Taxable Income or Loss and Currency Gain or Loss With Respect to a Qualified Business Unit

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 10016]

RIN 1545-BO07

Taxable Income or Loss and Currency Gain or Loss With Respect to a Qualified Business Unit

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final rule.

SUMMARY:

This document contains final regulations relating to the determination of taxable income or loss and foreign currency gain or loss with respect to a qualified business unit. These final regulations include an election to treat all items of a qualified business unit as marked items (subject to a loss suspension rule), an election to recognize all foreign currency gain or loss with respect to a qualified business unit on an annual basis, and a new transition rule.

DATES:

Effective date:

The final regulations are effective December 10, 2024.

Applicability dates:

For dates of applicability,

see

§ 1.987-15.

FOR FURTHER INFORMATION CONTACT:

Concerning the final regulations generally, Adam G. Province at (865) 329-4546; concerning the character and source of section 987 gain or loss, Larry Pounders at (202) 317-5465; concerning consolidated groups, Jeremy Aron-Dine at (202) 317-6847 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Authority

This document contains additions and amendments to 26 CFR part 1 (Income Tax Regulations) addressing the application of section 987 of the Internal Revenue Code (Code) and related provisions (the “final regulations”). The additions and amendments are issued under sections 987, 989, and 1502, pursuant to the express delegations of authority provided under those sections. The express delegations relied upon are referenced in the Background section of this preamble and in the Summary of Comments and Explanation of Revisions describing the individual sections of the final regulations. The final regulations are also issued under the express delegation of authority under section 7805 of the Code.

Background

This document contains final regulations under section 987 of the Code and related provisions under sections 861, 985 through 989, and 1502 of the Code. Section 987 applies to any taxpayer that has a qualified business unit (“QBU”) with a functional currency other than the dollar. Section 987(1) and (2) provide rules for determining and translating taxable income or loss (“section 987 taxable income or loss”) with respect to the QBU. In addition, foreign currency gain or loss must be determined under section 987(3) (“section 987 gain or loss”), which requires proper adjustments (as prescribed by the Secretary) for transfers of property between QBUs of the taxpayer having different functional currencies.

Sections 987 and 989 provide several explicit grants of regulatory authority. Section 987(3) directs the Secretary to prescribe the proper adjustments needed to determine the taxable income of the owner of a section 987 QBU. Those adjustments include (but are not limited to) rules for sourcing section 987 gain or loss recognized under section 987(3)(B). Similarly, section 987(2) provides that the income of a QBU is translated at the “appropriate” exchange rate. Section 989(b)(4) provides that the appropriate exchange rate generally is the average rate for the taxable year, “except as provided in regulations.”

Section 989(c) directs the Secretary to “prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subpart.”

1

The grant of authority in section 989(c) includes regulations limiting the recognition of foreign currency loss on certain remittances from QBUs, providing for the appropriate treatment of related party transactions (including transactions between QBUs of the same taxpayer), and setting forth procedures for determining the average exchange rate for any period. Section 989(c)(2), (5), and (6).

1

The reference to “this subpart” refers to subpart J of part III of subchapter N of chapter 1 of the Code, which includes section 987.

On December 8, 2016, the Department of the Treasury (“Treasury Department”) and the Internal Revenue Service (“IRS”) published Treasury Decision 9794, which contained final regulations under sections 861, 985, 987, 988, and 989 (the “2016 final regulations”), in the

Federal Register

(81 FR 88806). The same day, the Treasury Department and the IRS published Treasury Decision 9795, which contained temporary regulations under sections 987 and 988 (the “2016 temporary regulations”), in the

Federal Register

(81 FR 88854) and published a notice of proposed rulemaking (REG-128276-12, 81 FR 88882) (the “2016 proposed regulations”) in the

Federal Register

by cross-reference to the temporary regulations. On May 13, 2019, the Treasury Department and the IRS published Treasury Decision 9857, which contained final regulations under section 987 (the “2019 final regulations”), in the

Federal Register

(84 FR 20790).

On November 14, 2023, the Treasury Department and the IRS published proposed regulations (REG-132422-17) under sections 861, 985, 987, 988, 989, and 1502 of the Code (the “2023 proposed regulations”) in the

Federal Register

(88 FR 78134). The same day, the Treasury Department and the IRS also published a notice in the

Federal Register

(88 FR 77921) that reopened the comment period for the 2016 proposed regulations.

All written comments received in response to the 2016 proposed regulations and the 2023 proposed regulations are available at

https://www.regulations.gov

or upon request. A public hearing on the 2023 proposed regulations was not held because there were no requests to speak.

Concurrently with the publication of the final regulations, the Treasury Department and the IRS are publishing in the proposed rule section of this edition of the

Federal Register

(RIN 1545-BR37) a notice of proposed rulemaking providing additional proposed regulations under section 987 (REG-117213-24) (the “2024 proposed regulations”).

Summary of Comments and Explanation of Revisions

I. Overview

The Treasury Department and the IRS received a number of written comments in response to the 2016 proposed regulations and the 2023 proposed regulations. The comments, and the revisions made in response to those comments, are summarized in this Summary of Comments and Explanation of Revisions.

The final regulations retain the basic approach and structure of the 2023 proposed regulations, with the revisions described in this Summary of Comments and Explanation of Revisions.

II. Comments and Changes to Proposed § 1.987-1: Scope, Definitions, and Special Rules

Proposed § 1.987-1 would provide rules regarding the scope of the

regulations under section 987 (“section 987 regulations”), including which entities are subject to the regulations, rules relating to elections under section 987, and other rules.

A. Scope

Under proposed § 1.987-1(b)(1), the section 987 regulations would apply to all taxpayers, subject to a de minimis rule for pass-through entities with minimal U.S. ownership, but they would not apply to foreign individuals or foreign corporations that either are not controlled foreign corporations (“CFCs”) or are CFCs in which no United States shareholders (“U.S. shareholders”) own (within the meaning of section 958(a)) stock. In contrast to the 2016 final regulations, the 2023 proposed regulations would not provide an exception for banks, insurance companies, leasing companies, finance coordination centers, regulated investment companies, or real estate investment trusts (“specified entities”). The preamble to the 2023 proposed regulations explains that the current rate election and annual recognition election are expected to provide additional flexibility for specified entities to apply the section 987 regulations. 88 FR 78145. Taxpayers that make a current rate election would treat all assets and liabilities attributable to a section 987 QBU as marked items, and thus would not be required to track historic exchange rates. Taxpayers that make an annual recognition election would recognize all unrecognized section 987 gain or loss on an annual basis and would not be required to calculate the amount of a remittance with respect to a section 987 QBU under § 1.987-5.

See

parts II and IV of the Explanation of Provisions in the preamble to the 2023 proposed regulations. 88 FR 78138 through 78139, 78141 through 78143. In addition, including specified entities in the scope of the section 987 regulations is necessary to provide these entities with sufficient guidance under section 987 and to provide a consistent set of rules applicable to all taxpayers.

1. Specified Entities

Comments recommended that specified entities be excluded from the application of the section 987 regulations. The comments asserted that additional rules are needed to facilitate the application of the section 987 regulations to these entities. For example, according to the comments, it is unclear whether insurance reserves should be treated as marked items or historic items. A comment also noted that bank branches often engage in high volumes of intercompany transactions that could be difficult to account for under the section 987 regulations.

The Treasury Department and the IRS have determined that the final regulations can be applied by specified entities in an administrable manner and that excluding specified entities from the scope of the section 987 regulations would not provide sufficient guidance to ensure that these entities are using an appropriate method to apply section 987. Moreover, section 987 and its legislative history give no indication that Congress intended for banks, insurance companies, and other specified entities to be treated differently from other taxpayers for this purpose. Accordingly, specified entities are subject to the final regulations. However, the final regulations contain modifications intended to facilitate application of the section 987 regulations to these entities.

See

parts II.B (rules relating to insurance companies), V.B (hedging transactions), and VI (modifications to annual remittance rules to reduce the burden of tracking disregarded transfers) of this Summary of Comments and Explanation of Revisions.

