible QBU shall not result in a 

transfer to or from a section 987 QBU. 

Instead, the determination of whether a 

transfer has occurred in such case shall 

be made under paragraph (c)(5) of this 

section. For example, a transaction with 

respect to an eligible QBU that causes a 

direct owner of the eligible QBU to 

become an indirect owner of such 

eligible QBU, shall not, except to the 

extent provided in paragraph (c)(5) of 

this section, result in a transfer to or 

from a section 987 QBU. See for 

example, Rev. Rul. 99–5 (1999–1 CB 

434), Rev. Rul. 99–6 (1999–1 CB 432), 

see § 601.601(d)(2) of this chapter, and 

section 708 and the applicable 

regulations. 

(7) Application of general tax law 

principles. General tax law principles, 

including the circular cash flow, steptransaction, and substance-over-form 

doctrines, apply for purposes of 

determining whether there is a transfer 

of an asset or liability under this 

paragraph (c). 

(8) Interaction with § 1.988–1(a)(10). 

See § 1.988–1(a)(10) for rules regarding 

the treatment of an intra-taxpayer 

transfer of a section 988 transaction. 

(9) Examples. The following examples 

illustrate the principles of this 

paragraph (c). For purposes of these 

examples, it is assumed that X and Y are 

domestic corporations, have the dollar 

as their functional currency, and use the 

calendar year as their taxable year. It is 

also assumed that Business A and 

Business B are eligible QBUs, maintain 

books and records that are separate from 

the books and records of the entity that 

owns such eligible QBUs, and have the 

euro and the yen, respectively, as their 

functional currencies. Finally, it is 

assumed that DE1 and DE2 are entities 

that are disregarded as entities separate 

from their owner for U.S. tax purposes. 

For purposes of determining whether 

any of the transfers in these examples 

result in remittances, see § 1.987–5. 

Example 1. Transfer to a directly owned 

section 987 QBU. (i) Facts. X owns 100 

percent of the interests in DE1. DE1 owns 

Business A. X owns £100 that are not 

reflected on the books and records of 

Business A. Business A is in need of 

additional capital and, as a result, X loans the 

£100 to DE1 (to be used in Business A) in 

exchange for a note. 

(ii) Analysis. (A) The loan from X to DE1 

is not regarded for U.S. federal tax purposes 

and therefore is a disregarded transaction. As 

a result, the Business A note held by X, and 

the liability of DE1 under the note, are not 

taken into account under this section. 

However, the £100 of cash that was loaned 

from X to DE1 (and used in Business A) 

pursuant to the note must be taken into 

account under this paragraph (c). 

(B) The loan of ÷100 from X to DE1 is a 

disregarded transaction and, as a result of 

such disregarded transaction, the ÷100 is 

reflected on the books and records of 

Business A. Therefore, there has been a 

transfer of ÷100 from X to Business A. See 

§ 1.988–1(a)(10)(ii) for the application of 

section 988 to X as a result of the loan. 

Example 2. Transfer to a directly owned 

section 987 QBU. (i) Facts. X owns Business 

A and Business B. X owns equipment that is 

used in Business A and is reflected on the 

books and records of Business A. Because 

Business A has excess manufacturing 

capacity and X intends to expand the 

manufacturing capacity of Business B, the 

equipment formerly used in Business A 

discontinues being used in Business A and 

begins being used in Business B. As a result 

of such equipment being used by Business B, 

the equipment is removed from the books 

and records of Business A, and is recorded 

on the books and records of Business B. 

(ii) Analysis. As a result of Business B 

using the equipment formerly used by 

Business A, the equipment ceases to be 

reflected on the books and records of 

Business A, and becomes reflected on the 

books and records of Business B. As a result, 

such entries constitute a disregarded 

transaction. Therefore, there has been a 

transfer of the equipment from the Business 

A section 987 QBU to X, and a transfer by 

X of such equipment to the Business B 

section 987 QBU. 

Example 3. Intercompany sale of property 

between two section 987 QBUs. (i) Facts. X 

owns DE1 and DE2. DE1 and DE2 own 

Business A and Business B, respectively. DE1 

owns equipment that is used in Business A 

and is reflected on the books and records of 

Business A. For business reasons, DE1 sells 

a portion of the equipment used in Business 

A to DE2 for cash. The cash used by DE2 to 

acquire the equipment was generated by 

Business B and was reflected on Business B’s 

books and records. Following the sale, the 

cash and equipment will be used in Business 

A and Business B, respectively. As a result 

of such sale, the equipment is removed from 

the books and records of Business A, and is 

recorded on the books and records of 

Business B. Similarly, as a result of the sale, 

the cash is removed from the books and 

records of Business B, and is recorded on the 

books and records of Business A. 

(ii) Analysis. (A) The sale of equipment 

between DE1 and DE2 is not regarded for 

Federal tax purposes and therefore is a 

disregarded transaction. As a result, such sale 

is not taken into account under this section 

and does not give rise to an item of income, 

gain, deduction or loss pursuant to paragraph 

(c)(2)(iii) of this section. However, the cash 

and equipment exchanged by DE1 and DE2 

in connection with the sale must be taken 

into account under this paragraph (c). 

(B) The sale of the equipment is a 

disregarded transaction and, as a result of 

such disregarded transaction, the equipment 

ceases to be reflected on the books and 

records of Business A, and becomes reflected 

on the books and records of Business B. 

Therefore, there has been a transfer of the 

equipment from DE1’s Business A section 

987 QBU owned by X to X, and a subsequent 

transfer of such equipment from X to DE2’s 

Business B section 987 QBU, owned by X. 

(C) As a result of the sale of equipment 

(that is, the disregarded transaction), the cash 

proceeds cease to be reflected on the books 

and records of Business B, and become 

reflected on the books and records of 

Business A. Therefore, there has been a 

transfer of the cash from DE2’s Business B 

section 987 QBU owned by X to X, and a 

subsequent transfer of such cash from X to 

DE1’s Business A section 987 QBU, owned 

by X. 

Example 4. Transactions between directly 

and indirectly owned section 987 QBUs. (i) 

Facts. X owns 50% of the interest in P, a 

partnership. Y owns the other 50% interest 

in P. P owns 100% of the interests in DE1 

and DE2. DE1 owns Business A and DE2 

owns Business B. X and Y each have a 50% 

allocable share of the assets and liabilities of 

Business A and Business B, as determined 

under § 1.987–7, that constitute section 987 

QBUs. In connection with Business A, DE1 

licenses intangible property to both DE2 and 

X. X enters into the license agreement in a 

transaction other than in its capacity as a 

partner of P and, therefore, the license is 

considered as occurring between P and one 

who is not a partner within the meaning of 

section 707(a). DE2 uses the intangible 

property in Business B. Pursuant to the 

license agreement, X and DE2 pay a ÷30 and 

÷50 royalty, respectively, to DE1. 

(ii) Analysis. (A) The license from DE2 to 

DE1 is not regarded for U.S. tax purposes 

and, as a result, royalty payments under the 

license are disregarded transactions. Thus, 

neither the payment nor the receipt of the 

royalty pursuant to the license agreement 

gives rise to an item of income, gain, 

deduction or loss pursuant to paragraph 

(c)(2)(iii) of this section. However, the ÷50 of 

cash that is paid from DE2 to DE1 pursuant 

to the license agreement must be taken into 

account under this paragraph (c). 


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(B) As a result of the royalty payment from 

DE2 to DE1, ÷50 ceases being reflected on the 

books and records of Business B, and 

becomes reflected on the books and records 

of Business A. Accordingly, there has been a 

transfer of ÷25 from the Business B section 

987 QBUs of X and Y, to X and Y, 

respectively. Similarly, there has been a 

transfer of ÷25 from X and Y to their 

respective Business A section 987 QBUs. 

(C) The ÷30 royalty payment from X to DE1 

is not a disregarded transaction because it is 

regarded for U.S. Federal tax purposes. As a 

result, it gives rise to an item of income and 

deduction that must be taken into account in 

computing taxable income or loss of Business 

A pursuant to § 1.987–3. In addition, the 

payment does not give rise to a transfer as 

defined in this paragraph (c). 

Example 5. Acquisition of an interest in a 

partnership. (i) Facts. X owns 50% of the 

interest in P, a partnership. Y owns the other 

50% interest in P. P owns Business A. X and 

Y each have a 50% allocable share of the 

assets and liabilities of Business A as 

determined under § 1.987–7, that constitute 

section 987 QBUs. On December 31, year 1, 

Z, a domestic corporation with the dollar as 

its functional currency, contributes cash to P 

in exchange for a 20% interest in P. The cash 

Z contributes to P is not used in Business A 

and is not reflected on Business A’s books 

and records (but is instead reflected on P’s 

books and records). Immediately after Z’s 

contribution of cash to P, Z has a 20% 

allocable share of the assets and liabilities of 

Business A as determined under § 1.987–7. In 

addition, immediately following such 

contribution X and Y each own a 40% 

interest in P and have a 40% allocable share 

of the assets and liabilities of Business A, as 

determined under § 1.987–7, that constitute 

section 987 QBUs. 

(ii) Analysis. (A) As a result of Z’s 

acquisition of an interest in P, a section 987 

partnership, 10% of the assets and liabilities 

of Business A ceased being reflected on the 

books and records of both X’s and Y’s section 

987 QBUs. As a result, such amounts are 

treated as if they are transferred from such 

section 987 QBUs to X and Y. 

(B) As a result of Z’s acquisition of the 

interest in P, a section 987 partnership, Z was 

allocated 20% of the assets and liabilities of 

Business A. Because Z and Business A have 

different functional currencies, Z’s portion of 

the Business A assets and liabilities 

constitutes a section 987 QBU. Moreover, 

20% of the assets and liabilities of Business 

A are reflected on the books and records of 

Z’s section 987 QBU as a result of Z’s 

acquisition of the interest in P. Therefore, 

20% of the assets and liabilities of Business 

A are treated as transferred from Z to Z’s 

section 987 QBU. 

Example 6. Conversion of a DE to a 

partnership through a sale of an interest. (i) 

Facts. X owns 100% of the interests in DE1. 

DE1 owns Business A. On December 31, year 

1, Y acquires 50% of the DE1 interests from 

X for cash. Immediately after such 

acquisition, Y has a 50% allocable share of 

the assets and liabilities of Business A as 

determined under § 1.987–7. 

(ii) Analysis. (A) For Federal tax purposes 

DE1 is converted to a partnership when Y 

purchases the 50% interest in DE1. Y’s 

purchase of 50% of X’s interest in DE1 is 

treated as the purchase of 50% of Business 

A, which is treated as held directly by X for 

Federal tax purposes. Immediately after the 

deemed purchase of 50% of Business A, X 

and Y are treated as contributing their 

respective interests in Business A to a 

partnership. See Rev. Rul. 99–5 (situation 1), 

(1999–1 CB 434). See § 601.601(d)(2) of this 

chapter. For purposes of this paragraph (c), 

these deemed transactions are not taken into 

account. 

(B) As a result of Y’s acquisition of 50% 

of X’s interest in DE1, a section 987 DE, 50% 

of the assets and liabilities of Business A 

ceased being reflected on the books and 

records of X’s section 987 QBU. As a result, 

such amounts are treated as if they are 

transferred from X’s section 987 QBU to X. 

(C) As a result of Y’s acquisition of 50% 

of the interest in DE1, a section 987 DE, Y 

was allocated 50% of the assets and 

liabilities of Business A. Because Y and 

Business A have different functional 

currencies, Y’s portion of the Business A 

assets and liabilities constitutes a section 987 

QBU. Moreover, 50% of the assets and 

liabilities of Business A are reflected on the 

books and records of Y’s section 987 QBU as 

a result of Y’s acquisition of the 50% interest 

in DE1. Therefore, 50% of the assets and 

liabilities of Business A are treated as 

transferred by Y to Y’s section 987 QBU. 

Example 7. Conversion of a DE to a 

partnership through a contribution. (i) Facts. 

X owns 100% of the interests in DE1. DE1 

owns Business A. On December 31, year 1, 

Y contributes property to DE1 in exchange 

for an interest in DE1. The property 

transferred by Y to DE1 is used in Business 

A and is reflected on the books and records 

of Business A. Immediately after such 

contribution, X and Y each have a 50% 

allocable share of the assets and liabilities of 

Business A as determined under § 1.987–7. 

(ii) Analysis. (A) For Federal tax purposes 

DE1 is converted to a partnership when Y 

contributes property to DE1 in exchange for 

a 50% interest in DE1. Y’s contribution is 

treated as a contribution to a partnership in 

exchange for an ownership interest in the 

partnership. X is treated as contributing all 

of Business A to the partnership in exchange 

for a partnership interest. See Rev. Rul. 99–

5 (situation 2), (1999–1 CB 434). See 

§ 601.601(d)(2) of this chapter. For purposes 

of this paragraph (c), these deemed 

transactions are not taken into account. 

(B) As a result of Y’s acquisition of a 50% 

interest in DE1, 50% of the assets and 

liabilities of Business A ceased being 

reflected on the books and records of X’s 

section 987 QBU, and 50% of the assets 

contributed by Y to DE1 are reflected on the 

books and records of such section 987 QBU. 

As a result, 50% of the Business A assets are 

treated as if they are transferred from X’s 

section 987 QBU to X. Further, 50% of the 

assets contributed by Y to DE1 are treated as 

if they are transferred by X to X’s section 987 

QBU. 

(C) Because Y and Business A have 

different functional currencies, Y’s portion of 

the Business A assets and liabilities 

(including the property contributed by Y that 

is used in Business A) constitutes a section 

987 QBU. As a result of Y’s acquisition of a 

50% interest in DE1, 50% of the assets and 

liabilities of Business A are reflected on the 

books and records of Y’s section 987 QBU 

and, therefore, are treated as if they are 

transferred by Y to such section 987 QBU. 

Example 8. Termination of a partnership 

under section 708(b). (i) Facts. X owns 60% 

of the interest in P, a partnership. Y owns the 

other 40% interest in P. P owns Business A. 

X and Y have a 60% and 40% allocable share 

of the assets and liabilities of Business A, 

respectively, as determined under § 1.987–7, 

that constitute section 987 QBUs. On 

December 31, year 1, X sells a 50% interest 

in P to Y. After such sale, X and Y own 10% 

and 90%, respectively, in P. In addition, after 

such sale, X and Y have a 10% and 90% 

allocable share of the assets and liabilities of 

Business A, respectively, as determined 

under § 1.987–7. 

(ii) Analysis. (A) X’s sale of 50% of the 

interests in P to Y causes P to terminate 

pursuant to section 708(b). As a result of 

such termination, P is treated as if it 

contributes all of its assets and liabilities to 

a new partnership in exchange for an interest 

in the new partnership; and, immediately 

thereafter, P distributes 10% and 90% of the 

interests in the new partnership to X and Y, 

respectively, in liquidation of P. See § 1.708–

1(b)(4). For purposes of this paragraph (c), 

these deemed transactions are not taken into 

account. 

(B) As a result of Y’s acquisition of a 50% 

interest in P from X, 50% of the assets and 

liabilities of Business A ceased being 

reflected on the books and records of X’s 

section 987 QBU and become reflected on the 

books and records of Y’s section 987 QBU. 

As a result, 50% of the Business A assets are 

treated as if they are transferred from X’s 

section 987 QBU to X. Further, 50% of the 

Business A assets are treated as if they are 

transferred by Y to Y’s section 987 QBU. 

Example 9. Transfer of section 987 QBU to 

a partnership. (i) Facts. X owns Business A. 

On December 31, year 1, X and Y form P, a 

partnership. X transfers Business A to P in 

exchange for a 50% interest in P. Y transfers 

property to P in exchange for the other 50% 

interest in P. The property Y transfers to P 

is not used in Business A and is not reflected 

on the books and records of Business A (but 

is instead reflected on the books and records 

of P). After the formation of P, Business A 

continues to be an eligible QBU. In addition, 

after the formation of P, X and Y each have 

a 50% allocable share of the assets and 

liabilities of Business A, respectively, as 

determined under § 1.987–7. 

(ii) Analysis. As a result of X contributing 

Business A to P, 50% of the assets and 

liabilities of Business A ceased being 

reflected on the books and records of X’s 

section 987 QBU, and became reflected on 

the books and records of Y’s section 987 

QBU. As a result, 50% of the Business A 

assets are treated as if they are transferred 

from X’s section 987 QBU to X. Further, 50% 

of the Business A assets are treated as if they 

are transferred from Y to Y’s section 987 

QBU. 

Example 10. Contribution of assets to a 

corporation. (i) Facts. X owns Business A. On 


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December 31, year 1, X forms Z, a domestic 

corporation. X and Z do not file a 

consolidated tax return. X contributes 50% of 

its Business A assets and liabilities to Z in 

exchange for 100% of the stock of Z. The Z 

stock is recorded on the books and records 

of Business A. After the contribution, X 

continues to operate Business A, and 

Business A continues to maintain separate 

books and records from X. 

(ii) Analysis. Even though the Z stock is 

recorded on the books and records of 

Business A, it is not reflected on the books 

and records for purposes of section 987 

pursuant to paragraph (b)(2) of this section. 

As a result, there has been a transfer of 50% 

of the assets and liabilities of Business A to 

X, and a subsequent transfer of such assets 

and liabilities to Z. The answer would be the 

same even if X and Z filed a consolidated 

return. 