2. Partnerships and Certain Other Entities

One comment was received relating to the application of section 987 to partnerships, and the Treasury Department and the IRS continue to study this issue. The Treasury Department and the IRS have determined that, without additional guidance, the section 987 regulations in their entirety could not be applied to partnerships in an administrable way. Accordingly, the final regulations generally apply only with respect to corporations and individuals. However, as discussed in part VIII of this Summary of Comments and Explanation of Revisions, certain parts of the section 987 regulations (including the rules relating to suspension of section 987 loss and recognition of suspended section 987 loss) are applicable to partnerships and S corporations.

The section 987 regulations do not apply to trusts or estates (though trusts and estates can be subject to section 987) because additional guidance may be needed to apply section 987 to these entities. In particular, the Treasury Department and the IRS are studying whether specific rules are needed to address the apportionment of section 987 gain or loss between the estate or non-grantor trust and the beneficiaries or whether existing rules under section 643(a) (defining distributable net income of an estate or trust) sufficiently address this issue. In addition, specific rules may be needed to address a beneficiary's application of section 987 with respect to an estate or non-grantor trust that uses a different functional currency (which creates a separate layer of currency exposure). The Treasury Department and the IRS anticipate providing rules applicable to trusts and estates in future guidance.

3. Application to CFCs

The final regulations apply to individuals and corporations that are United States persons (“U.S. persons”) and to CFCs in which U.S. shareholders own stock (directly or indirectly within the meaning of section 958(a)).

See

§ 1.987-1(b)(1). As explained in parts II.A.2 and VIII of this Summary of Comments and Explanation of Revisions, the Treasury Department and the IRS are continuing to study the appropriate rules for applying section 987 to partnerships.

A comment recommended that the scope of the section 987 regulations be limited to section 987 QBUs owned directly by U.S. persons or by partnerships with partners that are U.S. persons. According to the comment, this would reduce the compliance burden on taxpayers and prevent the selective recognition of section 987 losses. The comment further asserted that, based on the legislative history of section 987(3), the statute primarily was intended to address section 987 QBUs owned by U.S. persons.

The comment suggested that simplified mechanics under section 986(c) could be used to account for currency gain or loss arising between the time earnings are generated by a section 987 QBU and the time of distribution, but the comment did not explain how those mechanics would operate. Section 986(c) requires a U.S. shareholder to recognize foreign currency gain or loss with respect to distributions of previously taxed earnings and profits attributable to movements in exchange rates between the date of the income inclusion giving rise to the previously taxed earnings and profits and the distribution of the previously taxed earnings and profits.

The final regulations do not adopt the recommendations made by the comment. It is necessary to apply section 987(1) and (2) to foreign entities because many aspects of the income tax rules effectively require that the determination of a taxpayer's items of income, gain, deduction, and loss be made in a single currency. In addition, it is not clear how a rule similar to section 986(c) could be applied to section 987 QBUs in lieu of section 987(3). Because a CFC's earnings and

profits are determined in the CFC's functional currency under section 986(b), currency gain or loss on previously taxed earnings and profits arises under section 986(c) when a CFC's functional currency appreciates or depreciates against the U.S. dollar between the time the inclusion is computed and the time the CFC distributes the previously taxed earnings and profits. However, section 986(c) would not account for changes in value of a section 987 QBU's functional currency (measured against the functional currency of its CFC-owner or the U.S. shareholder) because earnings and profits are not tracked in the section 987 QBU's functional currency.

However, the Treasury Department and the IRS are studying whether there are instances in which it would be possible to simplify the application of section 987 by modifying the application of section 987(3) (and the related regulations, including §§ 1.987-4 through 1.987-6, 1.987-8, and 1.987-11 through 1.987-13) to certain entities.

See

part II.B of the Comments and Request for Public Hearing section in the preamble to the 2024 proposed regulations.

B. Special Rules for Insurance Companies

1. Insurance Reserves

A comment requested clarification as to whether insurance reserves are treated as marked items. The comment noted that the definition of a marked item under the proposed regulations is tied to the treatment of an asset or liability under section 988 and that the application of section 988 to insurance reserves is not clear. The Treasury Department and the IRS agree that treating insurance reserves as marked items would facilitate the application of section 987 to insurance companies and would be consistent with the treatment of liabilities outside the insurance context. Accordingly, § 1.987-1(d)(1)(iv) includes insurance reserves in the definition of marked items.

2. Assets That Support Variable Contracts

a. Background on Variable Contracts

In general, variable contracts are life insurance and annuity contracts under which the amount of the insurance company's obligation depends, at least in part, on the value of the assets held in a separate account that is segregated from the general asset accounts of the insurance company. Provided certain requirements are met, under section 817(c), an insurance company that issues variable contracts (as defined in section 817(d)) must separately account for the various income, exclusion, deduction, asset, reserve, and other liability items properly attributable to such variable contracts.

As a general matter, section 807 provides that increases in the life insurance reserves of a life insurance company are deductible and decreases in the life insurance reserves are includible in income. However, section 817(a) provides that for purposes of determining the net decrease or increase in reserves under section 807(a) or (b), amounts subtracted from or added to separate account reserves by reason of the depreciation or appreciation of separate account assets (whether or not realized) are disregarded. Under section 817(a), deductions for items described in section 805(a)(1) and (6), which include claims and benefits accrued and losses incurred during the taxable year on insurance and annuity contracts, are similarly adjusted for the depreciation or appreciation of separate account assets. Additionally, section 817(b) provides that the basis of each separate account asset is decreased by the amount of depreciation, or increased by the amount of appreciation, of separate account assets (whether or not realized), to the extent separate account reserves are adjusted for such depreciation or appreciation under section 817(a). Generally, the result is a permanent elimination of any effects on company-level taxable income that would otherwise result from the change in the value of the separate account assets.

Sometimes, however, an insurance company may provide guarantees with respect to variable contracts with separate accounts that could require reserves to be held in a company's general account. Section 817(d)(3) recognizes this situation and states that “obligations under such guarantee which exceed obligations under the contract without regard to such guarantee shall be accounted for as part of the company's general account.” Such guarantees might involve a limit on losses or guarantees of minimum crediting rates. These amounts are not liabilities of the separate account.

Similarly, CFCs generally must follow the Code and subchapter L rules in determining their insurance income, with minor modifications for determining: (i) whether a contract is a life insurance or annuity contract, and (ii) the amount of insurance reserves. For example, U.S. tax requirements in sections 72(s), 101(f), 817(h), and 7702 do not apply so long as no policyholder, annuitant, insured, or beneficiary under the contract is a United States person and the contract is regulated as a life insurance or annuity contract in the issuer's home country. In addition, section 954(i) modifies the subchapter L computation of insurance reserves and its application to insurance contracts issued by CFCs.

See also

section 953(b)(3).

b. Treatment of Assets That Support Variable Contracts for Purposes of Section 987

A comment recommended that assets which support variable annuity and life insurance contracts be treated as marked items. The comment explained that these assets are required by law to be segregated from the general asset accounts of the insurance company in a separate account, and the related contracts reflect the investment return and market value of the separate account assets.

The comment asserted that both the separate account assets and the related insurance reserves should be treated as marked items in order to align the treatment of these assets and liabilities for purposes of section 987. Similarly, the comment recommended that these assets and liabilities should be treated as attributable to an eligible QBU if they are reflected on the books and records of the eligible QBU, even if they would otherwise be excluded under § 1.987-2(b)(2) (for example, if the separate account assets consist of stock or partnership interests).

The final regulations provide that separate account assets are treated as marked items.

See

§ 1.987-1(d)(1)(v). In addition, the final regulations carve out separate account assets from the exclusions in § 1.987-2(b)(2), so that separate account assets reflected on the books and records of an eligible QBU generally will be attributable to the eligible QBU.

See

§ 1.987-2(b)(2)(ii). These rules are expected to facilitate matching treatment of separate account assets and the related insurance contracts, consistent with the treatment of these items for statutory and financial accounting purposes and the nature of the issuer's economic obligations.

The final regulations define a separate account asset as an asset that is reflected on the books and records of an eligible QBU and is held in a separate account with respect to a separate account insurance contract.