Example 11. Transfers pursuant to general 

tax principles. (i) Facts. X owns 100 percent 

of the stock of Y. Y owns 100 percent of the 

interests in DE1. DE1 owns Business A. X 

owns ÷100. Because Business A is in need of 

additional capital, X transfers the ÷100 to Y 

as a contribution to capital and, as a result 

of such transfer, Business A records ÷100 on 

its separate books and records. Y did not 

record the ÷100 on its separate books and 

records. 

(ii) Analysis. As a result of the contribution 

of ÷100 from X to Y, the ÷100 is reflected on 

the books and records of Business A. 

Pursuant to paragraph (c)(7) of this section, 

the ÷100 is treated as if it was transferred first 

from X to Y. Therefore, the ÷100 recorded on 

the books and records of Business A is 

treated as a transfer from Y to Business A, 

even though there was no transaction 

between Y and Business A. See also § 1.988–

1(a)(10)(ii) for the application of section 988 

to Y as a result of the transaction. 

Example 12. Circular transfers. (i) Facts. X 

owns Business A. On December 30, year 1, 

Business A purports to transfer ÷100 to X. On 

January 2, year 2, X purports to transfer ÷50 

to Business A. On January 4, year 2, X 

purports to transfer another ÷50 to Business 

A. As of the end of year 1, X has an 

unrecognized section 987 loss with respect to 

Business A, such that a remittance, if 

respected, would result in recognition of a 

foreign currency loss under section 987. 

(ii) Analysis. Because the transfers by 

Business A are offset by a transfer from X that 

occurred in close temporal proximity, 

pursuant to paragraph (c) of this section, the 

IRS will scrutinize the transaction and may 

disregard the purported transfers to and from 

Business A for purposes of section 987. 

Example 13. Transfers without economic 

substance. (i) Facts. X owns Business A and 

Business B. On January 1, year 1, Business 

A purports to transfer ÷100 to X. On January 

4, year 1, X purports to transfer ÷100 to 

Business B. The account in which Business 

B deposited the ÷100 is used to pay the 

operating expenses and other costs of 

Business A. As of the end of year 1, X has 

an unrecognized section 987 loss with 

respect to Business A, such that a remittance, 

if respected, would result in recognition of a 

foreign currency loss under section 987. 

(ii) Analysis. Because Business A continues 

to have use of the transferred property, 

pursuant to paragraph (c) of this section, the 

IRS will scrutinize the transaction and may 

disregard the ÷100 purported transfer from 

Business A to X for purposes of section 987. 

Example 14. Offsetting positions in section 

987 QBUs. (i) Facts. X owns Business A and 

Business B. Business A and Business B each 

has the euro as its functional currency. X has 

not made a grouping election under § 1.987–

1(b)(2)(ii). On January 1, year 1, X borrowed 

÷1,000 from a third party lender, recorded 

the liability with respect to the borrowing on 

the books and records of Business A, and 

recorded the ÷1,000 of borrowed cash on the 

books and records of Business B. On 

December 31, year 2, when Business A has 

$100 of net unrecognized section 987 loss 

and Business B has $100 of net unrecognized 

section 987 gain resulting from the change in 

exchange rates with respect to the liability 

and the ÷1,000 cash, X terminates the 

Business A section 987 QBU. 

(ii) Analysis. Because Business A and 

Business B have offsetting positions in the 

euro, the IRS will scrutinize the transaction 

to determine if a principal purpose of 

recording the euro-denominated liability and 

the borrowed euros on the books and records 

of Business A and Business B, respectively, 

was the avoidance of tax under section 987. 

If such a principal purpose is present, the 

Commissioner may reallocate the items (that 

is, the euros and the euro-denominated 

liability) between Business A, Business B, 

and X, to reflect the economic substance of 

the transaction. 

Example 15. Offsetting positions with 

respect to a section 987 QBU and a section 

988 transaction. (i) Facts. X owns DE1, and 

DE1 owns Business A. On January 1, year 1, 

X borrows ÷1,000 from a third party lender 

and records the liability with respect to the 

borrowing on its books and records. X 

contributes the ÷1,000 loan proceeds to DE1 

and the ÷1,000 are reflected on the books and 

records of Business A. On December 31, year 

2, when Business A has $100 of net 

unrecognized section 987 loss resulting from 

the ÷1,000 cash received from the borrowing, 

and the euro-denominated borrowing, if 

repaid, would result in $100 of gain under 

section 988, X terminates the Business A 

section 987 QBU. 

(ii) Analysis. Because X and Business A 

have offsetting positions in the euro, the 

Internal Revenue Service will scrutinize the 

transaction to determine whether a principal 

purpose of recording the borrowed euros on 

the books and records of Business A, or not 

recording the corresponding eurodenominated liability on the books and 

records of Business A, was the avoidance of 

tax under section 987. If such a principal 

purpose is present, the Commissioner may 

reallocate the items (that is, the euros and the 

euro-denominated liability) between 

Business A and X to reflect the economic 

substance of the transaction. 

(d) Translation of items transferred to 

a section 987 QBU—(1) In general—(i) 

Assets. Except as otherwise provided in 

this section, the adjusted basis of an 

asset transferred to a section 987 QBU 

shall be translated into the section 987 

QBU’s functional currency at the spot 

rate as defined in § 1.987–1(c)(1)(i) and 

(ii) on the day of transfer. If the asset 

transferred is denominated in (or 

determined by reference to) the 

functional currency of the section 987 

QBU (for example, cash or note 

denominated in the functional currency 

of the section 987 QBU), no translation 

is required. 

(ii) Liabilities. Except as otherwise 

provided in this section, a liability of 

the owner that is transferred to a section 

987 QBU, shall be translated into the 

section 987 QBU’s functional currency 

at the spot rate (as defined in § 1.987–

1(c)(1)(i) and (ii)) on the day of transfer. 

If the liability transferred is 

denominated in (or determined by 

reference to) the functional currency of 

the section 987 QBU, no translation is 

required. 

(2) Items denominated in the owner’s 

functional currency. Transactions 

described in section 988(c)(1)(i) and (ii) 

and section 988(c)(1)(C) that are 

denominated in (or determined by 

reference to) the owner’s functional 

currency and that are attributable to a 

section 987 QBU under paragraph (b) of 

this section, shall not be translated and 

shall be carried on the balance sheet 

described in § 1.987–4(e) in the owner’s 

functional currency. 

§ 1.987–3 Determination of section 987 

taxable income or loss of an owner of a 

section 987 QBU. 

(a) Determination of the section 987 

taxable income or loss of an owner of a 

section 987 QBU. Except as otherwise 

provided in this section, the section 987 

taxable income or loss of an owner with 

respect to a section 987 QBU shall be 

determined in accordance with 

paragraphs (a)(1) and (a)(2) of this 

section. 

(1) In general—(i) Determination of 

each item of income, gain, deduction or 

loss in the section 987 QBU’s functional 

currency. Except as otherwise provided 

in this section, the section 987 QBU 

shall determine each item of income, 

gain, deduction or loss attributable to 

such QBU under § 1.987–2(b) in its 

functional currency under U.S. tax 

principles. 

(ii) Translation of items into the 

owner’s functional currency. The owner 

shall translate each item determined 

under this paragraph (a)(1) into its 

functional currency as provided in 

paragraph (b) of this section. 

(2) Determination in the case of a 

section 987 QBU owned indirectly 

through a partnership—(i) In general. 

Except as otherwise provided in this 

paragraph (a)(2), the taxable income or 

loss of a section 987 partnership, and 

the distributive share of any owner that 


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is a partner in such partnership, shall be 

determined in accordance with the 

provisions of subchapter K of this 

chapter. 

(ii) Determination of each item of 

income, gain, deduction or loss in the 

eligible QBU’s functional currency. 

Except as otherwise provided in this 

section, the section 987 partnership 

shall determine each item of income, 

gain, deduction or loss reflected on the 

books and records of each of its eligible 

QBUs under § 1.987–2(b) in the 

functional currency of each such QBU. 

(iii) Allocation of items of income, 

gain, deduction or loss of an eligible 

QBU. The section 987 partnership shall 

allocate the items of income, gain, 

deduction or loss of each eligible QBU 

among its partners in accordance with 

each partner’s distributive share of such 

income, gain, deduction, or loss as 

determined under subchapter K of this 

chapter. 

(iv) Translation of items into the 

owner’s functional currency. To the 

extent such items are reflected on the 

books and records of a section 987 QBU 

of a partner to whom they are allocated, 

the partner shall adjust the items to 

conform to U.S. tax principles and 

translate the items into the partner’s 

functional currency as provided in 

paragraph (b) of this section. 

(b) Exchange rates to be used in 

translating items of income, gain, 

deduction or loss of a section 987 QBU 

into the owner’s functional currency—

(1) In general. Except as otherwise 

provided in this section, the exchange 

rate to be used by an owner in 

translating an item of income, gain, 

deduction, or loss of a section 987 QBU 

as determined in § 1.987–2(b) into the 

owner’s functional currency shall be the 

yearly average exchange rate as defined 

in § 1.987–1(c)(2) for the taxable year. 

Alternatively, the owner may elect 

under § 1.987–1(f) to use the spot rate as 

defined in § 1.987–1(c)(1)(i) and (ii) for 

the day each item is properly taken into 

account. 

(2) Exceptions—(i) Depreciation, 

depletion, and amortization deductions. 

The exchange rate to be used by the 

owner in translating deductions 

allowable with respect to section 987 

historic assets (as defined in § 1.987–

1(e)) for depreciation, depletion, and 

amortization under the pertinent 

provisions of the Code shall be the 

historic exchange rate as determined 

under § 1.987–1(c)(3) for the property to 

which such deductions are attributable. 

(ii) Gain or loss from the sale of 

property. In the case of gain or loss 

recognized on a sale or other disposition 

of property that is reflected on the books 

and records of a section 987 QBU during 

the taxable year, the following exchange 

rates shall apply with respect to such 

sale or other disposition: 

(A) Amount realized—(1) In general. 

Except as otherwise provided in 

paragraph (b)(2)(ii)(A)(2), the exchange 

rate to be used in translating the amount 

realized of such property shall be the 

rate provided in paragraph (b)(1) of this 

section for the taxable year. 

(2) Certain section 987 marked assets. 

In the case of a section 987 marked asset 

(other than cash) that was held on the 

first day of the taxable year, the 

exchange rate to be used in translating 

the amount realized shall be the rate 

used for such asset in determining the 

owner functional currency net value of 

the section 987 QBU under § 1.987–

4(d)(1)(i)(B) for the preceding taxable 

year. However, in the case of a section 

987 marked asset (other than cash) 

transferred to the section 987 QBU or 

acquired by the section 987 QBU during 

the taxable year, the exchange rate to be 

used in translating the amount realized 

shall be the spot rate, as defined in 

§ 1.987–1(c)(1)(i) and (ii), for the day 

transferred or acquired. 

(B) Adjusted basis—(1) In general. 

Except as otherwise provided in 

paragraph (b)(2)(ii)(B)(2), the exchange 

rate to be used in translating the 

adjusted basis of such property shall be 

the historic exchange rate as determined 

under § 1.987–1(c)(3) for such asset. 

(2) Certain section 987 marked assets. 

In the case of a section 987 marked asset 

(other than cash) that was held on the 

first day of the taxable year, the 

exchange rate to be used in translating 

its adjusted basis shall be the rate used 

for such asset in determining the owner 

functional currency net value of the 

section 987 QBU under § 1.987–

4(d)(1)(i)(B) for the preceding taxable 

year. However, in the case of a section 

987 marked asset (other than cash) 

transferred to the section 987 QBU or 

acquired by the section 987 QBU during 

the taxable year, the exchange rate to be 

used in translating the adjusted basis of 

such asset shall be the spot rate, as 

defined in § 1.987–1(c)(1)(i) and (ii), for 

the day transferred or acquired. 

(3) Gain or loss on the sale, exchange 

or other disposition of an interest in a 

section 987 partnership. For purposes of 

determining the adjusted basis of a 

partner’s interest in a section 987 

partnership and computing gain or loss 

recognized on the sale, exchange or 

other disposition of such interest, see 

§ 1.987–7. 

(c) Items of income, gain, deduction 

or loss that are denominated in the 

functional currency of the owner. An 

item of income, gain, deduction or loss 

attributable to a section 987 QBU under 

§ 1.987–2(b) that is denominated in (or 

determined by reference to) the owner’s 

functional currency shall not be 

translated and shall be taken into 

account by the section 987 QBU under 

U.S. tax principles in the owner’s 

functional currency. 

(d) Items of income, gain, deduction 

or loss that are denominated in a 

nonfunctional currency (other than the 

functional currency of the owner). An 

item of income, gain, deduction or loss 

attributable to a section 987 QBU under 

§ 1.987–2(b) that is denominated in (or 

determined by reference to) a 

nonfunctional currency (other than the 

owner’s functional currency) shall be 

translated into the section 987 QBU’s 

functional currency at the spot rate as 

defined in § 1.987–1(c)(1)(i) and (ii) on 

the day such item is properly taken into 

account. 

(e) Section 988 transactions—(1) In 

general. Except as provided in 

paragraph (e)(2) of this section, section 

988 shall apply to the section 988 

transactions attributable to a section 987 

QBU under § 1.987–2(b), and the timing 

of any gain or loss shall be determined 

under the applicable provisions of the 

Internal Revenue Code. Such 

transactions are section 987 historic 

items as defined in § 1.987–1(e). 

(2) Certain transactions denominated 

in (or determined by reference to) the 

owner’s functional currency are not 

section 988 transactions. Transactions 

described in section 988(c)(1)(A)(i) and 

(ii) and section 988(c)(1)(C) that are 

denominated in (or determined by 

reference to) the owner’s functional 

currency and that are attributable to a 

section 987 QBU under § 1.987–2(b) 

shall not be treated as section 988 

transactions to such QBU. Thus, no 

currency gain or loss shall be recognized 

by a section 987 QBU under section 988 

with respect to such items. 

(f) Examples. The following examples 

illustrate the application of this section: 

Example 1. (i) U.S. Corp is a domestic 

corporation with the dollar as its functional 

currency. U.S. Corp owns French DE, a 

section 987 DE that has a section 987 branch 

with the euro as its functional currency. For 

purposes of paragraph (b)(1) of this section, 

U.S. Corp uses the yearly average exchange 

rate under § 1.987–1(c)(2) to translate items 

of income, gain, deduction or loss where 

such rate is appropriate. U.S. Corp also 

properly elects to use a spot rate convention 

under § 1.987–1(c)(1)(ii) where the spot rate 

is otherwise required. Under this convention, 

items booked during a particular month are 

translated at the average of the spot rates on 

the first and last day of the preceding month 

(the ‘‘convention rate’’). Accordingly, gross 

sales income is translated at the yearly 

average exchange rate and under paragraph 

(b)(2)(ii)(B) of this section the basis of assets 


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acquired during a month is translated into 

dollars at the convention rate. Assume that 

the yearly average exchange rate for 2009 is 

÷1 = $1.05. For the taxable year 2009, French 

DE sells 1,200 units of inventory for a sales 

price of ÷3 per unit. Assume that the 

purchase price for each inventory unit is 

÷1.50. Thus, French DE’s dollar gross sales 

will be computed as follows: 

GROSS SALES

Month # of units ÷ ÷/$ 2009 ave. 

exchange rate $ 

Jan ................................................................................................................... 100 300 ÷1=$1.05 315 

Feb ................................................................................................................... 200 600 ÷1=$1.05 630 

March ............................................................................................................... 0 0 ÷1=$1.05 0 

April .................................................................................................................. 200 600 ÷1=$1.05 630 

May .................................................................................................................. 100 300 ÷1=$1.05 315 

June ................................................................................................................. 0 0 ÷1=$1.05 0 

July ................................................................................................................... 100 300 ÷1=$1.05 315 

Aug ................................................................................................................... 100 300 ÷1=$1.05 315 

Sept .................................................................................................................. 0 0 ÷1=$1.05 0 

Oct ................................................................................................................... 0 0 ÷1=$1.05 0 

Nov ................................................................................................................... 100 300 ÷1=$1.05 315 

Dec ................................................................................................................... 300 900 ÷1=$1.05 945 

1,200 3,600 ........................ 3,780 

OPENING INVENTORY AND PURCHASES

Month # of units ÷ ÷/$ convention 

exchange rate $ 

Opening inventory from 2008 .......................................................................... 100 150 ÷1=$1.00 150 

Purchases: 

Jan ............................................................................................................ 300 450 ÷1=$1.00 450 

Feb ............................................................................................................ 0 0 ÷1=$1.05 0 

March ........................................................................................................ 0 0 ÷1=$1.03 0 

April ........................................................................................................... 300 450 ÷1=$1.02 459 

May ........................................................................................................... 0 0 ÷1=$1.04 0 

June .......................................................................................................... 0 0 ÷1=$1.05 0 

July ........................................................................................................... 300 450 ÷1=$1.06 477 

Aug ........................................................................................................... 0 0 ÷1=$1.05 0 

Sept .......................................................................................................... 0 0 ÷1=$1.06 0 

Oct ............................................................................................................ 0 0 ÷1=$1.07 0 

Nov ........................................................................................................... 300 450 ÷1=$1.08 486 

Dec ........................................................................................................... 0 0 ÷1=$1.08 0 

Total Purchases ................................................................................ 1,200 1,800 ........................ 1,872 

(ii) French DE uses a first in first out 

method of accounting for inventory (FIFO). 

Thus, for 2009, French DE is considered to 

have sold the 100 units of opening inventory 

($150), the 300 units purchased in January 

($450), the 300 units purchased in April 

($459), the 300 units purchased in July ($477) 

and 200 of the 300 units purchased in 

November ($324). Thus, French DE’s cost of 

goods sold is $1,860. French DE’s opening 

inventory for 2010 is 100 units of inventory 

with a dollar basis of $162. 

(iii) Accordingly, for purposes of section 

987 French DE has gross income in dollars 

of $1,920 ($3,780–$1,860). 

Example 2. (i) The facts are the same as in 

Example 1 except that for purposes of 

paragraph (b)(1) of this section, U.S. Corp 

properly elects to use a spot rate convention 

under § 1.987–1(c)(1)(ii) to translate items of 

income, gain, deduction or loss where such 

rate is appropriate. Thus, French DE’s dollar 

gross sales will be computed as follows: 

GROSS SALES

Sales # of units ÷ ÷/$ convention 

exchange rate $ 

Jan ................................................................................................................... 100 300 ÷1=$1.00 300 

Feb ................................................................................................................... 200 600 ÷1=$1.05 630 

March ............................................................................................................... 0 0 ÷1=$1.03 0 

April .................................................................................................................. 200 600 ÷1=$1.02 612 

May .................................................................................................................. 100 300 ÷1=$1.04 312 

June ................................................................................................................. 0 0 ÷1=$1.05 0 

July ................................................................................................................... 100 300 ÷1=$1.06 318 

Aug ................................................................................................................... 100 300 ÷1=$1.05 315 

Sept .................................................................................................................. 0 0 ÷1=$1.06 0 

Oct ................................................................................................................... 0 0 ÷1=$1.07 0 

Nov ................................................................................................................... 100 300 ÷1=$1.08 324 

Dec ................................................................................................................... 300 900 ÷1=$1.08 972 


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GROSS SALES—Continued 

Sales # of units ÷ ÷/$ convention 

exchange rate $ 

1,200 3,600 ........................ 3,783 

(ii) As in Example 1, French DE’s cost of 

goods sold is $1,860. 

(iii) Accordingly, for purposes of section 

987 French DE has gross income in dollars 

of $1,923 ($3,783¥$1,860). 

Example 3. The facts are the same as in 

Example 1 except that French DE sold raw 

land on November 1, 2009 for ÷10,000. The 

yearly average rate for 2009 was ÷1=$1.05. 

The land was purchased on October 16, 2007 

for ÷8,000 when the convention rate was 

÷1=$1.00. Under paragraph (a)(1) of this 

section, French DE will determine the 

amount realized and basis in euros. Under 

paragraph (a)(1)(ii) of this section, the 

amount realized is translated into dollars at 

the yearly average exchange rate for 2009 as 

provided in paragraph (b)(2)(ii)(A) of this 

section (÷10,000 × $1.05 = $10,500) and the 

basis at the convention rate for 2007 as 

provided in paragraph (b)(2)(ii)(B) of this 

section and § 1.987–1(c)(3) ÷8,000 × $1 = 

$8,000). Accordingly, the amount of gain 

reported by U.S. Corp on the sale of the land 

is $2,500 ($10,500¥$8,000). 

Example 4. The facts are the same as in 

Example 3 except that U.S. Corp properly 

elects under paragraph (b)(1) of this section 

to use the spot rate to translate items of 

income, gain, deduction or loss. Accordingly, 

the amount realized will be translated at the 

convention rate on the day of sale. Assume 

that the convention rate for November 2009 

is ÷1 = $1.08. Under these facts, the amount 

realized is $10,800 (÷10,000 × $1.08) and the 

basis on the day of purchase $8,000 (÷8,000 

× $1.00). The amount of gain reported by U.S. 

Corp on the sale of the land is $2,800 

($10,800¥$8,000). 

Example 5. The facts are the same as in 

Example 1 except that on September 15, 

2009, French DE provides services to an 

unrelated customer and receives a cash 

payment of ÷2,000 on that day. Under 

paragraph (b)(1) of this section, U.S. Corp 

translates the ÷2,000 item of income into 

dollars at the yearly average exchange rate of 

÷1 = $1.05. Accordingly, U.S. Corp will 

report income of $2,100 from providing 

services. 

Example 6. The facts are the same as in 

Example 5 except that U.S. Corp properly 

elects under paragraph (b)(1) of this section 

to use the spot rate to translate items of 

income, gain, deduction or loss. Assume that 

the convention rate for September 2009 is ÷1 

= $1.06. Under these facts, U.S. Corp 

translates the ÷2,000 item of income into 

dollars at the convention rate of ÷1 = $1.06. 

Accordingly, U.S. Corp will report income of 

$2,120 from providing services. 

Example 7. The facts are the same as in 

Example 1 except that on March 31, 2009, 

French DE incurs ÷500 of rental expense, 

÷300 of salary expense and ÷100 of utilities 

expense. Under paragraph (b)(1) of this 

section, U.S. Corp translates these items of 

expense at the yearly average exchange rate 

of ÷1 = $1.05. Accordingly the expenses are 

translated as follows: rental expense of $525, 

salary expense of $315 and utilities expense 

of $105. 

Example 8. The facts are the same as in 

Example 7 except that U.S. Corp properly 

elects under paragraph (b)(1) of this section 

to use the spot rate to translate items of 

income and expense. Assume that the 

convention rate for March 2009 is ÷1 = $1.03. 

Under these facts, U.S. Corp translates the 

÷500 of rental expense, ÷300 of salary 

expense and ÷100 of utilities expense at the 

convention rate of ÷1 = $1.03. Accordingly, 

the expenses are translated as follows: rental 

expense of $515, salary expense of $309 and 

utilities expense of $103. 

Example 9. The facts are the same as in 

Example 1 except that during 2009, French 

DE incurred ÷100 of depreciation expense 

with respect to a truck. The truck was 

purchased on January 15, 2008, when the 

convention rate was ÷1 = $1.02. Under 

paragraph (b)(2)(i) of this section, the ÷100 of 

depreciation is translated into dollars at the 

historic exchange rate. Since U.S. Corp has 

properly elected to use a spot rate 

convention, depreciation will be translated in 

accordance with the convention. 

Accordingly, U.S. Corp translates the ÷100 of 

depreciation to equal $102. 

Example 10. (i) The facts are the same as 

in Example 1 except that on January 12, 

2009, French DE performed services for a 

U.K. person and received £10,000 in 

compensation. The exchange rate on January 

12, 2009, was £1 = ÷1.25. Under paragraph 

(d) of this section, French DE will translate 

such income into euros at the spot rate on 

January 12, 2009. Accordingly, French DE 

will take into account ÷12,500 of income 

from services in 2009. Under paragraph (b)(1) 

of this section, U.S. Corp translates the 

÷12,500 item of income into dollars at the 

yearly average euro to dollar exchange rate. 

Assume that such exchange rate is ÷1 = 

$1.10. Accordingly, U.S. Corp translates the 

÷12,500 income from services to equal 

$13,750. 

(ii) On October 16, 2009, French DE 

disposes of the £10,000 for ÷10,000. Under 

section 988(c)(1)(C), the disposition is a 

section 988 transaction. Under § 1.988–

2(a)(2), French DE will realize a loss of 

÷2,500 (÷10,000 amount realized less 

÷12,500 basis). Under paragraph (b)(1) of this 

section, U.S. Corp translates the ÷2,500 loss 

into dollars at the yearly average euro to 

dollar exchange rate. Assume that such 

exchange rate is ÷1 = $1.05. Accordingly, 

U.S. Corp translates the ÷2,500 section 988 

loss to equal $2,625. 

§ 1.987–4 Determination of net 

unrecognized section 987 gain or loss of a 

section 987 QBU. 

(a) In general. The net unrecognized 

section 987 gain or loss of a section 987 

QBU shall be determined by the owner 

annually as provided in paragraph (b) of 

this section in the owner’s functional 

currency. Only assets and liabilities 

reflected on the books and records of the 

section 987 QBU under § 1.987–2(b) 

shall be taken into account. 

(b) Calculation of net unrecognized 

section 987 gain or loss of a section 987 

QBU. Net unrecognized section 987 gain 

or loss of a section 987 QBU for a 

taxable year shall equal the sum of—

(1) The section 987 QBU’s net 

accumulated unrecognized section 987 

gain or loss for all prior taxable years to 

which these regulations apply as 

determined in paragraph (c) of this 

section; and 

(2) The section 987 QBU’s 

unrecognized section 987 gain or loss 

for the current taxable year as 

determined in paragraph (d) of this 

section. 

(c) Net accumulated unrecognized 

section 987 gain or loss for all prior 

taxable years. A section 987 QBU’s net 

accumulated unrecognized section 987 

gain or loss for all prior taxable years is 

the aggregate of the amounts determined 

under paragraph (d) of this section for 

all prior years to which these 

regulations apply, reduced by the 

amounts taken into account under 

§ 1.987–5 upon a remittance for all such 

prior taxable years. This amount shall 

include amounts appropriately 

considered as net unrecognized 

exchange gain or loss under the 

transition rules of § 1.987–10. 

(d) Calculation of unrecognized 

section 987 gain or loss of a section 987 

QBU for a taxable year. The 

unrecognized section 987 gain or loss of 

a section 987 QBU for a taxable year 

shall be determined under paragraphs 

(d)(1) through (7) of this section as 

follows: 

(1) Step 1: Determine the change in 

the owner functional currency net value 

of the section 987 QBU for the taxable 

year ¥(i) In general. The change in the 

owner functional currency net value of 

the section 987 QBU for the taxable year 

shall equal—

(A) The owner functional currency 

net value of the section 987 QBU, 

determined in the functional currency 

of the owner under paragraph (e) of this 

section, on the last day of the current 

taxable year; less 


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(B) The owner functional currency net 

value of the section 987 QBU, 

determined in the functional currency 

of the owner under paragraph (e) of this 

section on the last day of the preceding 

taxable year. This amount shall be zero 

in the case of the QBU’s first taxable 

year. 

(ii) Year section 987 QBU is 

terminated. If a section 987 QBU is 

terminated under the rules of § 1.987–8 

during an owner’s taxable year, the 

owner functional currency net value of 

the section 987 QBU as provided in 

paragraph (d)(1)(i)(A) of this section 

shall be determined on the day the 

section 987 QBU is terminated. 

(2) Step 2: Increase the aggregate 

amount determined in step 1 by the 

assets transferred from the section 987 

QBU to its owner–(i) In general. The 

aggregate amount determined in 

paragraph (d)(1) of this section shall be 

increased by the total amount of assets 

described in paragraph (d)(2)(ii) of this 

section transferred from the section 987 

QBU to the owner during the taxable 

year translated into the owner’s 

functional currency as provided in 

paragraph (d)(2)(iii) of this section. 

(ii) Assets transferred from the section 

987 QBU to the owner during the 

taxable year. The assets transferred from 

the section 987 QBU to the owner for 

the taxable year shall equal the 

aggregate of—

(A) The amount of the section 987 

QBU’s functional currency and the 

adjusted basis of any section 987 

marked asset (as defined in § 1.987–

1(d)) transferred from the section 987 

QBU to the owner during the taxable 

year determined in the functional 

currency of the section 987 QBU and 

translated into the owner’s functional 

currency as provided in paragraph 

(d)(2)(iii)(A) of this section; and 

(B) The adjusted basis of any section 

987 historic asset (as defined in § 1.987–

1(e)) transferred to the owner during the 

taxable year determined in the 

functional currency of the section 987 

QBU and translated into the owner’s 

functional currency as provided in 

paragraph (d)(2)(iii)(B) of this section. 

Such amount shall be adjusted to take 

into account the proper translation of 

depreciation, depletion and 

amortization as provided in § 1.987–

3(b)(2)(i). 

(iii) Translation of amounts 

transferred from the section 987 QBU to 

the owner. In the case of a transfer from 

the section 987 QBU to an owner of any 

asset the following exchange rates shall 

be used: 

(A) In the case of an amount described 

in paragraph (d)(2)(ii)(A) of this section, 

the spot exchange rate, as defined in 

§ 1.987–1(c)(1), on the day of transfer. 

(B) In the case of a transfer of a 

section 987 historic asset, the historic 

exchange rate for such asset as defined 

in § 1.987–1(c)(3). 

(3) Step 3: Decrease the aggregate 

amount determined in steps 1 and 2 by 

the owner’s transfers to the section 987 

QBU—(i) In general. The aggregate 

amount determined in paragraphs (d)(1) 

and (d)(2) of this section shall be 

decreased by the total amount of assets 

transferred from the owner to the 

section 987 QBU during the taxable year 

determined in the functional currency 

of the owner as provided in paragraph 

(d)(3)(ii) of this section. 

(ii) Total of all amounts transferred 

from the owner to the section 987 QBU 

during the taxable year. The total 

amount of assets transferred from the 

owner to the section 987 QBU for the 

taxable year shall equal the aggregate 

of—

(A) The total amount of functional 

currency of the owner transferred to the 

section 987 QBU during the taxable 

year; and 

(B) The adjusted basis, determined in 

the functional currency of the owner, of 

any asset transferred to the section 987 

QBU during the taxable year (after 

taking into account § 1.988–1(a)(10)). 

(4) Step 4: Decrease the aggregate 

amount determined in steps 1 through 

3 by the amount of liabilities transferred 

from the section 987 QBU to the owner. 

The aggregate amount determined in 

paragraphs (d)(1) through (d)(3) of this 

section shall be decreased by the 

aggregate amount of liabilities 

transferred from the section 987 QBU to 

the owner. The amount of such 

liabilities shall be translated into the 

functional currency of the owner at the 

spot exchange rate, as defined in 

§ 1.987–1(c)(1), on the day of transfer. 

(5) Step 5: Increase the aggregate 

amount determined in steps 1 through 

4 by amount of liabilities transferred 

from the owner to the section 987 QBU. 

The aggregate amount determined in 

paragraphs (d)(1) through (d)(4) of this 

section shall be increased by the 

aggregate amount of liabilities 

transferred by the owner to the section 

987 QBU. The amount of such liabilities 

shall be translated into the functional 

currency of the owner, if required, at the 

spot exchange rate, as defined in 

§ 1.987–1(c)(1)(i) and (ii), on the day of 

transfer. 

(6) Step 6: Increase the aggregate 

amount determined in steps 1 through 

5 by the section 987 taxable loss of the 

section 987 QBU for the taxable year. In 

the case of a section 987 taxable loss of 

the section 987 QBU computed under 

§ 1.987–3 for the taxable year, the 

aggregate amount determined in 

paragraphs (d)(1) through (d)(5) of this 

section shall be increased by such 

section 987 taxable loss. 

(7) Step 7: Decrease the aggregate 

amount determined in steps 1 through 

5 by the section 987 taxable income of 

the section 987 QBU for the taxable 

year. In the case of section 987 taxable 

income of the section 987 QBU 

computed under § 1.987–3 for the 

taxable year, the aggregate amount 

determined in paragraphs (d)(1) through 

(d)(5) of this section shall be decreased 

by such section 987 taxable income. 

(e) Determination of the owner 

functional currency net value of a 

section 987 QBU—(1) In general. The 

owner functional currency net value of 

a section 987 QBU on the last day of a 

taxable year shall equal the aggregate 

amount of the QBU’s functional 

currency and the basis of each asset on 

the section 987 QBU’s balance sheet on 

that day, less the aggregate amount of 

each liability on the section 987 QBU’s 

balance sheet on that day translated, if 

necessary, into the owner’s functional 

currency as provided in paragraph (e)(2) 

of this section. Such amount shall be 

determined as follows: 

(i) The owner, or section 987 QBU on 

behalf of the owner, shall prepare a 

balance sheet for the relevant date from 

the section 987 QBU’s books and 

records (within the meaning of 

§ 1.989(a)–1(d)) as recorded in the 

section 987 QBU’s functional currency 

showing all assets and liabilities 

reflected on such books and records as 

provided in § 1.987–2(b). Assets and 

liabilities denominated in the functional 

currency of the owner shall be reflected 

on the balance sheet in the owner’s 

functional currency. 

(ii) The owner, or section 987 QBU on 

behalf of the owner, shall make 

adjustments necessary to conform the 

items reflected on the balance sheet 

described in paragraph (e)(1)(i) of this 

section to United States generally 

accepted accounting principles and tax 

accounting principles. 

(iii) The owner, or section 987 QBU 

on behalf of the owner, shall translate 

the asset and liability amounts on the 

adjusted balance sheet described in 

paragraph (e)(1)(ii) of this section into 

the functional currency of the owner in 

accordance with paragraph (e)(2) of this 

section. Assets and liabilities 

denominated in the functional currency 

of the owner are not translated. 

(2) Translation of balance sheet items 

into the owner’s functional currency. 

The amount of the section 987 QBU’s 

functional currency, the basis of an 

asset, or the amount of a liability (other 


jlentini on PROD1PC65 with PROPOSAL2
52906 Federal Register / Vol. 71, No. 173 / Thursday September 7, 2006 / Proposed Rules 

4Opening cash of ¥100,000 + ¥10,000 borrowed 

+ ¥12,000 income from services ¥ ¥2,000 expenses. 

than an asset or liability reflected on the 

balance sheet in the functional currency 

of the owner) shall be translated as 

follows: 

(i) Section 987 marked item. A section 

987 marked item as defined in § 1.987–

1(d) shall be translated into the owner’s 

functional currency at the spot exchange 

rate as defined in § 1.987–1(c)(1)(i) and 

(ii) on the last day of the taxable year. 