See

§ 1.987-1(h). A separate account insurance contract generally is defined as a contract that would be treated as an insurance contract for Federal income tax purposes for which the assets supporting the insurance reserves are required to be held in a separate account under the local insurance regulatory rules. In addition, the contract generally

must qualify as a variable contract under section 817(d). However, if the contract does not qualify as a variable contract under section 817(d) solely because it fails to meet one or more of the requirements in section 72(s), 101(f), 817(h), or 7702, the contract will be treated as a separate account insurance contract if it is regulated as a life insurance or annuity contract under foreign law, the contract reserves are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest (treating the reflection of the investment return and the market value of assets in the separate account as an assumed rate of interest), and no policyholder, annuitant, insured, or beneficiary under the contract is a United States person. These requirements are consistent with the requirements for life insurance or annuity contracts issued by CFCs.

3. Assets of an Insurance Company That Produce Financial Services Income

A comment recommended that assets of an insurance company that produce financial services income (within the meaning of section 904(d)(2)(D)(ii)(II) and (III)) should be treated as marked items. The comment asserted that the assets insurance companies hold to support insurance obligations are closely matched to those obligations and that concerns related to the selective recognition of large noneconomic losses under section 987 are not present for insurance companies.

The final regulations do not treat all assets that produce financial services income as marked assets. As a result, those assets are classified as marked or historic under the general rules of § 1.987-1(d) or (e). The definition of a marked item under § 1.987-1(d)(1) is intended to identify those items of a section 987 QBU that are directly exposed to changes in the value of a section 987 QBU's functional currency. This definition is designed to ensure that, in the absence of a current rate election, section 987 gain or loss recognized by the owner of a section 987 QBU represents bona fide economic gain or loss. To the extent that a section 987 QBU of an insurance company holds assets that are not directly exposed to exchange rate fluctuations (for example, publicly traded stock), and a current rate election is not in effect, those assets are properly characterized as historic items even if they generate financial services income.

4. Deferred Acquisition Costs

A comment recommended that the unamortized portion of specified policy acquisition expenses (as defined in section 848) should be treated as marked items. These specified policy acquisition expenses are generally a specified portion of general deductions and represent deferred acquisition costs. The comment noted that specified policy acquisition expenses are akin to prepaid expenses and the amount and timing of the related deductions are determined under insurance-specific tax rules.

The final regulations do not treat the unamortized portion of specified policy acquisition expenses as marked items. Although certain prepaid expenses are treated as marked items under § 1.987-1(d)(1)(ii), that rule applies only to prepaid expenses with an original term of one year or less. The preamble to the 2016 final regulations explains that, because these prepaid expenses have a short duration and often are small in amount, treating them as marked items promotes administrability without creating significant distortions. 81 FR 88810. By contrast, specified policy acquisition expenses under section 848 generally are amortized over a period of 15 years and can be substantial in magnitude. Thus, if specified policy acquisition expenses were treated as marked items, they could give rise to significant amounts of non-economic section 987 gain or loss.

C. Elections

The 2023 proposed regulations would provide that a current rate election or an annual recognition election may not be revoked without consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was made. Proposed § 1.987-1(g)(3)(ii)(B). Once revoked, a new current rate election or annual recognition election may not be made without consent for any taxable year beginning within 60 months of the first day of the taxable year for which it was revoked.

Id.

A comment recommended that, during the first five years in which the section 987 regulations are applicable, taxpayers should be allowed to make or revoke a current rate election without waiting 60 months or requesting consent. The comment noted that taxpayers may need more flexibility to reassess their elections during this initial period because they do not yet have sufficient information or experience regarding the impact of making (or not making) a current rate election.

The final regulations retain the 60-month limitation for taxpayers that make a current rate election or an annual recognition election and apply a similar limitation for purposes of the section 988 mark-to-market election (

see

part IV.C.1 of this Summary of Comments and Explanation of Revisions). Permitting taxpayers to make or revoke elections on a more frequent basis could increase the potential for manipulation and abuse. However, taxpayers that wish to change their elections without waiting 60 months can do so by requesting the Commissioner's consent, and the Commissioner may consider the need for additional flexibility on a case-by-case basis.

D. No Change in Method of Accounting

Proposed § 1.987-1(g)(4) provides that elections under section 987 are not governed by the general rules concerning changes in methods of accounting. In addition, the final regulations clarify that an election under section 987 is not treated as a method of accounting for purposes of section 446 or 481.

See

§ 1.987-1(g)(4). Similarly, the final regulations provide that application of the transition rules under § 1.987-10 is not treated as a change in method of accounting.

See

§ 1.987-10(k)(4). No inference is intended as to whether a change in section 987 methodology is considered a change in method of accounting before the final regulations become applicable (or with respect to partnerships or other entities that are not generally subject to the section 987 regulations).

III. Comments and Changes to Proposed § 1.987-2: Attribution of Items of an Eligible QBU, the Definition of a Transfer, and Related Rules

Proposed § 1.987-2 provides rules for attributing items to eligible QBUs and rules relating to transfers of assets or liabilities to or from eligible QBUs.

A. Attribution of Items to an Eligible QBU

Under the proposed regulations, items are attributable to an eligible QBU to the extent they are reflected on the eligible QBU's separate set of books and records. Proposed § 1.987-2(b)(1). The final regulations clarify that an item that is not taken into account for financial accounting purposes is attributed to an eligible QBU to the extent it would have been reflected on the eligible QBU's books and records if it were taken into account for financial accounting purposes (for example, amortization attributable to an item of intangible property that is recognized and taken into account for tax purposes due to a section 338 election, but is not recognized or taken into account for financial reporting purposes).

See

§ 1.987-2(b)(1). Similarly, in preparing

an adjusted balance sheet for a section 987 QBU, the owner must make adjustments to reflect items that were not reflected on the section 987 QBU's books and records for the taxable year but should be so reflected under United States tax accounting principles.

See

§ 1.987-1(h). No inference should be drawn from this clarification with respect to other similar rules that attribute items based on books and records including under § 1.904-4(f) (foreign branch category income) or § 1.1503(d)-5(c) (income or dual consolidated loss of a separate unit).

B. Disregarded Transactions

Under proposed § 1.987-2(c)(2)(i), an asset is treated as transferred to a section 987 QBU from its owner if, as a result of a disregarded transaction, the asset is reflected on the books and records of (or attributable to) the section 987 QBU. Similarly, an asset is treated as transferred from a section 987 QBU to its owner if, as a result of a disregarded transaction, the asset ceases to be reflected on (or attributable to) the books and records of the section 987 QBU. However, disregarded transactions do not give rise to items of income, gain, deduction, or loss that are taken into account in determining section 987 taxable income or loss under § 1.987-3. Proposed § 1.987-2(c)(2)(iii).

A comment recommended that interbranch loans made by banks and other regulated financial institutions should not be treated as transfers for purposes of determining the amount of a remittance under § 1.987-5(c). The comment asserted that an interbranch loan is not a permanent transfer because the borrower has an obligation to repay the lender. Another comment requested that the final regulations conform the treatment of disregarded transactions for purposes of section 987 with the reattribution rules provided in § 1.904-4(f)(2)(vi). Under this approach, disregarded payments would result in the reattribution of items of gross income between a section 987 QBU and its owner and between separate 987 QBUs of the same owner, and they would not be treated as transfers giving rise to the recognition of section 987 gain or loss. The comment noted that, under proposed § 1.987-2(c)(2), a disregarded payment for services or a sale of inventory (including a payment from one section 987 QBU to a different section 987 QBU with the same functional currency) could give rise to a remittance even though there is no net economic transfer of value. Further, because disregarded transactions do not give rise to section 987 taxable income or loss under proposed § 1.987-2(c)(2)(iii), the comment asserted that the amount of section 987 taxable income or loss may be different from the amount of income that is economically attributable to the section 987 QBU.

The final regulations retain the disregarded transaction rules of proposed § 1.987-2(c).