(ii) Section 987 historic item. A 

section 987 historic item as defined in 

§ 1.987–1(e) shall be translated into the 

owner’s functional currency at the 

historic exchange rate as defined in 

§ 1.987–1(c)(3). 

(f) Examples. The provisions of this 

section are illustrated by the following 

examples. Unless otherwise indicated, 

all items are assumed to be reflected on 

the books and records, within the 

meaning of § 1.987–2(b), of the relevant 

section 987 QBU. 

Example 1. (i) U.S. Corp is a calendar year 

domestic corporation with the dollar as its 

functional currency. On July 1, 2009, U.S. 

Corp establishes Japan Branch that has the 

yen as its functional currency. Japan Branch 

is a section 987 QBU of U.S. Corp. U.S. Corp 

properly elects to use a spot rate convention 

under § 1.987–1(c)(1)(ii) with respect to Japan 

Branch. Under this convention, the spot rate 

for any transaction occurring during a month 

is the spot rate on the first day of the month. 

U.S. Corp also elects under § 1.987–3(b)(1) to 

use this convention to translate items of 

income, gain, deduction, or loss into dollars. 

On July 1, 2009, when $1 = ¥100 (or ¥1 = 

$0.01), U.S. Corp transfers $1,000 to Japan 

Branch and raw land with a basis of $500. 

Japan Branch immediately purchases 

¥100,000 with the $1,000. On the same day, 

Japan Branch borrows ¥10,000. Assume that 

for the taxable year 2009, Japan Branch earns 

¥2,000 per month (total of ¥12,000 for the six 

month period from July 1, 2009, through 

December 31, 2009) for providing services 

and incurs ¥333.33 per month (total of ¥2,000 

when rounded for the six month period from 

July 1, 2009, through December 31, 2009) of 

related expenses. Assume that all items of 

income earned and expenses incurred by 

Japan Branch during 2009 are received and 

paid, respectively, in yen. Further, assume 

that the ¥12,000 of income when properly 

translated under the monthly convention 

equals $109.08 and that the ¥2,000 of related 

expenses equal $18.18. Thus, Japan Branch’s 

income translated into dollars equals $90.90. 

Assume that the spot exchange rate on the 

December 1, 2009, is $1 = ¥120 (¥1 = 

$0.00833). 

(ii) Under paragraph (a) of this section, 

U.S. Corp must compute the net 

unrecognized section 987 gain or loss of 

Japan Branch for 2009. Since this is Japan 

Branch’s first taxable year, the net 

unrecognized section 987 gain or loss as 

defined under paragraph (b) of this section is 

the branch’s unrecognized section 987 gain 

or loss for 2009 as determined in paragraph 

(d) of this section. The calculation under 

paragraph (d) of this section is made as 

follows: 

(iii) Step 1. Under paragraph (d) of this 

section, U.S. Corp must determine the change 

in the owner functional currency net value of 

Japan Branch for the year 2009 in dollars. 

The change in the owner functional currency 

net value of Japan Branch for 2009 is equal 

to the owner functional currency net value of 

Japan Branch determined in dollars on the 

last day of 2009, less the owner functional 

currency net value of Japan Branch 

determined in dollars on the last day of the 

preceding taxable year. 

(A) The owner functional currency net 

value of Japan Branch determined in dollars 

on the last day of the current taxable year is 

determined under paragraph (e) of this 

section. Such amount is the aggregate of the 

basis of each asset on Japan Branch’s balance 

sheet on December 31, 2009, less the 

aggregate of the amount of each liability on 

the Japan Branch’s balance sheet on that day, 

translated into dollars as provided in 

paragraph (e)(2) of this section. 

(B) For this purpose, Japan Branch will 

show the following assets and liabilities on 

its balance sheet for December 31, 2009: 

(1) Cash of ¥120,000 [($1,000 transferred 

and immediately converted to ¥100,000) + 

¥10,000 borrowed + ¥12,000 income from 

services ¥ ¥2,000 of expenses]. 

(2) Raw land with a basis of ¥50,000. 

(3) Liabilities of ¥10,000. 

(C) Under paragraph (e)(2) of this section, 

U.S. Corp will translate these items as 

follows. The cash of ¥120,000 is a section 987 

marked asset and the ¥10,000 liability is a 

section 987 marked liability as defined in 

§ 1.987–1(d). These items are translated into 

dollars on December 31, 2009, using the spot 

rate on December 1, 2009 of ¥1 =$ 0.00833. 

The raw land is a section 987 historic asset 

as defined in § 1.987–1(e) and is translated 

into the dollars at the convention rate for the 

day of transfer (¥1 = $0.01). Thus, the owner 

functional currency net value of Japan 

Branch on December 31, 2009, in dollars is 

$1,416.60 determined as follows: 

Asset Amount in ¥ Translation rate Amount in $ 

Cash ........................................................................... 4 120,000 12/01/09 spot convention rate on 12/31/09 of 

¥1=$0.00833.

999.60 

Land ........................................................................... 50,000 Historic rate on 7/1/09 of ¥1=$0.01 ................................. 500.00 

Total assets ........................................................ .................... ........................................................................................... 1,499.60 

Liability: 

Bank Loan .................................................................. 10,000 12/01/09 spot convention rate on 12/31/09 of ¥1 = 

$0.00833.

83.30 

Total liabilities ..................................................... .................... ........................................................................................... 83.30 

Owner functional currency net value of Japan Branch on 

December 31, 2009 in dollars.

.................... ........................................................................................... 1,416.30 

(D) Under paragraph (d)(1) of this section, 

the change in owner functional currency net 

value of Japan Branch for 2009 is equal to the 

owner functional currency net value of the 

branch determined in dollars on December 

31, 2009 ($1,416.30) less the owner 

functional currency net value of the branch 

determined in dollars on the last day of the 

preceding taxable year. Since this is the first 

taxable year of Japan Branch, the owner 

functional currency net value of Japan 

Branch determined in dollars on the last day 

of the preceding taxable year is zero under 

paragraph (d)(1)(i)(B) of this section. 

Accordingly, the change in owner functional 

currency net value of Japan Branch for 2009 

is $1,416.30. 

(iv) Step 2. Under paragraph (d)(2) of this 

section, the aggregate amount determined in 

paragraph (d)(1) of this section (step 1) is 

increased by the total amount of assets 

described in paragraph (d)(2)(ii) of this 

section transferred from the section 987 QBU 

to the owner during the taxable year 

translated into the owner’s functional 

currency as provided in paragraph (d)(2)(iii) 

of this section. Since no such amounts were 

transferred under these facts, there is no 

change in the $1,416.30 determined in step 

1. 

(v) Step 3. Under paragraph (d)(3) of this 

section, the aggregate amount determined in 

paragraphs (d)(1) and (2) of this section (steps 

1–2) is decreased by the total amount of 

assets transferred from the owner to the 

section 987 QBU during the taxable year as 

determined in paragraph (d)(3)(ii) of this 

section in dollars. On July 1, 2009, U.S. Corp 

transferred to Japan Branch $1,000 (which 

Japan Branch immediately converted into 

¥100,000) and raw land with a basis of $500 

(equal to ¥50,000 on the day of transfer). 


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5The depreciation assumptions are for illustrative 

purposes only and may not be consistent with true 

depreciation rates. 

Thus, the step 2 amount of $1,416.30 is 

reduced by $1,500.00 to equal ($83.70). 

(vi) Steps 4, 5 and 6. Since no liabilities 

were transferred by U.S. Corp to Japan 

Branch or vice versa, the amount determined 

after applying paragraphs (d)(1) through 

(d)(5) of this section is ($83.70). Further, 

paragraph (d)(6) of this section does not 

apply since Japan Branch does not have a 

section 987 taxable loss. 

(vii) Step 7. Under paragraph (d)(7) of this 

section, the aggregate amount determined 

after applying paragraphs (d)(1) through 

(d)(5) of this section (steps 1–5) is decreased 

by the section 987 taxable income of Japan 

Branch of $90.90. Accordingly, the 

unrecognized section 987 loss of Japan 

Branch for 2009 is $174.60 

(¥$83.70¥$90.90). 

Example 2. (i) U.S. Corp, a calendar year 

domestic corporation with the dollar as its 

functional currency, operates in the United 

Kingdom through UK Branch. UK Branch has 

the pound as its functional currency and is 

a section 987 QBU. U.S. Corp properly elects 

to use a spot rate convention under § 1.987–

1(c)(1)(ii). Under this convention, the spot 

rate for any transaction occurring during a 

month is the average of the pound spot rate 

and the 30-day forward rate for pounds on 

the next-to-last Thursday of the preceding 

month. Pursuant to § 1.987–3(b)(1), U.S. Corp 

uses the yearly average exchange rate as 

defined in § 1.987–1(c)(2) to translate items 

of income, gain, deduction, or loss into 

dollars for the taxable year, where 

appropriate. The yearly average exchange 

rate for 2009 was £1 = $1.05. The closing 

balance sheet of UK Branch for the prior year 

(2008) reflected the following assets and 

liabilities. With respect to assets, UK Branch 

held—

(A) Cash of £100; 

(B) Plant purchased in May 2007 with an 

adjusted basis of £1000; 

(C) A machine purchased in May 2007 

with an adjusted basis of £200; 

(D) Inventory of 100 units manufactured in 

December 2008 with a basis of £100; 

(E) Portfolio stock (as defined in § 1.987–

2(b)(2)(ii)) in ABC Corporation purchased in 

September 2008 with a basis of £158; and 

(F) $50 acquired in 2008 (and held in a 

non-interest bearing account). 

With respect to liabilities, UK Branch has 

£50 of long-term debt entered into in 2007 

with F Bank, an unrelated bank. The plant, 

machine, inventory, stock and dollars are 

section 987 historic assets as defined in 

§ 1.987–1(e). The cash of £100 and long-term 

debt are section 987 marked items as defined 

under § 1.987–1(d). Assume the U.S. Corp 

translated UK Branch’s 2008 closing balance 

sheet as follows: 

Assets Amount in £ Translation Rate Amount in $ 

Cash ............................................ 100 Spot convention rate in Dec. 2008 £1 = $1 ................................................... 100.00 

Plant ............................................ 1,000 Historic rate-2007 May convention rate £1= $0.90 ........................................ 900.00 

Machine ....................................... 200 Historic rate-2007 May convention rate £1= $0.90 ........................................ 180.00 

Stock ........................................... 158 Historic rate-2008 Sept. convention rate £1= $.95 ........................................ 150.00 

Inventory ...................................... 100 Historic rate-2008 Dec. convention rate £1 = $1 ........................................... 100.00 

Dollars ......................................... $50 Dollars are not translated ............................................................................... 50.00 

Total assets .......................... .................... ......................................................................................................................... 1,480.00 

Liabilities: 

Bank Loan ................................... £50 Spot convention rate in Dec. 2008 £1 = $1 ................................................... 50.00 

Total liabilities ...................... .................... ......................................................................................................................... 50.00 

2008 ending owner functional currency net value (in dollars)..................... ......................................................................................................................... 1,430 

(ii) UK Branch uses the first in first out 

method of accounting for inventory. In 2009, 

UK Branch sold 100 units of inventory for a 

total of £300 and purchased another 100 

units of inventory in December 2009 for 

£100. Assume that the dollar basis of the 

inventory purchased in December 2009 when 

translated at the December 2009 monthly 

convention rate is $110; that depreciation 

with respect to the plant is £33 and for the 

machine £405; and that UK Branch incurred 

£30 of business expenses during 2009. 

Assume all items of income earned and 

expenses incurred during 2009 are received 

and paid, respectively, in pounds. The yearly 

average exchange rate for 2009 is £1 = $1.05. 

Under § 1.987–3, UK Branch’s section 987 

taxable income or loss is determined as 

follows: 

Item Amount in £ Translation Rate Amount in $ 

Gross receipts ............................ 300 2009 yearly ave. rate £1 = $1.05 ........................................................................... 315.00 

Less: 

COGS .................................. (100) Historic rate-Dec. 2008 convention rate £1= $1 .................................................... (100.00) 

Gross income ............... 200 ................................................................................................................................. 215.00 

Dep: 

Plant .................................... (33) Historic rate-May 2007 convention rate £1= $0.90 ................................................ (29.70) 

Machine ............................... (40) Historic rate-May 2007 convention rate £1= $0.90 ................................................ (36.00) 

Other expenses .......................... (30) 2009 yearly ave. rate £1 = $1.05 ........................................................................... (31.50) 

Total expenses ............. .................... ................................................................................................................................. 97.20 

Section 987 taxable income ....... .................... ................................................................................................................................. 117.80 

Accordingly, UK Branch has $117.80 of 

section 987 taxable income. 

(iii) Assume that in December 2009, UK 

Branch transferred $20 and £30 to U.S. Corp 

and that U.S. Corp transferred a computer 

with a basis of $10 to UK Branch. The 

convention exchange rate for December 2009 

is £1 = $1.10. Finally, assume that U.S. 

Corp’s net accumulated unrecognized section 

987 gain or loss for all prior taxable years as 

determined in paragraph (c) of this section is 

$30. 

(iv) The unrecognized section 987 gain or 

loss of UK Branch for 2009 is determined as 

follows: 

(A) Step 1: Determine the change in owner 

functional currency net value of UK Branch. 

Under paragraph (d)(1) of this section, the 


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6 £100 on the closing 2008 balance sheet plus 

£300 gross receipts less £100 inventory cost, less 

£30 of additional expenses, less £30 transferred to 

U.S. Corp. 

7 £1,000 on the closing 2008 balance sheet less 

£33 depreciation. 

8 £200 on the closing 2008 balance sheet less £40 

depreciation. 

9 Dollars are reduced by $20 transferred to U.S. 

Corp. 

change in owner functional currency net 

value for the taxable year must be 

determined. This amount is equal to the 

owner functional currency net value of UK 

Branch determined under paragraph (e) of 

this section on the last day of 2009, less the 

owner functional currency net value of UK 

Branch determined on the last day of 2008. 

The owner functional currency net value of 

UK Branch on December 31, 2009, and the 

change in owner functional currency net 

value is determined as follows: 

Asset Amount in £ Translation rate Amount in $ 

Cash ................................................... 6 240 Spot convention rate in Dec. 2009 £1 = $1.10 .............................................. 264.00 

Plant ................................................... 7 967 Historic rate-May 2007 convention rate £1 = $0.90 ....................................... 870.30 

Machine .............................................. 8160 Historic rate-May 2007 convention rate £1 = $0.90 ....................................... 144.00 

Inventory ............................................. 100 Historic rate—Dec. 2009 convention rate £1 = $1.10 .................................... 110.00 

Computer ............................................ 9 Historic rate—Dec. 2009 convention rate £1 = $1.10 .................................... 10.00 

Stock ................................................... 158 Historic rate—Sept. 2008 convention rate £1 = $.95 ..................................... 150.00 

Dollars ................................................ 9 $ 30 Dollars are not translated ............................................................................... 30.00 

Total assets ................................. .................... ......................................................................................................................... 1,578.30 

Liability: 

Bank Loan ................................... £50 Spot convention rate in Dec. 2009 £1 = $1.10 .............................................. 55.00 

Total liabilities .............................. .................... ......................................................................................................................... 55.00 

2009 ending owner functional currency net value (in dollars)..................... ......................................................................................................................... 1,523.30 

Less: 2008 ending owner functional 

currency net value (in dollars).

.................... ......................................................................................................................... ($1,430.00) 

Change in owner functional currency 

net value.

.................... ......................................................................................................................... 93.30 

(B) Step 2: Increase the aggregate amount 

described in step 1 by each owner’s share of 

assets transferred by the section 987 QBU to 

its owners. Under paragraph (d)(2) of this 

section, the aggregate amount determined in 

step 1 must be increased by the total amount 

of assets described in paragraph (d)(2)(ii) of 

this section transferred from UK Branch to 

U.S. Corp during the taxable year, translated 

into U.S. Corp’s functional currency as 

provided in paragraph (d)(2)(iii) of this 

section. The amount of assets transferred 

from UK Branch to U.S. Corp during 2009 is 

determined as follows: 

Asset Amount in £ Translation rate Amount in $ 

£30 currency ........................ 30 Spot convention rate in Dec. 2009 £1 = $1.10 ............................................................. 33.00 

$20 currency ........................ $20 Dollars are not translated .............................................................................................. 20.00 

Total .............................. .................... ........................................................................................................................................ 53.00 

(C) Step 3: Decrease the aggregate amount 

described in steps 1 and 2 by the owner’s 

transfers to the section 987 QBU. Under 

paragraph (d)(3) of this section, the aggregate 

amount determined in steps 1 and 2 must be 

decreased by the total amount of all assets 

transferred from U.S. Corp to UK Branch 

during the taxable year as determined in 

paragraph (d)(3)(ii) of this section. The 

amount of assets transferred from U.S. Corp 

to UK Branch is determined as follows: 

Asset Amount in £ Translation rate Amount in $ 

Computer ............................. £9 Spot convention rate in Dec. 2009 £1 = $1.10 ............................................................. $10.00 

Total .............................. .................... ........................................................................................................................................ 10.00 

(D) Step 4: Decrease the aggregate amount 

determined in steps 1 through 3 by the 

amount of liabilities transferred by the 

section 987 QBU to the owner. Under 

paragraph (d)(4) of this section, the aggregate 

amount determined in steps 1 through 3 must 

be decreased by the aggregate amount of 

liabilities transferred by UK Branch to U.S. 

Corp. Under these facts, such amount is $0. 

(E) Step 5: Increase the aggregate amount 

determined in steps 1 through 4 by the 

amount of liabilities transferred by the owner 

to the section 987 QBU. Under paragraph 

(d)(5) of this section, the aggregate amount 

determined in steps 1 through 4 must be 

increased by the aggregate amount of 

liabilities transferred by U.S. Corp to UK 

Branch. Under these facts, such amount is $0. 

(F) Step 6: Increase the aggregate amount 

determined in steps 1 through 5 by the 

section 987 taxable loss of the section 987 

QBU for the taxable year. Under paragraph 

(d)(6) of this section, the aggregate amount 

determined in steps 1 through 5 must be 

increased by the section 987 taxable loss of 

UK Branch. Since UK Branch had no such 

taxable loss in 2009, paragraph (d)(6) of this 

section does not apply. 

(G) Step 7: Decrease the aggregate amount 

determined in steps 1 through 5 by the 

section 987 taxable income of the section 987 

QBU for the taxable year. Under paragraph 

(d)(7) of this section, the aggregate amount 

determined in steps 1 through 5 must be 

decreased by the section 987 taxable income 

of UK Branch. The amount of UK Branch’s 

taxable income, as determined above, is 

$117.80. 

(v) Summary. Taking steps 1 through 7 into 

account, the amount of U.S. Corp’s 

unrecognized section 987 gain or loss with 


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respect to UK Branch in 2009 is computed as 

follows: 

Step Amount in $ Balance 

1 ............................................................................................................................................................................... + 93.30 $93.30 

2 ............................................................................................................................................................................... + 53.00 146.30 

3 ............................................................................................................................................................................... ¥10.00 136.30 

4 ............................................................................................................................................................................... ¥0 136.30 

5 ............................................................................................................................................................................... + 0 136.30 

6 ............................................................................................................................................................................... + 0 136.30 

7 ............................................................................................................................................................................... ¥117.80 18.50 

Thus, U.S. Corp’s unrecognized section 

987 gain in 2009 with respect to U.K. Branch 

is $18.50. As of the end of 2009, before taking 

into account the recognition of any section 

987 gain or loss under § 1.987–5, U.S. Corp’s 

net unrecognized section 987 gain is $48.50 

(i.e., $30 accumulated from prior years, plus 

$18.50 in 2009). 

§ 1.987–5 Recognition of section 987 gain 

or loss. 

(a) Recognition of section 987 gain or 

loss by the owner of a section 987 QBU. 

The taxable income of an owner of a 

section 987 QBU shall include the 

owner’s section 987 gain or loss 

recognized with respect to the section 

987 QBU for the taxable year. For any 

taxable year, the owner’s section 987 

gain or loss recognized with respect to 

a section 987 QBU shall be equal to—

(1) The owner’s net unrecognized 

section 987 gain or loss of the section 

987 QBU determined under § 1.987–4 

on the last day of such taxable year (or, 

if earlier, on the day the section 987 

QBU is terminated under § 1.987–8); 

multiplied by 

(2) The owner’s remittance proportion 

for the taxable year, as determined 

under paragraph (b) of this section. 

(b) Remittance proportion. The 

owner’s remittance proportion with 

respect to a section 987 QBU for a 

taxable year is the quotient, equal to—

(1) The remittance, as determined 

under paragraph (c) of this section, to 

the owner from the section 987 QBU for 

such taxable year; divided by 

(2) The total adjusted basis of the 

gross assets of the section 987 QBU as 

of the end of the taxable year (or, if 

terminated prior to the end of such 

taxable year under § 1.987–8, the day of 

termination) that are reflected on its 

year-end balance sheet (or, if terminated 

prior to the end of such taxable year 

under § 1.987–8, the balance sheet on 

the day terminated), translated into the 

owner’s functional currency as provided 

in § 1.987–4(e)(2) and increased by the 

amount of the remittance. 

(c) Remittance—(1) Definition. A 

remittance shall be determined in the 

owner’s functional currency and shall 

equal the excess, if any, of—

(i) The total of all amounts transferred 

from the section 987 QBU to the owner 

during the taxable year, as determined 

in paragraph (d) of this section; over 

(ii) The total of all amounts 

transferred from the owner to the 

section 987 QBU during the taxable 

year, as determined in paragraph (e) of 

this section. 

(2) Day when a remittance is 

determined. An owner’s remittance 

from a section 987 QBU shall be 

determined on the last day of the 

owner’s taxable year (or, if earlier, on 

the day the section 987 QBU is 

terminated under § 1.987–8). 

(3) Termination. A termination of a 

section 987 QBU as determined under 

§ 1.987–8 is treated as a remittance of all 

the gross assets of the section 987 QBU 

to the owner on the date of such 

termination. See § 1.987–8(d). 

Accordingly, the remittance proportion 

in the case of a termination is 1. 

(d) Total of all amounts transferred 

from the section 987 QBU to the owner 

for the taxable year. For purposes of 

paragraph (c)(1)(i) of this section, the 

total of all amounts transferred from the 

section 987 QBU to the owner for the 

taxable year shall be determined in the 

owner’s functional currency under 

§ 1.987–4(d)(2) with reference to the 

adjusted basis of the assets transferred. 

Solely for this purpose, the amount of 

liabilities transferred from the owner to 

the section 987 QBU determined under 

§ 1.987–4(d)(5) shall be treated as a 

transfer of assets from the section 987 

QBU to the owner in an amount equal 

to the amount of such liabilities. 

(e) Total of all amounts transferred 

from the owner to the section 987 QBU 

for the taxable year. For purposes of 

paragraph (c)(1)(ii) of this section, the 

total of all amounts transferred from the 

owner to the section 987 QBU for the 

taxable year shall be determined in the 

owner’s functional currency under 

§ 1.987–4(d)(3) with reference to the 

adjusted basis of the assets transferred. 

Solely for this purpose, the amount of 

liabilities transferred from the section 

987 QBU to the owner determined 

under § 1.987–4(d)(4) shall be treated as 

a transfer of assets from the owner to the 

section 987 QBU in an amount equal to 

the amount of such liabilities. 

(f) Determination of owner’s adjusted 

basis in transferred assets—(1) In 

general. The owner’s adjusted basis in 

an asset received in a transfer from the 

section 987 QBU (whether or not such 

transfer is made in connection with a 

remittance as defined in paragraphs (c) 

of this section) shall be determined 

under the rules prescribed in paragraphs 

(f)(2) through (f)(4) of this section. 

(2) Section 987 marked asset. The 

basis of a section 987 marked asset shall 

be determined in the owner’s functional 

currency and shall be the same as the 

amount determined under § 1.987–

4(d)(2)(ii)(A). 

(3) Section 987 historic asset. The 

basis of a section 987 historic asset shall 

be determined in the owner’s functional 

currency and shall be the same as the 

amount determined under § 1.987–

4(d)(2)(ii)(B). 

(4) Partner’s adjusted basis in 

distributed assets. See also section 732 

and § 1.987–7 for purposes of 

determining an owner’s adjusted basis 

of an asset distributed from a section 

987 QBU owned indirectly through a 

section 987 partnership. 

(g) Examples. The following examples 

illustrate the calculation of section 987 

gain or loss under this section: 

Example 1. (i) U.S. Corp, a calendar year 

domestic corporation with the dollar as its 

functional currency, operates in the U.K. 

through U.K. DE, an entity disregarded as an 

entity separate from its owner under 

§§ 301.7701–1 through 301.7701–3 of this 

chapter. U.K. DE has a section 987 branch 

(U.K. section 987 branch) with the pound as 

its functional currency. During year 2, the 

following transfers took place between U.S. 

Corp and U.K. section 987 branch. On 

January 5, year 2, U.S. Corp transferred to 

U.K. section 987 branch $300 (which the 

branch used during the year to purchase 

services). On March 5, year 2, U.K. section 

987 branch transferred a machine to U.S. 

Corp. Assume that the pound adjusted basis 

of the machine when properly translated into 

dollars under §§ 1.987–4(d)(2)(ii)(B) and 

paragraph (d) of this section is $500. On 

November 1, year 2, U.K. section 987 branch 

transferred pound cash to U.S. Corp. Assume 


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that the dollar amount of the pounds when 

properly translated under § 1.987–

4(d)(2)(ii)(A) and paragraph (d) of this section 

is $2,300. On December 7, year 2, U.S Corp 

transferred a truck to U.K. section 987 branch 

with an adjusted basis of $2,000. 

(ii) Assume that at the end of year 2, U.K. 

section 987 branch holds assets, properly 

translated into the owner’s functional 

currency pursuant to § 1.987–4(e)(2), 

consisting of a computer with a pound 

adjusted basis equivalent to $500, a truck 

with a pound adjusted basis equivalent to 

$2,000, and pound cash equivalent to $2,850. 

In addition, assume that U.K. section 987 

branch has a pound liability entered into in 

year 1 with Bank A. The liability, when 

translated into the owner functional currency 

pursuant to § 1.987–4(e)(2), is equivalent to 

$200. All such assets and liabilities are 

reflected on the books and records of U.K. 

section 987 branch. Assume that the net 

unrecognized section 987 gain for U.K. 

section 987 branch as determined under 

§ 1.987–4 as of the last day of year 2 is $80. 

(iii) U.S. Corp’s section 987 gain with 

respect to U.K. section 987 branch is 

determined as follows: 

(A) Computation of amount of remittance. 

Under paragraphs (c)(1) and (2) of this 

section, U.S. Corp must determine the 

amount of the remittance for year 2 in the 

owner’s functional currency (dollars) on the 

last day of year 2. The amount of the 

remittance for year 2 is $500, determined as 

follows: 

Transfers from U.K. section 987 branch to 

U.S. Corp in dollars: 

Machine ....................................... $500 

Cash (U.K. pounds) ..................... 2,300 

$2,800 

Transfers from U.S. Corp to U.K. section 

987 branch in dollars: 

Cash (U.S. dollars) ....................... $300 

Truck ............................................ 2,000 

2,300 

Computation of amount of remittance: 

Aggregate transfers from U.K. 

section 987 branch to U.S. 

Corp .......................................... $2,800 

Less: aggregate transfers from 

U.S. Corp to U.K. section 987 

branch ....................................... (2,300) 

Total remittance ................... 500 

(B) Computation of branch gross assets 

plus remittance. Under paragraph (b)(2) of 

this section, U.K. section 987 branch must 

determine the total basis of its gross assets 

that are reflected on its year-end balance 

sheet translated into the owner’s functional 

currency, and must increase this amount by 

the amount of the remittance. 

Total basis of U.K. section 987 branch’s 

gross assets at end of year 2 plus remittance 

in dollars: 

Computer ..................................... $500 

Cash (U.K. pounds) ..................... 2,850 

Truck ............................................ 2,000 

Total gross assets .................. 5,350 

Remittance ................................... 500 

Total gross assets + remittance ...................... 5,850 

(C) Computation of remittance proportion. 

Under paragraph (b) of this section, U.K. 

section 987 branch must compute the 

remittance proportion as follows: 

Amount of remittance ................. $500 

Total basis of U.K. section 987 

branch’s gross assets at end of 

Year 2, increased by amount 

of remittance ............................ 5,850 

Remittance/gross assets .............. 0.085 

Remittance proportion ................ 0.085 

(D) Computation of section 987 gain or 

loss. The amount of U.S. Corp’s section 987 

gain or loss that must be recognized with 

respect to U.K. section 987 branch is 

determined under paragraph (a) of this 

section. 

Net unrecognized section 987 

gain ........................................... $80 

Remittance proportion ................ × 0.085 

U.S. Corp’s section 987 gain 

for Year 2: ......................... $6.80 

Example 2. U.S. Corp, a calendar year 

domestic corporation with the dollar as its 

functional currency, operates in the U.K. 

through U.K. DE, an entity disregarded as an 

entity separate from its owner. U.K. DE has 

a section 987 branch (U.K. section 987 

branch) with the pound as its functional 

currency. During year 2, the following 

transfers took place between U.S. Corp and 

U.K. section 987 branch. On March 1, year 

2, U.S. Corp transferred to U.K. section 987 

branch a computer with a basis of $100. On 

November 1, year 2, U.K. section 987 branch 

transferred pounds to U.S. Corp. Assume that 

the dollar amount of the pounds when 

properly translated under § 1.987–

4(d)(2)(ii)(A) and paragraph (d) of this section 

is $300. On the same day, U.K. section 987 

branch transferred of $20 to U.S. Corp. 

(ii) Assume that at the end of year 2, U.K. 

section 987 branch holds assets translated (as 

necessary) into the owner functional 

currency pursuant to § 1.987–4(e)(2) 

consisting of a plant with a pound adjusted 

basis equivalent $1,000, pound cash 

equivalent to $100, a machine with a pound 

adjusted basis equivalent to $200, portfolio 

stock (within the meaning of § 1.987–

2(b)(2)(ii)) in ABC Corporation with a pound 

adjusted basis equivalent to $150, inventory 

of 100 units with an aggregate pound 

adjusted basis equivalent to $100 and a 

computer with a pound adjusted basis 

equivalent to $100. In addition, assume that 

U.K. section 987 branch has a pound liability 

that it entered into with Bank A in year 1. 

When properly translated into dollars 

pursuant to § 1.987–4(e)(2) the principal 

amount of the liability is equal to $500. All 

such assets and liabilities are reflected on the 

books and records of U.K. section 987 

branch. Assume that the net unrecognized 

987 gain for U.K. section 987 branch as 

determined under § 1.987–4 as of the last day 

of year 2 is $100. 

(iii) U.S. Corp’s section 987 gain with 

respect to U.K. section 987 branch is 

determined as follows: 

(A) Computation of amount of remittance. 

Under paragraphs (c)(1) and (2) of this 

section, U.S. Corp must determine the 

amount of the remittance for year 2 in the 

owner’s functional currency on the last day 

of year 2. The amount of the remittance for 

year 2 is $220 determined as follows: 

Transfers from U.K. section 987 branch to 

U.S. Corp in dollars: 

Cash (U.K. pounds) ..................... $300 

Cash (U.S. dollars) ....................... 20 

320 

Transfers from U.S. Corp to U.K. section 

987 branch in dollars: 

Computer ..................................... $100 

Computation of amount of remittance: 

Aggregate transfers from U.K. 

section 987 branch to U.S. 

Corp .......................................... $320 

Less: aggregate transfers from 

U.S. Corp to U.K. branch ......... ($100) 

Total remittance: ......................... $220 

Computation of amount of remittance: 

Aggregate transfers from U.K. 

section 987 branch to U.S. 

Corp .......................................... $320 

Less: aggregate transfers from 

U.S. Corp to U.K. branch ......... 100 

Total remittance: .................. 220 

(B) Computation of branch gross assets 

plus remittance. Under paragraph (b)(2) of 

this section, U.K. section 987 branch must 

determine the total basis of its gross assets as 

are reflected on its year-end balance sheet 

translated into dollars and must increase this 

amount by the amount of the remittance. 

Total pound basis of U.K. section 987 

branch’s gross assets translated into dollars 

at end of Year 2: 

Plant ............................................. $1,000 

Cash (U.K. pounds) ..................... 100 

Inventory ...................................... 100 

Machine ....................................... 200 

Computer ..................................... 100 

Portfolio Stock ............................. 150 

Total gross assets .................. 1,650 

Remittance ................................... 220 

Total gross assets + remittance .................................. 1,870 

(C) Computation of remittance proportion. 

Under paragraph (b) of this section, U.K. 

section 987 branch must compute the 

remittance proportion as follows: 

Amount of remittance ................. $220 

Total basis of U.K. section 987 

branch’s gross assets at tend of 

year 2, increased by amount of 

remittance ................................. 1,870 

Remittance/gross assets ............... 0.118 

Remittance proportion ................ 0.118 

(D) Computation of section 987 gain or 

loss. The amount of U.S. Corp’s section 987 

gain or loss that must be recognized with 

respect to U.K. section 987 branch is 

determined under paragraph (a) of this 

section. 

Net unrecognized section 987 

gain ........................................... $100.00 

Remittance proportion ................ × 0.118 


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U.S. Corp’s section 987 gain 

for year 2 ........................... 11.80 

§ 1.987–6 Character and source of section 

987 gain or loss. 

(a) Ordinary income or loss. Section 

987 gain or loss is ordinary income or 

loss for Federal income tax purposes. 

(b) Source and character of section 

987 gain or loss—(1) In general. Except 

as otherwise provided in this section, 

the owner of a section 987 QBU must 

determine the source and character of 

section 987 gain or loss in the year of 

a remittance under the rules of this 

paragraph (b) for all purposes of the 

Internal Revenue Code, including 

sections 904(d), 907 and 954. 

(2) Method required to characterize 

and source section 987 gain or loss. The 

owner must use the asset method set 

forth in § 1.861–9T(g) to characterize 

and source section 987 gain or loss. The 

modified gross income method 

described in § 1.861–9T(j) cannot be 

used. 