See

§ 1.987-2(c). These rules are needed to properly account for the effect of a disregarded transaction on the balance sheet of a section 987 QBU for purposes of determining the owner's net unrecognized section 987 gain or loss under § 1.987-4, the amount of a remittance under § 1.987-5(c), and to properly determine the owner's basis in transferred assets under § 1.987-5(f).

In the case of a disregarded lending transaction in which a section 987 QBU lends money to its owner, although the owner remains obligated to repay the borrowed funds, the disregarded loan is not an asset that can be attributed to the QBU for tax purposes. Accordingly, for tax purposes, the QBU-lender's balance sheet is diminished by the amount of the loan in the same way as any other transfer from the QBU to its owner. To the extent the loan is funded and repaid within the same taxable year, the two transfers will offset in computing the remittance amount under § 1.987-5(c). However, when a disregarded loan spans multiple taxable years, the owner must account for the effect of the transaction on the net equity of the section 987 QBU (as regarded for tax purposes).

In addition, the final regulations do not provide for reattribution of gross income between a section 987 QBU and its owner or between section 987 QBUs of the same owner for purposes of section 987. When a section 987 QBU makes a disregarded payment to its owner, the payment properly triggers the recognition of section 987 gain or loss because the transferred asset has been withdrawn from the QBU and is no longer accounted for in the section 987 QBU's functional currency. Even if the transaction does not reduce the economic value of the section 987 QBU on a net basis (for example, because the disregarded payment is made in exchange for services of equal value), it nonetheless results in a net withdrawal of asset basis from the functional currency environment of the section 987 QBU and is therefore properly treated as a remittance for purposes of section 987. Moreover, a rule determining the amount of a remittance based on the value of property transferred from a section 987 QBU would be difficult to administer and prone to manipulation.

Similarly, because disregarded transactions do not give rise to taxable income or loss under general tax principles, they are not taken into account in determining section 987 taxable income or loss.

See

§ 1.987-2(c)(2)(iii). Instead, the regarded income of an owner that is properly reflected on the books and records of (or attributable to) a section 987 QBU under § 1.987-2(b) is determined in the functional currency of the section 987 QBU and translated into the owner's functional currency under the rules of § 1.987-3. Disregarded payments do not serve to reattribute gross income between a section 987 QBU and its owner for purposes of determining section 987 taxable income or loss. Such a reattribution rule would add complexity to the section 987 regulations (for example, when income is reattributed in a taxable year following the taxable year in which the disregarded payment is made), and it would not serve any necessary function.

However, the final regulations contain targeted modifications that are intended to reduce the compliance burden of accounting for certain transfers between a section 987 QBU and its owner.

See

part VI of this Summary of Comments and Explanation of Revisions (describing modifications to the annual remittance rules to reduce the burden of tracking and translating disregarded transfers). Additionally, if an owner elects to group section 987 QBUs with the same functional currency under § 1.987-1(b)(3)(ii), transactions between the section 987 QBUs will not be treated as transfers between the section 987 QBUs and their owner for purposes of section 987.

IV. Comments and Changes to Proposed § 1.987-3: Determination of Section 987 Taxable Income or Loss of an Owner of a Section 987 QBU

Proposed § 1.987-3 would provide rules for determining taxable income or loss of a section 987 QBU, including section 988 transactions of a section 987 QBU. Additional rules relating to section 988 transactions would be provided in § 1.987-3 of the 2016 proposed regulations, for which the comment period was reopened in 2023.

A. Treatment of Section 988 Transactions Under the 2016 Proposed Regulations

The 2016 proposed regulations provide that the determination of whether a transaction is a section 988 transaction is made by reference to the section 987 QBU's functional currency. Thus, a transaction otherwise within the scope of section 988 that is denominated in a functional currency other than the section 987 QBU's

functional currency generally would be treated as a section 988 transaction.

See

§ 1.987-3(b)(4)(i) of the 2016 proposed regulations. However, section 988 transactions of a section 987 QBU denominated in, or determined by reference to, the owner's functional currency (“specified owner functional currency transactions”) would not be treated as section 988 transactions of the section 987 QBU.

See

§ 1.987-3(b)(4)(ii) of the 2016 proposed regulations.

The 2016 proposed regulations would further provide that section 988 gain or loss of a section 987 QBU generally is determined by reference to the owner's functional currency.

See

§ 1.987-3(b)(4)(i) of the 2016 proposed regulations. However, section 988 gain or loss with respect to certain short-term section 988 transactions (“qualified short-term section 988 transactions”) accounted for under a mark-to-market method of accounting would be determined in the functional currency of the section 987 QBU, and not the functional currency of its owner.

See

§ 1.987-3(b)(4)(iii) of the 2016 proposed regulations. The 2016 proposed regulations would provide an election under which taxpayers can apply a mark-to-market method of accounting with respect to all qualified short-term section 988 transactions.

See

§ 1.987-3(b)(4)(iii)(C) of the 2016 proposed regulations.

Under the 2016 final regulations (and the 2023 proposed regulations), a transaction denominated in a currency other than the section 987 QBU's functional currency is treated as a historic item.

See

§ 1.987-1(d) and (e). However, the 2016 proposed regulations provide an exception under which a qualified short-term section 988 transaction for which section 988 gain or loss is determined by reference to the functional currency of the section 987 QBU is a marked item.

See

§ 1.987-1(d)(3) of the 2016 proposed regulations.

The preamble to the 2023 proposed regulations requested comments as to whether section 988 gain or loss on nonfunctional currency transactions of a section 987 QBU (including specified owner functional currency transactions) should be determined in the functional currency of the section 987 QBU when a current rate election or annual recognition election is in effect. 88 FR 78154. The preamble expressed concern that, if such a rule were adopted, specified owner functional currency transactions would give rise to offsetting positions in the functional currency of the section 987 QBU; this could create opportunities for taxpayers to recognize losses while deferring the offsetting gains.

Id.

For example, if a section 987 QBU held assets denominated in its owner's functional currency, and the section 987 QBU's functional currency weakened against that of its owner, the section 987 QBU would have unrecognized section 988 gain and the owner would have an inverse amount of unrecognized section 987 loss. The owner could cause the QBU to make a remittance triggering the recognition of section 987 loss, while deferring the section 988 gain.

B. Comments on the 2023 Proposed Regulations Regarding Section 988 Transactions of Section 987 QBUs

Comments asserted that the section 988 rules of the 2016 proposed regulations would impose a substantial compliance burden on taxpayers. The comments noted that for financial accounting purposes, foreign currency gain or loss on nonfunctional currency transactions of a QBU is measured by reference to the functional currency of the QBU. In addition, taxpayers typically hedge their exposure to nonfunctional currency transactions of a QBU by reference to the QBU's functional currency. One comment noted that it is common for section 987 QBUs of insurance companies to hold assets denominated in U.S. dollars for commercial reasons and that treating these assets as historic items would increase the compliance burden on insurance companies.

Comments suggested that the rules of the 2016 proposed regulations be modified to provide that: (i) section 988 gain or loss on nonfunctional currency transactions of a section 987 QBU is determined by reference to the functional currency of the section 987 QBU, (ii) specified owner functional currency transactions are treated as section 988 transactions, and (iii) section 988 transactions of a section 987 QBU are treated as marked items. Alternatively, comments requested that (if the default rules of the 2016 proposed regulations are retained) taxpayers should be permitted to elect this modified treatment.

According to the comments, the recommended modifications would achieve greater consistency with financial accounting standards and would ease the compliance burden on taxpayers. One comment stated that such an approach would also be more consistent with the statutory requirement to determine a section 987 QBU's taxable income or loss in the QBU's functional currency under sections 985 and 987. Comments noted that the opportunity for selective recognition of losses is limited to the extent the taxpayer makes a current rate election (because section 987 losses will be subject to suspension) or an annual recognition election (because section 987 gain or loss is recognized annually without regard to whether a remittance is made). One comment asserted that, even if neither of these elections is in effect, it is difficult to selectively recognize material section 987 losses attributable to section 988 transactions because the remittance proportion under § 1.987-5 is determined with respect to all the assets of the section 987 QBU.