(3) Method required to characterize 

and source section 987 gain or loss with 

respect to regulated investment 

companies and real estate investment 

trusts. [Reserved]. 

(c) Example. The following example 

illustrates the application of this 

section. 

Example. CFC is a controlled foreign 

corporation as defined in section 957 

with the Swiss franc (Sf) as its 

functional currency. CFC holds all the 

interest in a section 987 DE as defined 

in § 1.987–1(b)(6)(iii) that has a section 

987 branch with significant operations 

in Germany (German Branch). German 

Branch has the euro as its functional 

currency. For the year 2009, CFC 

recognizes section 987 gain of Sf10,000 

under §§ 1.987–4 and 1.987–5. Applying 

the rules of this section, German Branch 

has total average assets of Sf1,000,000 

which generate income as follows: 

Sf750,000 of assets that generate foreign 

source general limitation income under 

section 904(d)(1)(I), none of which is 

subpart F income under section 952; 

and Sf250,000 of assets that generate 

foreign source passive income under 

section 904(d)(1)(B), all of which is 

subpart F income. Under paragraph (b) 

of this section, Sf7,500 (Sf750,000/ 

Sf1,000,000 × Sf10,000) of the section 

987 gain will be treated as foreign 

source general limitation income which 

is not subpart F income and Sf2,500 

(Sf250,000/Sf1,000,000 × Sf10,000) will 

be treated as foreign source passive 

income which is subpart F income. All 

of the section 987 gain is treated as 

ordinary income. 

§ 1.987–7 Section 987 partnerships. 

(a) In general. In the case of an owner 

that is a partner in a section 987 

partnership, this section provides rules 

for determining the owner’s share of 

assets and liabilities of a section 987 

QBU owned indirectly, as described in 

§ 1.987–1(b)(4)(ii), through a section 987 

partnership. In addition, this section 

provides rules coordinating these 

regulations with subchapter K of 

chapter 1 of the Internal Revenue Code. 

(b) Assets and liabilities of an eligible 

QBU or a section 987 QBU held 

indirectly through a partnership. A 

partner’s share of the assets and 

liabilities reflected under § 1.987–2(b) 

on the books and records of an eligible 

QBU or a section 987 QBU owned 

indirectly through a partnership shall be 

determined in a manner that is 

consistent with the manner in which the 

partners have agreed to share the 

economic benefits and burdens (if any), 

corresponding to the assets and 

liabilities, taking into account the rules 

and principles of sections 701 through 

761, and the applicable regulations, 

including section 704(b) and § 1.701–2. 

(c) Coordination with subchapter K—

(1) Partner’s adjusted basis in its 

partnership interest—(i) In general. 

Except as provided in this paragraph, a 

partner’s adjusted basis in its section 

987 partnership interest shall be 

maintained in the functional currency of 

that partner and shall not be adjusted as 

a result of any fluctuations in the value 

of the partner’s functional currency and 

the functional currency of any section 

987 QBU owned indirectly through the 

section 987 partnership. 

(ii) Adjustments for section 987 

taxable income or loss and section 987 

gain or loss—(A) Section 987 taxable 

income or loss. A partner’s share of the 

items of income, gain, deduction or loss 

taken into account in calculating section 

987 taxable income or loss of a section 

987 QBU, determined under § 1.987–3, 

held indirectly through a section 987 

partnership shall be treated as income 

or loss of the section 987 partnership 

through which the partner indirectly 

owns the interest. As a result, the 

partner’s allocable share of the items of 

income, gain, deduction or loss taken 

into account in calculating section 987 

taxable income or loss of the section 987 

QBU shall be taken into account, 

following conversion into the partner’s 

functional currency, in determining the 

appropriate adjustments to the partner’s 

adjusted basis in its partnership interest 

under section 705. 

(B) Section 987 gain or loss. Solely for 

purposes of determining the appropriate 

adjustments to a partner’s adjusted basis 

in its interest in a section 987 

partnership under section 705, an 

individual or corporation that owns a 

section 987 QBU indirectly through a 

section 987 partnership shall treat any 

section 987 gain or loss of such section 

987 QBU as gain or loss of the section 

987 partnership. Any adjustments to the 

adjusted basis of a partner’s interest in 

such section 987 partnership required 

under this paragraph (c)(1)(ii)(B) of this 

section shall occur prior to determining 

the effect under the Internal Revenue 

Code of any sale, exchange, distribution 

or other event. 

(iii) Adjustments for contributions 

and distributions. For purposes of 

making adjustments to the partner’s 

adjusted basis in its interest in a section 

987 partnership, as a result of any 

contributions or distributions (including 

deemed contributions and distributions 

under section 752) between the section 

987 partnership and the owner of a 

section 987 QBU owned indirectly 

through the partnership, such amounts 

will be taken into account in the 

owner’s functional currency. 

(iv) Determination of deemed 

distributions and contributions under 

section 752—(A) Increase in partner’s 

liabilities. For purposes of determining 

the amount of any increase in a 

partner’s share of the liabilities of the 

partnership, or any increase in the 

partner’s individual liabilities by reason 

of the assumption by such partner of a 

liability of the partnership, which are 

reflected on the books and records of a 

section 987 QBU owned indirectly 

through such partnership and which are 

denominated in a functional currency 

different from the partner’s, the amount 

of such liabilities shall be translated 

into the functional currency of the 

partner using the spot rate (as defined 

in § 1.987–1(c)(1)(i) and (ii)) on the date 

of such increase. 

(B) Decrease in partner’s liabilities. 

For purposes of determining the amount 

of any decrease in a partner’s share of 

the liabilities of the partnership which 

were reflected on the books and records 

of a section 987 QBU owned indirectly 

through such partnership and which are 

denominated in a functional currency 

different from the partner’s functional 

currency, the amount of such liabilities 

shall be translated into the functional 

currency of the partner using the 

historic rate (as defined in § 1.987–

1(c)(3)) for the date on which such 

liabilities increased the partner’s 

adjusted basis in its partnership interest 

under section 752. 

(2) Special rule for determining gain 

or loss on the sale, exchange or other 

disposition of an interest in a section 

987 partnership. For purposes of 

determining the amount realized by a 


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partner in a section 987 partnership on 

the sale, exchange, or other disposition 

of that partner’s interest in such 

partnership, the amount of liabilities 

reflected on the books and records of a 

section 987 QBU (in a functional 

currency different from such partner) 

from which that partner is relieved as a 

result of such disposition, and which 

are included in the amount realized 

pursuant to section 752(d), shall be 

translated into the partner’s functional 

currency using the historic exchange 

rate (as determined under § 1.987–

1(c)(3)) for the date on which such 

liabilities increased the partner’s 

adjusted basis in its partnership interest 

under section 752. 

(d) Examples. The purpose of the 

following examples is to illustrate the 

application of section 987 to 

partnerships and their partners. The 

examples are not meant to be a 

comprehensive interpretation of the 

step-by-step computations involved in 

computing net unrecognized section 987 

gain or loss. Thus, for the sake of 

simplicity, the examples only calculate 

section 987 gain or loss by reference to 

certain identified assets and liabilities, 

rather than by all the assets and 

liabilities of the section 987 QBU (as is 

required under these regulations). See 

§ 1.987–4 and the examples therein for 

step-by-step computations for 

determining the unrecognized section 

987 gain or loss of the owner of a 

section 987 QBU. 

Example 1. Computation of an owner’s net 

unrecognized section 987 gain or loss. (i) 

Facts. PRS is a partnership which owns 

QBUx, an eligible QBU, operating in the 

United Kingdom. QBUx has the pound as its 

functional currency determined under 

§ 1.985–1 taking into account all of QBUx’s 

activities before application of this section. 

PRS has two equal partners that are domestic 

corporations, A and B, each with the U.S. 

dollar as its functional currency. The 

portions of QBUx allocated to A and B under 

paragraph (b) of this section are section 987 

QBUs of A and B because under § 1.987–

1(b)(2), such portions are allocated from an 

eligible QBU with a different functional 

currency than A and B, respectively. Assume 

that PRS has no items of section 987 taxable 

income or loss for 2007. On January 1, 2007, 

A and B each contribute $50 to PRS. PRS 

immediately converts the $100 into £100. 

The £100 is reflected, in accordance with 

§ 1.987–2(b), on the books and records of 

QBUx. On January 1, 2007, the spot rate is 

$1 = £1. On December 31, 2007, the spot rate 

is $1.50 = £1. Pursuant to § 1.987–3(b)(1), A 

and B use the yearly average exchange rate, 

as defined in § 1.987–1(c)(2), to translate 

items of income, gain, deduction, or loss into 

dollars for the taxable year. Assume the 

yearly average exchange rate is $1.25 = £1 ($1 

= £.80). Under the PRS partnership 

agreement, A and B each have an equal 

interest in all items of partnership income 

and loss. 

(ii) Calculation of net unrecognized section 

987 gain or loss. Under paragraph (b) of this 

section, A and B are each allocated 50 from 

eligible QBUx. This amount is reflected on 

the balance sheet of the section 987 QBU of 

A and B, respectively, for purposes of 

determining the unrecognized section 987 

gain or loss under § 1.987–4. Pursuant to 

§ 1.987–4(d), the net unrecognized section 

987 gain of A’s section 987 QBU and B’s 

section 987 QBU is $25. 

Example 2. Computation of owner’s net 

unrecognized section 987 gain or loss. (i) 

Facts. The facts are the same as Example 1, 

except that in addition to the £100 

contributed by A and B, PRS incurred a £50 

recourse liability from an unrelated third 

party on January 1, 2007. The liability and 

the £50 are both reflected on the books and 

records of QBUx under § 1.987–2(b). Under 

section 752, and the regulations thereunder, 

A and B bear the economic risk of loss with 

respect to the £50 recourse debt equally. 

(ii) Calculation of net unrecognized section 

987 gain or loss. Under paragraph (b) of this 

section, A and B are each allocated £75 from 

QBUx. In addition, under paragraph (b) of 

this section, A and B are each allocated £25 

of the liability of QBUx because the 

economic burden of such liability, taking into 

account sections 701 through 761 of the 

Code, is borne equally by A and B. Under 

§ 1.987–4(d), A and B each have net 

unrecognized section 987 gain of $25. 

(iii) Determination of partner’s adjusted 

basis in PRS. Pursuant to paragraph (c)(1)(i) 

of this section and section 985(a), A and B 

must determine the adjusted basis in their 

PRS partnership interests in U.S. dollars. 

Under sections 722, 752(a) and paragraph 

(c)(1)(iv)(A) of this section, the adjusted bases 

in such interests are increased by the U.S. 

dollar amount of a deemed contribution 

determined using the spot rate for the date 

on which such liability was incurred. 

Therefore, A and B will increase the adjusted 

basis in their PRS partnership interests by 

$25. 

Example 3. Computation of owner’s net 

unrecognized section 987 gain or loss. (i) 

Facts. The facts are the same as Example 2, 

except as follows: On January 1, 2007, 

instead of incurring a £50 recourse liability, 

PRS incurred a £50 nonrecourse liability 

from an unrelated third party, which was 

secured by and used to purchase nondepreciable real property located in the 

United Kingdom. Under the partnership 

agreement, A and B agree to share all items 

of partnership income and loss equally, 

except that A guaranteed the nonrecourse 

liability and, in addition, the partnership 

agreement provides that A will be allocated 

any gain from the sale or exchange of the 

non-depreciable property. Further, the 

partnership agreement provides that in the 

event the partnership liquidates prior to 

satisfying the liability, the non-depreciable 

property shall be distributed to A. 

(ii) Calculation of net unrecognized section 

987 gain or loss. Under paragraph (b) of this 

section, A and B are each allocated £50 from 

eligible QBUx. In addition, because A bears 

the economic burden of the nonrecourse 

liability incurred by PRS and the economic 

benefits of the non-depreciable property 

securing such liability, both of which are 

reflected on the books and records of QBUx 

under § 1.987–2(b), A is allocated, for 

purposes of applying § 1.987–4(d), both the 

£50 liability and the non-depreciable 

property with an adjusted tax basis of £50. 

Under § 1.987–4(d), A’s net unrecognized 

section 987 gain is $0, and B’s net 

unrecognized section 987 gain is $25. 

(iii) Determination of partner’s adjusted 

basis in PRS. Pursuant to paragraph (c)(1)(i) 

of this section and section 985(a), A and B 

must determine the adjusted bases in their 

PRS partnership interests in U.S. dollars. 

Under sections 722, 752(a) and paragraph 

(c)(1)(iv) of this section, A’s adjusted basis is 

increased by the U.S. dollar amount of the 

deemed contribution determined using the 

spot rate for the date on which such liability 

was incurred. Therefore, A will increase the 

adjusted basis in its PRS partnership interest 

by $50. 

Example 4. Computation of owner’s share 

of items of section 987 taxable income. (i) 

Facts. The facts are the same as in Example 

1, except that during 2007 PRS earns £50 

which are reflected on the books and records 

of QBUx. In accordance with the partnership 

agreement, the £50 are allocated equally 

between A and B. 

(ii) Calculation of section 987 taxable 

income or loss. Under § 1.987–3, A and B’s 

allocable share of the taxable income of 

QBUx, as determined by PRS, and adjusted 

to conform to U.S. tax principles, is £25 each. 

Under § 1.987–3, A and B must convert their 

allocable share of the £25 into U.S. dollars 

using the yearly average exchange rate for the 

year, in accordance with § 1.987–1(c)(2). As 

a result, A and B each take into account as 

their respective distributive share of PRS 

income $31.25. Under paragraph (c)(1)(ii)(A) 

of this section, section 985(a) and section 

705, such amounts, as reflected in U.S. 

dollars, will be taken into account in 

determining any adjustments to the adjusted 

bases of A’s and B’s partnership interests. In 

addition, such amounts will be taken into 

account in calculating, under § 1.987–4, the 

unrecognized section 987 gain or loss of the 

section 987 QBUs of A and B. 

Example 5. Computation of owner’s share 

of items of section 987 taxable income. (i) 

Facts. The facts are the same as in Example 

4, except A and B agree to allocate the £50 

of income to A. Assume for purposes of this 

example that such allocation has substantial 

economic effect as provided under section 

704(b). 

(ii) Calculation of section 987 taxable 

income or loss. Under § 1.987–3, A and B’s 

allocable share of the taxable income of 

QBUx, as determined by PRS, and adjusted 

to conform to U.S. tax principles, is £50 and 

£0, respectively. Under § 1.987–3, A and B 

must convert their allocable share into U.S. 

dollars using the yearly average exchange 

rate for the year, in accordance with § 1.987–

1(c)(2). As a result, A and B must each take 

into account as their respective distributive 

share of PRS income $62.50 and $0, 

respectively. Under paragraph (c)(1)(ii)(A) of 

this section, section 985(a) and section 705, 

such amounts, as reflected in U.S. dollars, 


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will be taken into account in determining any 

adjustments to the adjusted bases of A’s and 

B’s respective partnership interests. In 

addition, such amounts will be taken into 

account in calculating, under § 1.987–4, the 

unrecognized section 987 gain or loss of the 

section 987 QBUs of A and B. 

Example 6. Election by de minimis partner 

to not take into account section 987 gain or 

loss. (i) Facts. The facts are the same as in 

Example 1, except assume that A owns, 

directly or indirectly, less than 5% of the 

total capital and profits interest in PRS and, 

as a result, is eligible to elect, under § 1.987–

1(b)(1)(ii) not to apply the provisions of the 

regulations under section 987 for purposes of 

taking into account the section 987 gain or 

loss of A’s section 987 QBU. Assume further 

that A makes such election. On January 1, 

2008, A sells its interest to an unrelated third 

party, C, for $75. 

(ii) Determination of partner’s adjusted 

basis in PRS. Pursuant to paragraph (c)(1)(i) 

of this section and section 985(a), A must 

determine the adjusted basis of its PRS 

partnership interest in U.S. dollars. A’s basis 

in PRS is $50, the amount of its contribution 

to PRS. 

(iii) Sale of partnership interest by A. 

Under section 1001, A’s amount realized on 

the sale of the partnership interest to C is 

$75. A’s adjusted basis of its PRS partnership 

interest is $50, the amount of A’s 

contribution to PRS, unadjusted by the 

fluctuations between the pound and the U.S. 

dollar. A’s gain on the sale of the partnership 

interest is $25. 

§ 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 provides 

certain effects of terminations. 

Paragraph (e) 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 when—

(1) Its activities cease, such that it no 

longer meets the definition of an eligible 

QBU as defined in § 1.987–1(b)(3); 

(2) Substantially all (within the 

meaning of section 368(a)(1)(C)) of the 

section 987 QBU’s assets are transferred 

from such section 987 QBU to its owner, 

as provided under § 1.987–2(c). 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 (for example, a 

contribution of property to a DE or a 

partnership) as provided under § 1.987–

2(c) shall be reduced by assets that are 

transferred from the owner to such 

section 987 QBU, as provided under 

§ 1.987–2(c), pursuant to the same 

transaction; 

(3) A foreign corporation that is a 

controlled foreign corporation (as 

defined in section 957) that is the owner 

of a section 987 QBU ceases to be a 

controlled foreign corporation; or 

(4) The owner of such section 987 

QBU ceases to exist (including in 

connection with a transaction described 

in section 381(a)). 