Other comments recommended providing an election under which taxpayers could recognize section 988 gain or loss with respect to all section 988 transactions of a section 987 QBU on a mark-to-market basis (effectively expanding the special rule for qualified short-term section 988 transactions to cover all section 988 transactions of a QBU). For example, one comment requested mark-to-market timing for section 988 transactions of a section 987 QBU that is subject to an annual recognition election. According to this comment, because mark-to-market timing would apply to both section 988 and section 987 gains and losses on a current basis, the potential for abuse or selective loss recognition would be limited. Another comment requested that the definition of a qualified short-term section 988 transaction under proposed § 1.987-3(b)(4)(iii)(B) be expanded to include long-term transactions that have been properly identified as a hedge for U.S. tax purposes.

Finally, a comment recommended that, if the rules of the 2016 proposed regulations relating to section 988 transactions are retained in the final regulations, the applicability date of the final regulations should be deferred until taxable years beginning after December 31, 2026, so that taxpayers have adequate time to update their internal accounting systems.

C. Treatment of Section 988 Transactions Under the Final Regulations

1. Section 988 Mark-To-Market Election

The final regulations provide that a taxpayer may elect to recognize section 988 gain or loss with respect to section 988 transactions of a section 987 QBU under a mark-to-market method of accounting (a “section 988 mark-to-market election”).

See

§ 1.987-3(b)(4)(ii). This election is expected to result in consistent treatment of section 988 transactions for tax and financial reporting purposes and to reduce the potential for selective recognition of

losses relating to these transactions, as indicated by the comments. The section 988 mark-to-market election is subject to the same timing and consistency requirements as a current rate election or an annual recognition election.

See

§ 1.987-1(g).

The section 988 mark-to-market election does not apply to a section 988 transaction that is contributed to a section 987 QBU with a built-in loss if the section 988 transaction was not subject to a mark-to-market method of accounting in the hands of the transferor.

See

§ 1.987-3(b)(4)(ii)(B). This rule is intended to prevent taxpayers from accelerating the recognition of section 988 loss by contributing a section 988 transaction with a built-in loss to a section 987 QBU that is subject to the section 988 mark-to-market election.

2. Treatment of Section 988 Transactions of a Section 987 QBU Under the Final Regulations

The final regulations provide new rules for applying section 988 with respect to nonfunctional currency transactions of a section 987 QBU. In response to the comments summarized in part IV.B of this Summary of Comments and Explanation of Revisions, the Treasury Department and the IRS have determined that a different framework is appropriate in order to reduce the compliance burden and complexity of the section 987 regulations.

Under the final regulations, whether an asset or liability of a section 987 QBU is a section 988 transaction is determined by reference to the functional currency of the section 987 QBU (instead of the owner's functional currency).

See

§ 1.987-3(b)(4)(i). The final regulations further provide that section 988 gain or loss with respect to section 988 transactions of a section 987 QBU (including transactions denominated in the owner's functional currency) is determined in the functional currency of the section 987 QBU, and section 988 transactions are treated as marked items.

See

§§ 1.987-1(d)(1)(iii) and 1.987-3(b)(4)(i). The final regulations do not provide an exception for specified owner functional currency transactions; thus, such transactions are treated as section 988 transactions of the section 987 QBU.

However, the final regulations provide an anti-abuse rule to prevent taxpayers from entering into section 988 transactions through an eligible QBU for the purpose of generating offsetting amounts of gain and loss that can selectively be recognized or deferred. Under § 1.987-2(b)(3)(iv), section 988 transactions will not be treated as attributable to an eligible QBU if they are entered into (or reflected on the eligible QBU's books and records) with a principal purpose of generating offsetting amounts of section 988 gain and section 987 loss or offsetting amounts of section 988 loss and section 987 gain. Section 988 transactions also are subject to the general anti-avoidance rules of § 1.987-2(b)(3)(i) through (iii).

V. Comments and Changes to Proposed § 1.987-4: Determination of Net Unrecognized Section 987 Gain or Loss of a Section 987 QBU

Proposed § 1.987-4 provides rules for computing net unrecognized section 987 gain or loss with respect to a section 987 QBU. In particular, proposed § 1.987-4(d) provides a ten-step formula for computing unrecognized section 987 gain or loss for the current taxable year. The first step of this formula is to compute the change in owner functional currency net value (“OFCNV”) for the taxable year. Proposed § 1.987-4(d)(1). The other steps make adjustments for changes to OFCNV that are not attributable to changes in the exchange rate. Steps 2 through 5 relate to transfers of assets and liabilities between a section 987 QBU and its owner, and steps 6 through 9 relate to income or loss of the section 987 QBU. Proposed § 1.987-4(d)(2) through (9). Step 10 is a residual adjustment for any increase or decrease to the section 987 QBU's balance sheet that is not otherwise accounted for. Proposed § 1.987-4(d)(10). If a current rate election is in effect, taxpayers are required to apply only steps 1 through 5 and step 10.

Under proposed § 1.987-4(e), OFCNV is determined by preparing a tax basis balance sheet reflecting the section 987 QBU's assets and liabilities. The basis of each asset and the amount of each liability is then translated into the owner's functional currency at the appropriate exchange rate. Under the default rules, marked items are translated at the year-end spot rate, while historic items are translated at the applicable historic rate. However, taxpayers that make a current rate election under § 1.987-1(d)(2) translate all items on the year-end balance sheet at the year-end spot rate.

A. Mechanics for Calculating Unrecognized Section 987 Gain or Loss for the Current Taxable Year

1. Earnings and Capital Method

The preamble to the 2023 proposed regulations notes that, under a current rate election, the total amount of section 987 gain or loss recognized by an owner with respect to a section 987 QBU would be similar to the amount computed under the earnings and capital method, which was described in proposed regulations published in the

Federal Register

in 1991 (56 FR 48457, September 25, 1991) (the “1991 proposed regulations”). 88 FR 78138 through 78139. Under the earnings and capital method, the owner of a section 987 QBU computes section 987 gain or loss by maintaining an equity pool in the QBU's functional currency and a basis pool in the owner's functional currency. The equity and basis pools are increased by income of the section 987 QBU and contributions from the owner, and they are decreased by losses of the section 987 QBU and distributions from the section 987 QBU to the owner. The preamble to the 1991 proposed regulations explains that the equity pool generally represents the amount of branch equity (adjusted basis of assets net of liabilities), and the basis pool represents the owner's basis in branch equity. 56 FR 48458.

Comments requested that the final regulations include an election to apply the earnings and capital method of the 1991 proposed regulations in lieu of the current rate election. These comments indicated that, even if a current rate election is in effect, proposed § 1.987-4 imposes a heightened compliance burden (as compared to the earnings and capital method) because it requires taxpayers to prepare tax basis balance sheets for each of their section 987 QBUs on an annual basis. In addition, the comments asserted that taxpayers are already familiar with the earnings and capital method and would be less likely to make errors in applying that method because taxpayers track book-to-tax adjustments in computing taxable income but do not make book-to-tax adjustments to their balance sheets. One comment recommended allowing taxpayers to use the earnings and capital method only if a current rate election and an annual recognition election are both in effect.

The final regulations do not permit taxpayers to use the earnings and capital method. As explained in the preamble to the 2023 proposed regulations, such an election would allow different taxpayers to apply section 987 using fundamentally different methodologies, which would increase the overall complexity of the section 987 regulations and make them more difficult to administer. 88 FR 78138. For example, it would be difficult for taxpayers to transition from one method to another in an administrable way. Moreover, under the earnings and capital method, the amount of section

987 gain or loss recognized is determined based on the percentage of a section 987 QBU's net equity remitted (rather than the percentage of gross assets remitted, as required under § 1.987-5), which can inappropriately accelerate the recognition of section 987 gain or loss. If a section 987 QBU has negative net equity, section 987 gain or loss cannot be recognized under the earnings and capital method until the section 987 QBU terminates, which is inconsistent with the statutory requirement to recognize currency gain or loss on transfers of property from the section 987 QBU.