(c) Transactions described in section 

381(a)—(1) Liquidations. A termination 

does not occur when the owner of a 

section 987 QBU ceases to exist in a 

liquidation described in section 332, 

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. A termination 

does not occur when the owner of the 

section 987 QBU ceases to exist in a 

reorganization described in section 

381(a)(2), 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 and the acquiring 

corporation is a foreign corporation that 

is not a controlled foreign corporation 

immediately after 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) 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. As a 

result, any net unrecognized section 987 

gain or loss of the section 987 QBU is 

recognized. See § 1.987–5. For purposes 

of the preceding sentence, the amount of 

net unrecognized section 987 gain or 

loss is determined as of the date of 

termination by closing the books and 

records of the section 987 QBU on that 

date. 

(e) Examples. The following examples 

illustrate the principles of this section: 

Example 1. Cessation of operations. (i) 

Facts. DC, a domestic corporation, has a sales 

office in Country X (Country X Branch) that 

is a section 987 QBU. DC closes its Country 

X Branch. 

(ii) Analysis. The cessation of the activities 

of the Country X Branch causes a termination 

of the section 987 QBU under paragraph 

(b)(1) of this section. 

Example 2. Incorporation of section 987 

QBU. (i) Facts. DC, a domestic corporation, 

has a branch in Country X (Country X 

Branch) that is a section 987 QBU. DC 

transfers all the assets and liabilities of 

Country X Branch to DS, a domestic 

corporation, in exchange for stock of DS in 

a transaction qualifying under section 351. 

(ii) Analysis. Country X Branch terminates 

pursuant to paragraph (b)(1) of this section 

because the Country X Branch ceases to be 

an eligible QBU of DC. 

Example 3. Cessation of controlled foreign 

corporation status. (i) Facts. DC, a domestic 

corporation, owns all of the stock of FC, a 

controlled foreign corporation as defined in 

section 957. FC has a section 987 QBU. FA, 

a foreign corporation owned solely by foreign 

persons, purchases all of the FC stock. FC 

will not constitute a controlled foreign 

corporation after the transaction. 

(ii) Analysis. Because FC ceases to qualify 

as a controlled foreign corporation after the 

sale of the FC stock, FC’s section 987 QBU 

terminates pursuant to paragraph (b)(3) of 

this section. 

Example 4. Section 332 liquidation. (i) 

Facts. DC, a domestic corporation, operates 

in Country X through FC, a wholly-owned 

foreign corporation organized under the laws 

of Country X. FC also has a branch in 

Country Y (Country Y Branch) that is a 

section 987 QBU. Pursuant to a liquidation 

described in section 332, FC transfers all of 

its assets and liabilities to DC. 

(ii) Analysis. FC’s liquidation is a 

termination as provided in paragraph (b)(4) 

of this section because FC ceases to exist. The 

exception for certain section 332 liquidations 

provided under paragraph (c)(1) of this 

section does not apply because DC is a 

domestic corporation and FC is a foreign 

corporation. See paragraph (c)(1)(ii) of this 

section. 

Example 5. Transfers to and from section 

987 QBU pursuant to the same transaction. 

(i) Facts. DC1, a domestic corporation, owns 

Entity A, a DE. Entity A conducts a business 

in Country X and that business is an eligible 

QBU and a section 987 QBU (Country X 

QBU) of DC1. DC2, a domestic corporation, 

contributes property to Entity A in exchange 

for a 95% interest in Entity A. The property 

DC2 contributes to Entity A is used in the 

business conducted by the Country X QBU 

and is reflected on its books and records as 

provided under § 1.987–2(b). Moreover, 

Entity A is converted to a partnership as a 

result of the contribution. See Rev. Rul. 99–

5 (situation 2), (1999–1 CB 434). See 

§ 601.601(d)(2) of this chapter. Also, as a 

result of the contribution, and pursuant to 

§ 1.987–2(c)(5), 95% of the assets and 

liabilities on the books and records of DC1’s 

section 987 QBU are deemed to be 

transferred from such QBU to DC1, and DC1 

is deemed to transfer to such QBU 5% of the 


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property, as determined under § 1.987–7, 

contributed by DC2 to Entity A. 

(ii) Analysis. As a result of the contribution 

of property from DC2 to Entity A, assets were 

transferred from DC1’s section 987 QBU to 

DC1. Similarly, assets were transferred from 

DC1 to its section 987 QBU as a result of the 

contribution. Accordingly, for purposes of 

determining whether substantially all the 

assets of Country X QBU were transferred 

from DC1’s section 987 QBU as provided 

under paragraph (b)(2) of this section, the 

assets transferred from DC1’s section 987 

QBU to DC1 under § 1.987–2(c) are reduced 

by the amount of assets transferred from DC1 

to such section 987 QBU pursuant to the 

contribution. 

§ 1.987–9 Recordkeeping requirements. 

(a) In general. A taxpayer that is an 

owner of a section 987 QBU shall keep 

such reasonable records as are sufficient 

to establish the QBU’s section 987 

taxable income or loss and section 987 

gain or loss. See section 987 and section 

6001 and the applicable regulations. 

(b) Supplemental information. An 

owner’s obligation to maintain records 

under section 6001 and paragraph (a) of 

this section is not satisfied unless the 

following information is maintained in 

such records: 

(1) The amount of the items of 

income, gain, deduction or loss 

attributed to each section 987 QBU of 

the owner in the functional currency of 

the section 987 QBU. 

(2) The amount of assets and 

liabilities attributed to each section 987 

QBU of the owner in the functional 

currency of the QBU. 

(3) The exchange rates used to 

translate items of income, gain, 

deduction or loss of each section 987 

QBU into the owner’s functional 

currency. If a spot rate convention is 

used, the manner in which such 

convention is determined. 

(4) The exchange rates used to 

translate the assets and liabilities of 

each section 987 QBU into the owner’s 

functional currency. If a spot rate 

convention is used, the manner in 

which such convention is determined. 

(5) The amount of the items of 

income, gain, deduction or loss 

attributed to each section 987 QBU of 

the owner translated into the functional 

currency of the owner. 

(6) The amount of assets and 

liabilities attributed to each section 987 

QBU of the owner translated into the 

functional currency of the owner. 

(7) The amount of assets and 

liabilities transferred by the owner to a 

section 987 QBU determined in the 

functional currency of the owner. 

(8) The amount of assets and 

liabilities transferred by the section 987 

QBU to the owner determined in the 

functional currency of the owner. 

(9) The amount of the unrecognized 

section 987 gain or loss for the taxable 

year. 

(10) The amount of the net 

unrecognized section 987 gain or loss at 

the close of the taxable year. 

(11) If a remittance is made, the 

average tax book value of assets as 

determined under § 1.861–9T(g). 

(12) The transition information 

required to be determined under 

§ 1.987–10(c)(2)(v). 

(c) Retention of records. The records 

required by this section must be kept at 

all times available for inspection by the 

Internal Revenue Service, and shall be 

retained so long as the contents thereof 

may become material in the 

administration of the Internal Revenue 

Code. 

§ 1.987–10 Transition rules. 

(a) Scope—(1) In general. These 

transition rules shall apply to any 

taxpayer that is an owner of a section 

987 QBU pursuant to § 1.987–1(b)(4) on 

the transition date (as defined in 

paragraph (b) of this section). A 

taxpayer to whom this section applies 

must transition from the method 

previously used by such taxpayer to 

comply with section 987 (the ‘‘prior 

section 987 method’’) to the method 

prescribed by these regulations pursuant 

to the rules set forth in paragraph (c) of 

this section. 

(2) Limitation where the prior method 

was unreasonable. Notwithstanding 

paragraph (a)(1) of this section, if the 

prior section 987 method was 

unreasonable (including the case where 

the taxpayer failed to make the 

determinations required under section 

987 for any open taxable year), then the 

taxpayer must apply the rules of 

paragraph (c)(4) of this section (and 

cannot apply the rules of paragraph 

(c)(3) of this section) to transition to the 

method prescribed by these regulations. 

(b) Transition date. The transition 

date is the first day of the first taxable 

year to which these regulations apply to 

a taxpayer. 

(c) Transition methods and 

corresponding rules—(1) In general. 

Except as provided in paragraph (a)(2) 

of this section, a taxpayer must 

transition from its prior method to the 

method prescribed by these regulations 

under the ‘‘deferral transition method’’

of paragraph (c)(3) of this section or the 

‘‘fresh start transition method’’ of 

paragraph (c)(4) of this section. If a 

taxpayer fails to comply with the rules 

of this section, the Area Director, Field 

Examination, Small Business/Self 

Employed or the Director, Field 

Operations, Large and Mid-Size 

Business having jurisdiction of the 

taxpayer’s return for the taxable year 

shall determine the appropriate 

transition method. 

(2) Conformity rules. The taxpayer 

(including all members that file a 

consolidated return that includes that 

taxpayer), and any controlled foreign 

corporation as defined in section 957 in 

which the taxpayer owns more than 50 

percent of the voting power or stock (as 

determined in section 957(a)), must 

consistently apply the same transition 

method for each qualified business unit 

subject to section 987 owned on the 

transition date. 

(3) Deferral transition method—(i) In 

general. Pursuant to the deferral 

transition method prescribed by this 

paragraph (c)(3), section 987 gain or loss 

must be determined on the transition 

date under the taxpayer’s prior section 

987 method as if all qualified business 

units of the taxpayer subject to section 

987 (taking into account the conformity 

rules of paragraph (c)(2) of this section) 

terminated on the last day of the taxable 

year preceding the transition date. This 

deemed termination applies solely for 

purposes of this section. Any section 

987 gain or loss determined with respect 

to a section 987 QBU under the 

preceding sentence shall not be 

recognized on the transition date but 

shall be considered as net unrecognized 

section 987 gain or loss of the section 

987 QBU in the first taxable year for 

which these regulations are effective (in 

addition to any net unrecognized 

section 987 gain or loss otherwise 

determined for such taxable year). 

Recognition of net unrecognized section 

987 gain or loss determined under the 

preceding sentence is governed by 

§ 1.987–5 for periods after the transition 

date. The owner of a qualified business 

unit that is deemed to terminate under 

these rules is treated as having 

transferred all of the assets and 

liabilities attributable to such qualified 

business unit to a new section 987 QBU 

on the transition date. 

(ii) Translation rates used to 

determine the amount of assets and 

liabilities transferred from the owner to 

the section 987 QBU for the section 987 

QBU’s first taxable year beginning on 

the transition date. The exchange rates 

used to determine the amount of assets 

and liabilities transferred from the 

owner to the section 987 QBU on the 

transition date (for example, for 

purposes of making calculations under 

§ 1.987–4) under the deferral transition 

method in this paragraph (c)(3) shall be 

determined with reference to the 

historic exchange rates on the day the 

assets were acquired or liabilities 

entered into by the qualified business 

unit deemed terminated, adjusted to 


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take into account any gain or loss 

determined under paragraph (c)(3)(i) of 

this section. See Examples 1 and 2 of 

paragraph (d) of this section. 

(4) Fresh start transition method—(i) 

In general. Pursuant to the fresh start 

transition method prescribed by this 

paragraph (c)(4), on the transition date 

all qualified business units of the 

taxpayer subject to section 987 (taking 

into account the conformity rules of 

paragraph (c)(2) of this section) are 

deemed terminated on the last day of 

the taxable year preceding the transition 

date. This deemed termination applies 

solely for purposes of this section. No 

section 987 gain or loss is determined or 

recognized on such deemed 

termination. The owner of a qualified 

business unit that is deemed to 

terminate under this method is treated 

as having transferred all of the assets 

and liabilities attributable to such 

qualified business unit to a section 987 

QBU on the transition date. 

(ii) Translation rates used to 

determine the amount of assets and 

liabilities transferred from the owner to 

the section 987 QBU for the section 987 

QBU’s first taxable year on the 

transition date. The exchange rates used 

to determine the amount of assets and 

liabilities transferred from the owner to 

the section 987 QBU on the transition 

date (for example, for purposes of 

making calculations under § 1.987–4) 

under the fresh start transition method 

of this paragraph (c)(4) shall be 

determined with reference to the 

historic exchange rates on the day the 

assets were acquired or liabilities 

entered into by the qualified business 

unit deemed terminated. See Example 3 

of paragraph (d) of this section. 

(5) Double counting prohibited. The 

transition method used by the taxpayer 

cannot result in taking into account 

section 987 gain or loss with respect to 

an asset or liability attributable to a 

period prior to the transition date more 

than once. 

(6) Reporting. The taxpayer must 

attach a statement to its return for the 

first taxable year beginning on the 

transition date providing the following 

information: 

(i) A description of each qualified 

business unit to which these rules 

apply, the qualified business unit’s 

owner and its principal place of 

business, and a description of the prior 

method used by the taxpayer to 

determine section 987 gain or loss with 

respect to such qualified business unit. 

(ii) The transition method used by the 

taxpayer under paragraph (c) of this 

section for each qualified business unit. 

(iii) If the taxpayer uses the deferral 

transition method prescribed in 

paragraph (c)(3) of this section with 

respect to a qualified business unit, an 

explanation of the method used to 

determine section 987 gain or loss. 

(iv) If the taxpayer uses the deferral 

transition method prescribed in 

paragraph (c)(3) of this section with 

respect to a qualified business unit, the 

amount treated as net unrecognized 

section 987 gain or loss under paragraph 

(c)(3)(i) of this section. 

(v) The method used by the taxpayer 

for determining the exchange rates used 

to translate the basis of assets and the 

amount of liabilities of a section 987 

QBU into the functional currency of the 

owner on the transition date as provided 

in paragraphs (c)(3)(ii) and (c)(4)(ii) of 

this section for purposes of applying 

these regulations. 

(d) Examples. The principles of this 

section are illustrated by the following 

examples: 

Example 1. Deferral transition method. (i) 

U.S. Corp is a domestic corporation with the 

dollar as its functional currency. U.S. Corp 

owns UK Branch, a branch with the pound 

as its functional currency. UK Branch was 

formed on January 1, 2006. U.S. Corp uses 

the method prescribed in the 1991 proposed 

section 987 regulations to determine the 

section 987 gain or loss of UK Branch. U.S. 

Corp contributed £6,000 to UK Branch on 

January 1, 2006. On the same day, UK Branch 

bought a truck for £4,000 and a computer for 

£1,000. Assume that the spot rate on January 

1, 2006, is £1 = $1. UK Branch had profits 

determined under § 1.987–1(b)(1)(i) through 

(iii) of the 1991 proposed section 987 

regulations of £250 in each taxable year of 

2006, 2007, 2008, and 2009. Assume that the 

average exchange rates used to translate UK 

Branch’s profits under the 1991 proposed 

section 987 regulations were as follows: 

2006—£1 = $1.10; 2007—£1 = $1.20; 2008—

£1 = $1.30; 2009—£1 = $1.40. UK Branch 

makes no remittances to U.S. Corp in any 

year. On January 1, 2010, UK Branch 

transitions to the method provided in 

§§ 1.987–1 through 1.987–11 of these 

regulations pursuant to paragraph (a) of this 

section. U.S. Corp chooses to use the deferral 

transition method of paragraph (c)(3) of this 

section in transitioning from its prior section 

987 method (the method set forth in the 1991 

proposed section 987 regulations) to the 

method prescribed in the §§ 1.987–1 through 

1.987–11 of these regulations. The spot rate 

on December 31, 2009, is £1 = $2. 

(ii) Pursuant to paragraph (c)(3) of this 

section, U.S. Corp must determine UK 

Branch’s section 987 gain or loss on January 

1, 2010 using its prior section 987 method 

(the method prescribed under the 1991 

proposed section 987 regulations), as if UK 

Branch terminated on December 31, 2009. On 

December 31, 2009, UK Branch has an equity 

pool of £7,000 and a basis pool of $7,250 

determined under the 1991 proposed section 

987 regulations based on the following 

amounts: 

Asset Amount in £ Translation rate Amount in $ 

Cash .................................... £1,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ $1,000 

Cash .................................... 250 Ave. rate for 2006 of £1=$1.10 ..................................................................................... 275 

Cash .................................... 250 Ave. rate for 2007 of £1=$1.20 ..................................................................................... 300 

Cash .................................... 250 Ave. rate for 2008 of £1=$1.30 ..................................................................................... 325 

Cash .................................... 250 Ave. rate for 2009 of £1=$1.40 ..................................................................................... 350 

Truck .................................... *4,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 4,000 

Computer ............................. *1,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 1,000 

Total assets .................. 7,000 ........................................................................................................................................ 7,250 

Liabilities .............................. 0 ........................................................................................................................................ 0 

* Depreciation not taken into account for purposes of this example. 

Accordingly, under § 1.987–3(h)(3)(i) of the 

1991 proposed section 987 regulations, UK 

Branch determines its section 987 gain or 

loss on December 31, 2009, as follows: 

Equity Pool on 12/31/09 ......... £7,000 

Multiplied by spot rate on 

date of deemed termination 

of £1=$2 ................................ ×$2 

14,000 

Spot Value of Equity Pool ....... 14,000 

Less 100% of Basis Pool ......... (7,250) 

Section 987 gain ............... 6,750 

(iii) Under paragraph (c)(3)(i) of this 

section, U.S. Corp does not recognize the 

$6,750 of section 987 gain determined on the 

transition date. Instead, the $6,750 will be 

treated as net unrecognized section 987 gain 

of UK Branch for 2010 and subsequent years 


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(in addition to any net unrecognized section 

987 gain or loss otherwise determined at the 

close of 2010 and subsequent years). 