However, the final regulations modify the existing framework of § 1.987-4 to allow taxpayers that make a current rate election to use certain elements of the earnings and capital method in lieu of preparing a tax basis balance sheet.

2

These modifications are expected to minimize the compliance burden of transitioning from the 1991 proposed regulations to the final regulations. Under the final regulations, if a current rate election is in effect, OFCNV is computed by determining the aggregate basis of the QBU's assets, net of the QBU's liabilities, in the functional currency of the section 987 QBU (“QBU net value”) and translating the QBU net value into the owner's functional currency at the year-end spot rate.

See

§ 1.987-4(e)(2)(i) and (ii). The final regulations provide that QBU net value can be computed without a tax basis balance sheet using the formula provided in § 1.987-4(e)(2)(iii).

2

Taxpayers would still need to track the gross assets of a section 987 QBU for other purposes, including the denominator of the remittance proportion under § 1.987-5.

The formula provided in § 1.987-4(e)(2)(iii) is modeled on the formula used to track the equity pool under the 1991 proposed regulations, with certain modifications. Under this formula, the QBU net value on the last day of the taxable year is equal to the QBU net value at the end of the preceding taxable year, adjusted by transfers of assets and liabilities between the section 987 QBU and its owner and by income or loss of the section 987 QBU (each determined in the section 987 QBU's functional currency). If a taxpayer determines QBU net value under § 1.987-4(e)(2)(iii), the taxpayer must retain the information used to determine QBU net value for each taxable year in lieu of retaining adjusted balance sheets.

See

§ 1.987-9(b)(2).

2. Cumulative Translation Adjustment

Comments requested that taxpayers be permitted to use the cumulative translation adjustment (“CTA”) determined under U.S. generally accepted accounting principles (“U.S. GAAP”) to compute their unrecognized section 987 gain or loss. Alternatively, some comments recommended that taxpayers should be allowed to use the CTA for this purpose only with respect to small QBUs and subject to certain tax adjustments. One comment suggested that section 987 gain or loss with respect to small QBUs should be recognized when the CTA is included in income from continuing operations under U.S. GAAP.

The final regulations do not permit taxpayers to use the CTA to determine their net unrecognized section 987 gain or loss. As explained in the preamble to the 2023 proposed regulations, section 987(3) requires currency gain or loss to be recognized at the time of a remittance, rather than when the CTA is included in income for U.S. GAAP purposes. 88 FR 78141. Moreover, the Treasury Department and the IRS have determined that significant differences may arise between the computation of the CTA for financial accounting purposes and the determination of unrecognized section 987 gain or loss under § 1.987-4(d). For example, the CTA is unlikely to reflect the correct amount of currency gain or loss for tax purposes because of book-to-tax differences in the basis of assets or because certain items are disregarded for tax purposes but regarded for financial accounting purposes. If the comment's recommended approach were adopted, complex rules would be needed to adjust the CTA amount in order to derive the correct amount to be recognized for tax purposes.

3. Simplified Accounting for Disregarded Transactions

A comment recommended that taxpayers that make a current rate election should be permitted to determine unrecognized section 987 gain or loss for the taxable year by applying only two steps: step 1 (determining the change in OFCNV) and step 10 (reducing the amount determined in step 1 by the change in QBU net value, translated into the owner's functional currency at the yearly average exchange rate). The recommended rule would have the effect of accounting for all transfers between the owner and the section 987 QBU (which would otherwise be accounted for under steps 2 through 5) as part of step 10; consequently, the net amount of all transfers would be translated at the yearly average exchange rate. The comment posited that this approach would simplify the computations for taxpayers with a high volume of disregarded intercompany transactions.

The final regulations retain the requirement to apply steps 2 through 5 when a current rate election is in effect. Under these steps, transfers of marked assets and liabilities between a section 987 QBU and its owner generally are translated at the spot rate applicable on the date of transfer. Because the applicable spot rate may differ significantly from the yearly average exchange rate, it would not be appropriate to account for all transfers between a section 987 QBU and its owner by translating them at the yearly average exchange rate under step 10. The Treasury Department and the IRS continue to study possible simplifications of § 1.987-4 relating to disregarded transactions between a section 987 QBU and its owner, including whether, in certain circumstances, unrecognized section 987 gain or loss for a taxable year could be computed using only steps 1 and 10.

See

§ 1.987-2(f) of the 2024 proposed regulations for proposed rules containing an election under which certain disregarded transactions between a section 987 QBU and its owner would not be taken into account in computing unrecognized section 987 gain or loss.

B. Hedging Transactions

1. Comment on Matching Source and Character of Section 988 Gain or Loss From a Hedging Transaction With the Source and Character of Section 987 Gain or Loss

A comment recommended adoption of a hedging rule under which a taxpayer that hedges exchange rate risk with respect to its net investment in a section 987 QBU could match the source and character of the section 988 gain or loss arising from the hedging transaction with that of the section 987 gain or loss attributable to the hedged section 987 QBU. Alternatively, the comment suggested that the hedging transaction could be integrated with the section 987 QBU, such that section 988 gain or loss with respect to the hedging transaction would directly offset the section 987 QBU's unrecognized section 987 gain or loss. The comment asserted that implementing either of these recommended rules would mitigate the potential for adverse consequences (or windfalls) under section 987 when the owner's foreign currency exposure is economically hedged. The comment noted that these rules would be particularly beneficial for taxpayers that make a current rate election and an

annual recognition election (and thus recognize section 987 gain or loss whether or not there is a remittance).

2. Treatment of Section 987 Hedging Transactions Under the Final Regulations

The Treasury Department and the IRS agree with the comment that it would be appropriate to permit symmetrical treatment of currency gain or loss with respect to a net investment hedge and the hedged section 987 QBU.

3

Accordingly, § 1.987-14 of the final regulations provides new rules that apply to certain identified hedging transactions entered into by the owner of a section 987 QBU (“section 987 hedging transactions”).

3

The Treasury Department and the IRS previously published proposed regulations in the

Federal Register

on December 19, 2017 (82 FR 60135), which contained proposed rules relating to the treatment of a net investment hedge for purposes of the business needs exception to the definition of foreign personal holding company income under section 954(c)(1)(D) and § 1.954-2(g)(2)(ii). Those proposed regulations would apply only for purposes of the business needs exception and do not address the potential for mismatches in other contexts.

Under § 1.987-14(d), section 988 gain or loss that would otherwise be recognized on a section 987 hedging transaction (“hedging gain or loss”) is instead taken into account in adjusting the owner's unrecognized section 987 gain or loss for the taxable year (as determined under § 1.987-4(d)). For example, if the owner has unrecognized section 987 gain for the taxable year under § 1.987-4(d), the owner's hedging loss reduces the unrecognized section 987 gain. However, hedging loss cannot reduce unrecognized section 987 gain for the taxable year below zero, and hedging gain cannot reduce unrecognized section 987 loss for the taxable year below zero. This limitation ensures that hedging gain or loss in excess of the currency exposure generated by the section 987 QBU for the taxable year is not taken into account under section 987.

3. Requirements To Qualify as a Section 987 Hedging Transaction

A section 987 hedging transaction generally is defined as a financial instrument (a “hedge”) entered into by the owner of a section 987 QBU for the purpose of managing exchange rate risk with respect to the owner's net investment in the section 987 QBU as part of the normal course of the owner's trade or business. The hedge may be entered into with an unrelated counterparty or with a related person. For example, a CFC that owns a section 987 QBU may enter into a hedge with its U.S. parent, which has entered into a similar, offsetting, transaction with a third party.

Several requirements must be met in order for a hedge to qualify as a section 987 hedging transaction. First, the hedge must be identified as a section 987 hedging transaction with respect to the hedged QBU on or before the day the owner enters into the hedge.

See

§ 1.987-14(b)(2)(i) and (c). A hedge cannot be identified as a section 987 hedging transaction with respect to more than one section 987 QBU. However, if a grouping election is in effect under § 1.987-1(b)(3)(ii), all section 987 QBUs that have the same functional currency will be treated as a single section 987 QBU. The final regulations also provide a special rule for cases in which a taxpayer fails to properly identify a hedge due to inadvertent error.