Recognition of net unrecognized section 987 

gain or loss is governed by § 1.987–5. 

(iv) Pursuant to paragraph (c)(3)(ii) of this 

section, when computing the exchange rates 

used to determine the amount of assets and 

liabilities transferred from U.S. Corp to UK 

Branch on the transition date, U.S. Corp must 

adjust the historic exchange rates attributable 

to such assets to take into account UK 

Branch’s section 987 gain determined under 

paragraph (c)(3) of this section. Under these 

facts, where all of UK Branch’s assets are 

considered to generate deferred section 987 

gain, U.S. Corp takes into account this 

section 987 gain by translating the assets 

deemed contributed by U.S. Corp to UK 

Branch on the transition date using the same 

spot rate it used to determine UK Branch’s 

section 987 gain on the deemed termination 

date of December 31, 2009. Accordingly, on 

January 1, 2010, U.S. Corp translates the 

assets deemed contributed (cash is segregated 

for ease of illustration) to UK Branch as 

follows: 

Asset Amount in £ Translation rate Amount in $ 

Cash .................................... £1,000 Spot rate on 12/31/09 of £1=$2 .................................................................................... $2,000 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Truck .................................... 4,000 Spot rate on 12/31/09 of £1=$2 .................................................................................... 8,000 

Computer ............................. 1,000 Spot rate on 12/31/09 of £1=$2 .................................................................................... 2,000 

Total assets .................. 7,000 ........................................................................................................................................ 14,000 

Liabilities .............................. 0 ........................................................................................................................................ 0 

Example 2. Deferral transition method. (i) 

The facts are the same as in Example 1 

except that U.S. Corp and UK Branch use an 

‘‘earnings only’’ approach to determine 

section 987 gain or loss prior to the transition 

date. Under this approach, U.S. Corp 

maintains a basis and equity pool for UK 

Branch’s earnings and a separate basis and 

equity pool for UK Branch’s capital. Section 

987 gain or loss is only recognized on 

remittances of earnings (but not with respect 

to capital) under principles similar to those 

of the 1991 proposed section 987 regulations. 

Remittances are first considered as 

distributed from the earnings equity pool and 

then from the capital equity pool. For 

purposes of this example, this method is 

assumed to be a reasonable section 987 

method and does not violate § 1.987–10(a)(2). 

(ii) Using principles similar to those set 

forth in § 1.987–2 of the 1991 proposed 

section 987 regulations, the earnings equity 

pool of UK Branch is £1,000 (£250 earned in 

each taxable year of 2006, 2007, 2008 and 

2009) and the corresponding earnings basis 

pool is $1,250 ($275 in 2006, $300 in 2007, 

$325 in 2008 and $350 in 2009). The capital 

equity pool is £6,000 and the corresponding 

capital basis pool is $6,000 (contributed cash 

of £6,000 translated to equal $6,000—which 

U.S. Corp can trace to contributed cash 

remaining of £1,000 with a translated basis 

equal to $1,000; a truck of £4,000 with a 

translated basis equal to $4,000; and a 

computer of £1,000 with a translated basis 

equal to $1,000). 

(iii) Pursuant to paragraph (c)(3)(i) of this 

section, U.S. Corp must determine UK 

Branch’s section 987 gain or loss on January 

1, 2010, using its prior section 987 method 

(the ‘‘earnings only’’ method), as if UK 

Branch terminated on December 31, 2009. 

Using principles similar to § 1.987–3(h) of 

the 1991 proposed section 987 regulations 

with respect to the earnings equity and basis 

pool, U.S. Corp would determine $750 of 

section 987 gain as follows: 

Earnings Equity Pool on 

12/31/09 ............................... £1,000 

Multiplied by spot rate on 

date of deemed termination 

of £1=$2 ................................ × $2 

$2,000 

Spot Value of Earnings Equity 

Pool ....................................... $2,000 

Less 100% of Earnings Basis 

Pool ....................................... ($1,250) 

Section 987 gain ............... $750 

(iv) Under paragraph (c)(3)(i) of this 

section, U.S. Corp does not recognize the 

$750 of section 987 gain determined on the 

transition date. Instead, the $750 will be 

treated as net unrecognized section 987 gain 

of UK Branch for 2010 and subsequent years 

(in addition to any net unrecognized section 

987 gain or loss otherwise determined at the 

close of 2010 and subsequent years). 

Recognition of net unrecognized section 987 

gain or loss is governed by § 1.987–5. 

(v) Pursuant to paragraph (c)(3)(ii) of this 

section, when computing the exchange rates 

used to determine the amount of assets and 

liabilities transferred from U.S. Corp to UK 

Branch on the transition date, U.S. Corp must 

adjust the historic exchange rates attributable 

to such assets to take into account UK 

Branch’s section 987 gain determined under 

paragraph (c)(3) of this section. Under these 

facts, U.S. Corp may reasonably take into 

account UK Branch’s section 987 gain by 

translating those UK Branch’s assets that 

generated such gain using the same spot rate 

it used to determine UK Branch’s section 987 

gain on the termination date of December 31, 

2009 and by determining the translation rate 

of other assets by reference to the traced basis 

of such assets. Accordingly, on January 1, 

2010, U.S. Corp translates the deemed 

contributions to UK Branch as follows: 

Asset Amount in £ Translation rate Amount in $ 

Contributed Cash ................. £1,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ $1,000 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Cash .................................... 250 Spot rate on 12/31/09 of £1=$2 .................................................................................... 500 

Truck .................................... 4,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 4,000 

Computer ............................. 1,000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 1,000 

Total assets .................. 7,000 ........................................................................................................................................ 8,000 

Liabilities .............................. 0 ........................................................................................................................................ 0 

(vi) If UK Branch was not able to trace 

historic dollar basis as set forth in paragraph 

(v) of this Example 2, when translating the 

assets deemed contributed to UK Branch on 

January 1, 2010, under paragraph (c)(3)(ii) of 

this section, U.S. Corp would be required to 

use exchange rates that take into account a 

reasonable allocation of the aggregate historic 

basis and the $750 of deferred section 987 

gain to the UK Branch assets. 

Example 3. Fresh start transition method. 

(i) The facts are the same as in Example 1, 


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except that U.S. Corp chooses to use the fresh 

start transition method of paragraph (c)(4) of 

this section in transitioning from the 1991 

proposed regulations to the method 

prescribed in the current regulations. 

Pursuant to paragraph (c)(4)(i) of this section, 

UK Branch is deemed to terminate on 

December 31, 2009. However, no section 987 

gain or loss will be determined or recognized. 

On January 1, 2010, when translating the 

assets deemed contributed to UK Branch, 

U.S. Corp will use the historic exchange rates 

existing on the date the assets were acquired 

by UK Branch pursuant to paragraph (c)(4)(ii) 

of this section. Accordingly, U.S. Corp 

translates the assets deemed contributed 

(cash is segregated for ease of illustration) to 

UK Branch as follows: 

Asset Amount in £ Translation rate Amount in $ 

Contributed Cash ................. £1000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ $1,000 

Cash .................................... 250 Ave. rate for 2006 of £1=$1.10 ..................................................................................... 275 

Cash .................................... 250 Ave. rate for 2004 of £1=$1.20 ..................................................................................... 300 

Cash .................................... 250 Ave. rate for 2005 of £1=$1.30 ..................................................................................... 325 

Cash .................................... 250 Ave. rate for 2006 of £1=$1.40 ..................................................................................... 350 

Truck .................................... 4000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 4,000 

Computer ............................. 1000 Spot rate on 1/1/06 of £1=$1 ........................................................................................ 1,000 

Total assets .................. 7000 ........................................................................................................................................ 7,250 

Liabilities .............................. 0 ........................................................................................................................................ 0 

(ii) If UK Branch was not able to trace 

historic dollar basis as set forth in paragraph 

(i) of this Example 3, when translating the 

assets deemed contributed to UK Branch on 

January 1, 2010, under paragraph (c)(3)(ii) of 

this section, U.S. Corp would be required to 

use exchange rates that take into account a 

reasonable allocation of the aggregate historic 

basis of the UK Branch assets. 

§ 1.987–11 Effective date. 

(a) In general. Except as otherwise 

provided in this section, these 

regulations shall apply to taxable years 

beginning one year after the first day of 

the first taxable year following the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. 

(b) Election to apply these regulations 

to taxable years beginning after the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. A taxpayer may 

elect to apply these regulations to 

taxable years beginning after the date of 

publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. Such election 

shall be binding on all members that file 

a consolidated return with the taxpayer 

and any controlled foreign corporation, 

as defined in section 957, in which the 

taxpayer owns more than 50 percent of 

the voting power or stock (as 

determined in section 957(a)). An 

election made under this paragraph 

shall be made in accordance with 

§ 1.987–1(f). 

Par. 6. Section 1.988–1 is amended 

by: 

1. Adding paragraphs (a)(3) and (a)(4). 

2. Revising paragraph (a)(10)(ii). 

3. Adding two sentences to the end of 

paragraph (i). 

The additions and revision read as 

follows: 

§ 1.988–1 Certain definitions and special 

rules. 

* * * * * 

(a) * * * 

(3) Certain transactions of a section 

987 QBU denominated in the functional 

currency of the owner are not treated as 

section 988 transactions. Transactions 

described in § 1.987–3(e)(2) (regarding 

certain transactions that are 

denominated in the functional currency 

of the owner of a section 987 QBU) are 

not treated as section 988 transactions to 

a section 987 QBU. Thus, no currency 

gain or loss shall be recognized by a 

section 987 QBU under section 988 with 

respect to such items. 

(4) Treatment of assets and liabilities 

of a partnership or DE that are not 

attributed to an eligible QBU—(i) Scope. 

This paragraph (a)(4) applies to assets 

and liabilities of a partnership, or of an 

entity disregarded as an entity separate 

from its owner for U.S. Federal income 

tax purposes (DE), that are not 

attributable to an eligible QBU (within 

the meaning of § 1.987–1(b)(3)) as 

provided under § 1.987–2(b). 

(ii) Partnerships. For purposes of 

applying section 988 and the applicable 

regulations to transactions involving the 

assets and liabilities described in 

paragraph (a)(4)(i) of this section that 

are held by a partnership, the owners of 

the partnership (within the meaning of 

§ 1.987–1(b)(4)) shall be treated as 

owning their share of such assets and 

liabilities. Section 1.987–7(b) shall 

apply for purposes of determining an 

owner’s share of such assets or 

liabilities. 

(iii) Disregarded entities. For purposes 

of applying section 988 and the 

applicable regulations to transactions 

involving the assets and liabilities 

described in paragraph (a)(4)(i) of this 

section that are held by a DE, the owner 

of the DE (within the meaning of 

§ 1.987–1(b)(4)) shall be treated as 

owning all of such assets and liabilities. 

(iv) Example. The following example 

illustrates the application of paragraph 

(a)(4) of this section: 

Example. Liability held through a 

partnership. (i) Facts. P, a foreign 

partnership, has two equal partners, X and Y. 

X is a domestic corporation with the dollar 

as its functional currency. Y is a foreign 

corporation that has the yen as its functional 

currency. On January 1, year 1, P borrowed 

yen and issued a note to the lender that 

obligated P to pay interest and repay 

principal to the lender in yen. Also on 

January 1, year 1, P used the yen it borrowed 

from the lender to acquire 100% of the stock 

of F, a foreign corporation, from an unrelated 

person. P also holds an eligible section 987 

QBU (within the meaning of § 1.987–1(b)(3)) 

that has the yen as its functional currency. 

P maintains one set of books and records. 

The assets and liabilities of the eligible QBU 

are reflected on the P books and records as 

provided under § 1.987–2(b). The F stock 

held by P, and the yen liability incurred to 

acquire the F stock, are also recorded on the 

books and records of P, but are not reflected 

on such books and records for purposes of 

section 987 pursuant to § 1.987–2(b)(2)(i)(A) 

and (C), respectively. 

(ii) Analysis. X’s portion of the assets and 

liabilities of the eligible QBU owned by P is 

a section 987 QBU. Y’s portion of the assets 

and liabilities of the eligible QBU owned by 

P is not a section 987 QBU because Y and 

the eligible QBU have the same functional 

currency. Because the F stock and yendenominated liability incurred to acquire 

such stock are not reflected on the books and 

records of the eligible QBU, they are not 

subject to section 987. In addition, because 

the F stock and the yen-denominated liability 

incurred to acquire such stock are held by P 

(but not attributable to P’s eligible QBU), X 

and Y are treated as owning their share of 

such stock and liability, determined under 

§ 1.987–7(b), for purposes of applying section 

988. As a result, P’s becoming the obligor 

under the portion of the yen-denominated 

note that is treated as being an obligation of 

X is a section 988 transaction pursuant to 

paragraphs (a)(1)(ii), (a)(2)(ii) and (a)(3) of 

this section. Similarly, the disposition of yen 

on payments of interest and principal on the 

liability, to the extent such yen are treated as 


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owned by X, are section 988 transactions 

under paragraphs (a)(1)(i) and (a)(3) of this 

section. P’s becoming the obligor under Y’s 

portion of the yen-denominated note, and Y’s 

portion of the yen disposed of in connection 

with payments on such note, are not section 

988 transactions because Y has the yen as its 

functional currency. 

(5) [Reserved]. 

* * * * * 

(10) * * * 

(ii) Certain transfers. (A) Exchange 

gain or loss with respect to 

nonfunctional currency or any item 

described in paragraph (a)(2) of this 

section entered into with another 

taxpayer shall be realized upon a 

transfer (as defined under § 1.987–2(c)) 

of such currency or item from an owner 

to a section 987 QBU or from a section 

987 QBU to the owner where as a result 

of such transfers the currency or other 

such item—

(i) Loses its character as 

nonfunctional currency or an item 

described in paragraph (a)(2) of this 

section; or 

(ii) Where the source of the exchange 

gain or loss could be altered absent the 

application of this paragraph (a)(10)(ii). 

(B) Such exchange gain or loss shall 

be computed in accordance with 

§ 1.988–2 (without regard to § 1.988–

2(b)(8) as if the nonfunctional currency 

or item described in paragraph (a)(2) of 

this section had been sold or otherwise 

transferred at fair market value between 

unrelated taxpayers. For purposes of the 

preceding sentence, a taxpayer must use 

a translation rate that is consistent with 

the translation conventions of the 

section 987 QBU to which or from 

which, as the case may be, the item is 

being transferred. In the case of a gain 

or loss incurred in a transaction 

described in this paragraph (a)(10)(ii) 

that does not have a significant business 

purpose, the Commissioner, may defer 

such gain or loss. 

* * * * * 

(i) * * * Generally, the revisions to 

paragraphs (a)(3), (a)(4), (a)(5), and 

(a)(10)(ii) of this section shall apply to 

taxable years beginning one year after 

the first day of the first taxable year 

following the date of publication of a 

Treasury decision adopting this rule as 

a final regulation in the Federal 

Register. If a taxpayer makes an election 

under § 1.987–11(b), then the effective 

date of the revisions to paragraphs 

(a)(3), (a)(4), and (a)(10)(ii) of this 

section with respect to the taxpayer 

shall be consistent with such election. 

Par. 7. Section 1.988–4 is amended by 

revising paragraph (b)(2) to read as 

follows: 

§ 1.988–4 Source of gain or loss realized 

on a section 988 transfer. 

* * * * * 

(b) * * * 

(2) Proper reflection on the books of 

the taxpayer or qualified business 

unit—(i) In general. For purposes of 

paragraph (b)(1) of this section, the 

principles of § 1.987–2(b) shall apply in 

determining whether an asset, liability, 

or item of income or expense is reflected 

on the books of a qualified business 

unit. 

(ii) Effective date. Generally, 

paragraph (b)(2)(i) of this section shall 

apply to taxable years beginning one 

year after the first day of the first taxable 

year following the date of publication of 

a Treasury decision adopting this rule as 

a final regulation in the Federal 

Register. If a taxpayer makes an election 

under § 1.987–11(b), then the effective 

date of paragraph (b)(2)(i) with respect 

to the taxpayer shall be consistent with 

such election. 

* * * * * 

Par. 8. Section 1.989(a)–1 is amended 

as follows: 

1. The last sentence of paragraph 

(b)(2)(i) is revised. 

2. Paragraph (b)(4) is added. 

The revision and addition reads as 

follows: 

§ 1.989(a)–1 Definition of a qualified 

business unit. 

(b) * * * 

(2) * * * 

(i) Persons—* * * A trust or estate is 

a QBU of the beneficiary. 

* * * * * 

(4) Effective date. Generally, the 

revisions to paragraph (b)(2)(i) of this 

section shall apply to taxable years 

beginning one year after the first day of 

the first taxable year following the date 

of publication of a Treasury decision 

adopting this rule as a final regulation 

in the Federal Register. If a taxpayer 

makes an election under § 1.987–11(b), 

then the effective date of the revisions 

to paragraph (b)(2)(i) of this section with 

respect to the taxpayer shall be 

consistent with such election. 

* * * * * 

§ 1.989(c)–1 [Removed] 

Par. 9. Section 1.989(c)–1 is removed. 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 06–7250 Filed 9–6–06 8:45 am] 

BILLING CODE 4830–01–P 


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