See

§ 1.987-14(c)(2).

Second, a current rate election must be in effect for the taxable year.

See

§ 1.987-14(b)(2)(ii). In the absence of a current rate election, gain or loss on a net investment hedge is unlikely to be comparable in amount to the owner's unrecognized section 987 gain or loss, and thus the rules of § 1.987-14 would not serve their intended function.

Third, the owner (and any members of the same controlled group that are parties to the hedge) must account for section 988 gain or loss with respect to the hedge under a mark-to-market method of accounting (for example, under section 1256 or in reliance on proposed § 1.988-7).

See

§ 1.987-14(b)(2)(iii). As a result of this requirement, foreign currency gain or loss on the hedge will be taken into account in the taxable year in which the related currency gain or loss is determined under § 1.987-4(d)).

Fourth, under U.S. GAAP, foreign currency gain or loss on the hedge must be properly accounted for as a cumulative foreign currency translation adjustment to shareholders' equity.

See

§ 1.987-14(b)(2)(iv). This requirement helps to ensure that the hedge is economically related to the owner's net investment in the section 987 QBU.

Fifth, the hedge must be entered into by the owner of the section 987 QBU, and not by a section 987 QBU of the owner (that is, the hedge cannot itself be an asset attributable to a section 987 QBU).

See

§ 1.987-14(b)(2)(v).

Finally, an anti-abuse rule provides that a hedge does not qualify as a section 987 hedging transaction if the hedge or a related transaction is entered into with a principal purpose of converting section 987 gain or loss into section 988 gain or loss.

See

§ 1.987-14(b)(3). For example, a taxpayer that owns a section 987 QBU might enter into a hedging transaction with a related party without hedging the related party's resulting exchange rate risk (effectively shifting the exchange rate risk without reducing the group's overall foreign currency exposure) for the purpose of taking the related foreign currency gain or loss into account under section 988 (rather than section 987). Under the anti-abuse rule, the net investment hedge would not be treated as a section 987 hedging transaction.

4. Consolidated Groups

With regard to consolidated groups (as defined in § 1.1502-1(h)), § 1.987-14(b)(2)(v) of the final regulations requires that the same corporation be the owner of the QBU and enter into the section 987 hedging transaction with respect to that QBU (similar requirements apply when a member of a consolidated group engages in a section 988(d) hedging transaction under § 1.988-5(a)(5)(v) or (b)(2)(i)(F)). The Treasury Department and the IRS continue to study whether it would be possible to treat consolidated group members as a single corporation for purposes of § 1.987-14 and the section 988(d) hedging transaction rules without inappropriately shifting income among members of the group.

See also

TD 8400, 57 FR 9172, 9176 (soliciting comments on whether to permit the rules of § 1.988-5 to be applied by treating consolidated group members as a single corporation).

VI. Comments and Changes to Proposed § 1.987-5: Recognition of Section 987 Gain or Loss

Proposed § 1.987-5 provides rules for determining the amount of section 987 gain or loss recognized by the owner of a section 987 QBU.

Under proposed § 1.987-5(a), when a section 987 QBU makes a remittance, the owner recognizes section 987 gain or loss. In general, the amount recognized equals the section 987 QBU's net unrecognized section 987 gain or loss multiplied by the owner's remittance proportion. The remittance proportion is determined in the owner's functional currency; it is equal to the amount of the remittance for the taxable year, divided by the aggregate basis of the section 987 QBU's gross assets reflected on its year-end balance sheet (without reduction for the remittance). Proposed § 1.987-5(b). For a taxable year, the amount of a remittance equals the excess of (i) the aggregate of all amounts transferred from the section 987 QBU to the owner during the taxable year; over (ii) the aggregate of all amounts transferred from the owner to the section 987 QBU

during the taxable year (each determined in the owner's functional currency). Proposed § 1.987-5(c).

A comment noted that, for taxpayers with a high volume of disregarded intercompany transactions, it can be difficult to track the amount of each transfer between the section 987 QBU and its owner and to translate the transfer into the owner's functional currency at the appropriate exchange rate. The comment recommended that the amount of a remittance should be deemed to be equal to the change in the QBU's net value (if negative) for the taxable year.

Despite compliance and administrative burdens that may result in certain cases from tracking disregarded transfers for purposes of determining the amount of a remittance, it would not be appropriate to determine the remittance amount based solely on the negative change in net value of a section 987 QBU. Such an approach would not properly account for distributions out of a section 987 QBU's current year earnings. For example, if a section 987 QBU distributed an amount exactly equal to its current year earnings, there would be no change in the QBU's net value (and thus, no remittance) under the comment's recommended approach, even if the QBU made a substantial distribution. Section 987(3) and its legislative history indicate that Congress intended for gain or loss to be recognized on any remittance from a section 987 QBU, without regard to whether the remittance is sourced from current year earnings, prior year earnings, or capital contributions.

Nonetheless, the final regulations provide two modifications that are intended to reduce the burden of tracking disregarded transfers for purposes of § 1.987-5 while preserving consistency with the text and purpose of section 987. First, the final regulations provide an alternative formula for computing the annual remittance that is based on the comment's recommended approach (and does not require tracking of individual transfers) but contains an adjustment to account for remittances out of current-year income. Under this formula, the remittance amount is equal to the negative change in net value of the section 987 QBU (determined in the QBU's functional currency), adjusted for income and loss of the section 987 QBU.

See

§ 1.987-5(c)(2). Mathematically, this formula will produce an amount that is equal to the aggregate net transfer from the section 987 QBU to its owner for the taxable year.

Second, § 1.987-5(b) and (c) provide that the numerator and denominator of the remittance proportion (that is, the amount of the remittance and the section 987 QBU's gross assets) are determined in the section 987 QBU's functional currency, rather than the owner's functional currency. As a result, it is not necessary to separately translate each transfer for purposes of determining the annual remittance.

VII. Comments and Changes to Proposed § 1.987-6: Character and Source of Section 987 Gain or Loss

A. Determining the Character and Source of Section 987 Gain or Loss

1. In General

Under proposed § 1.987-6, section 987 gain or loss is assigned to the statutory and residual groupings in two steps: an initial assignment under proposed § 1.987-6(b)(2)(i), followed by a reassignment described in proposed § 1.987-6(b)(2)(ii). The initial assignment is made using the asset method under §§ 1.861-9(g) and 1.861-9T(g). It is made after the application of the income attribution rules of § 1.904-4(f)(2)(vi) or § 1.951A-2(c)(7), but before expenses are allocated and apportioned to gross income and before the application of provisions that require a net income computation. Section 987 gain or loss may be reassigned if required after the application of provisions that require a net income computation. For example, if an item of section 987 gain is initially assigned to tentative tested income, it will be reassigned to tested income or residual income depending on whether the taxpayer has made the GILTI high-tax exclusion election and, if so, whether the item (described in proposed § 1.987-6(b)(2)(iii)) is subject to a high rate of tax.

2. Asset Method

The asset method under §§ 1.861-9 and 1.861-9T is intended to serve as an administrable proxy for a section 987 QBU's historical earnings, in line with the statutory requirement of section 987(3)(B) (which provides that section 987 gain or loss is sourced by reference to the source of the income giving rise to post-1986 accumulated earnings). As explained in the preamble to the 2016 final regulations, it would be complex and burdensome to source and characterize section 987 gain or loss with direct reference to post-1986 accumulated earnings, and the gross assets of a section 987 QBU provide a reasonable proxy for historical earnings that is relatively easy to administer. 81 FR 88814.

A comment recommended that CFCs which apportion interest expense using the modified gross income method be permitted to use the same method to determine the character and source of section 987 gain or loss (rather than using the asset method under §§ 1.861-9(g) and 1.861-9T(g)). According to the comment, the asset method may not accurately reflect the income earned by the CFC for the taxable year, and section 987 losses often could be allocated to a subpart F income group in excess of the income recognized in that group for the taxable year. The comment noted that the use of the modified gross income method would be more administrable and would more readily allow section 987 losses to be used against gross income recognized in the current year, since the source and character of the section 987 loss would be determined by reference to the section 987 QBU's gross income for the current year.

The final regulations do not permit CFCs to use the modified gross income method to source and characterize section 987 gain or loss because the source and character of a section 987 QBU's gross income may vary significantly from year to year, including by reason of extraordinary events or as a result of tax planning. Accordingly, the gross income earned in a single year is not a sufficiently reliable proxy for historical earnings for purposes of section 987(3)(B).

3. Timing of Source and Character Determination

The 2023 proposed regulations provide that the initial assignment of section 987 gain or loss would generally be made in the taxable year in which the section 987 gain or loss is treated as recognized, deferred, or suspended. Proposed § 1.987-6(b)(1).

Comments requested that the character and source of suspended section 987 loss and deferred section 987 gain or loss be determined in the year in which it is recognized, rather than in the year in which it becomes suspended or deferred. The comments noted that the proposed rules would require extensive tracking of the source and character of section 987 gain or loss in multiple categories over multiple years. Comments also posited that the potential for distortion due to changes in the basis of a QBU's assets or shifts in the character of its income would be present whether the section 987 gain or loss is characterized in the taxable year in which it becomes suspended or deferred or in the taxable year in which it is recognized.

The final regulations retain the rules of proposed § 1.987-6(b)(1)(ii) and (iii), under which suspended section 987 loss and deferred section 987 gain or loss are

characterized in the year of suspension and deferral, respectively, for several reasons.

First, making an initial assignment in the taxable year of deferral or suspension provides parity in the timing of the characterization of gains and losses (that is, both gains and losses are characterized in the year of a remittance or termination).

Second, this rule is expected to produce source and character determinations that more closely align with the historical income of the section 987 QBU during the period in which the relevant section 987 gain or loss arose. Making an initial assignment in the taxable year of deferral or suspension means that source and character are determined by reference to the assets of the section 987 QBU contemporaneously with the remittance or termination, while the affected assets are still taken into account for purposes of applying the asset method under §§ 1.861-9 and 1.861-9T. By contrast, waiting until the year of recognition would require deferred section 987 gain or loss and (in some cases) suspended section 987 loss to be characterized after the section 987 QBU has been terminated and its assets have been transferred to a related party, which could result in substantial distortions.

Third, the timing rule of § 1.987-6(b)(1)(ii) is needed to facilitate the separate application of the loss-to-the-extent-of-gain rule under § 1.987-11(e) to section 987 gain or loss in each recognition grouping. As explained in part X.B.3 of this Summary of Comments and Explanation of Revisions, in order to prevent taxpayers from avoiding the loss limitation through the selective recognition of section 987 gains that are subject to a low rate of tax (or are not subject to U.S. tax), § 1.987-11(e) provides that suspended section 987 loss in a recognition grouping is not recognized until section 987 gain in the same recognition grouping is recognized. For this rule to achieve its policy objective, suspended section 987 loss must be sourced and characterized before determining whether it can be recognized under § 1.987-11(e). If suspended section 987 loss were not characterized until the year of recognition, there would be no administrable way to identify suspended section 987 loss in the relevant recognition grouping for purposes of § 1.987-11(e) because the source and character of the suspended section 987 loss would not yet have been determined.

Finally, in response to comments regarding compliance burden generally, the final regulations include a number of new rules intended to simplify the tracking of suspended section 987 loss or deferred section 987 gain or loss. For instance, the new de minimis rule (described in part X.A.1 of this Summary of Comments and Explanation of Revisions) is expected to reduce the burden of tracking suspended section 987 loss because section 987 loss will be suspended only if it exceeds the de minimis threshold (the lesser of $3 million or two percent of gross income).

See

§ 1.987-11(c)(2). In addition, taxpayers that make the annual recognition election generally would not be subject to the deferral and loss suspension rules (and thus would not need to track deferred section 987 gain or loss or suspended section 987 loss). The lookback rule (described in part X.B.1 of this Summary of Comments and Explanation of Revisions) will permit suspended section 987 loss to be recognized in the year of a remittance to the extent of gain recognized during the lookback period, which will limit the amount of suspended section 987 loss carried forward to future years. Additionally, the new rules relating to the characterization of section 987 gain or loss for purposes of subpart F (described in part VII.B of this Summary of Comments and Explanation of Revisions) provide taxpayers more flexibility in characterizing their section 987 gain and loss relating to subpart F income groups, including an election that will limit the number of subpart F income groups for which tracking is required.

B. Characterization of Section 987 Gain or Loss for Purposes of Subpart F

1. In General

Under proposed § 1.987-6(b)(2)(i)(C), section 987 gain or loss assigned to a subpart F income group is treated as foreign currency gain or loss attributable to section 988 transactions not directly related to the business needs of the CFC for purposes of section 954(c)(1)(D).

Some comments recommended that, for subpart F purposes, section 987 gain or loss should instead be assigned to the same subpart F income groups as the income generated by the section 987 QBU's assets. The comments noted that the recommended rule would better align the characterization of section 987 gain or loss with the underlying assets and income of the section 987 QBU and would permit broader utilization of section 987 loss because the loss could be netted against income in the same subpart F income groups. One comment asserted that the recommended rule would be more consistent with section 987(3)(B), which requires section 987 gain or loss to be sourced by reference to the source of the income giving rise to post-1986 accumulated earnings.

Other comments stated that section 987 gain or loss should not be treated as foreign personal holding company income described in section 954(c)(1)(D) because section 954(c)(1)(D) refers to foreign currency gains or losses under section 988 and makes no reference to gain or loss recognized under section 987(3). One comment questioned whether section 987 gain or loss should be assigned to any subpart F income group because section 954 does not explicitly identify section 987 gain as a category of subpart F income.

Another comment requested that, if proposed § 1.987-6(b)(2)(i)(C) is retained for taxpayers applying the default rules, a different rule should be provided for taxpayers that make a current rate election (under which all assets and liabilities of a section 987 QBU give rise to currency gain or loss). A comment also recommended that, if proposed § 1.987-6(b)(2)(i)(C) is retained, the final regulations should clarify that, for taxpayers predominantly engaged in the active conduct of a banking, insurance, financing, or similar business, section 987 gain or loss that is assigned to a subpart F income group is treated as financial services income within the meaning of section 904(d)(2)(C).

Other comments requested that, if section 987 gain or loss is treated as gain or loss from section 988 transactions not directly related to the business needs of the CFC, taxpayers should be permitted to use the elections available under § 1.954-2(g)(3) (characterizing section 988 gain or loss that arises from a specific category of subpart F income as gain or loss in that category) and § 1.954-2(g)(4) (treating all section 988 gain or loss as foreign personal holding company income). One comment recommended that, for purposes of the election under § 1.954-2(g)(3), section 987 gain or loss should be allocated to categories of foreign base company income on a proportionate basis without requiring direct tracing of section 987 gain or loss to specific transactions or assets.

The final regulations retain the approach in the 2023 proposed regulations and treat section 987 gain or loss as subpart F income to the extent that the assets of the section 987 QBU generate subpart F income under the asset method of §§ 1.861-9(g) and 1.861-9T(g).

See

§ 1.987-6(b)(2)(i)(A). However, the Treasury Department and the IRS agree with the comments that assigning section 987 gain or loss to the

same subpart F income groups as the income generated by the section 987 QBU's assets is most consistent with the principles of section 987(3)(B) and is therefore the most appropriate exercise of authority under sections 987(3) and 989(c). Accordingly, under the final regulations, the characterization of section 987 gain or loss is determined under the general rule of § 1.987-6 using the asset method of §§ 1.861-9(g) and 1.861-9T(g), including by assigning section 987 gain or loss to subpart F income groups. Thus, for example, if a QBU's assets generate foreign base company sales income, the section 987 gain or loss will be characterized as foreign base company sales income.

The Treasury Department and the IRS do not agree with the suggestion that section 987 gain or loss cannot give rise to subpart F income merely because section 954 does not explicitly identify section 987 gain as a separate category of subpart F income. Section 987(3) requires “proper adjustments (as prescribed by the Secretary)” to taxable income of the owner of a section 987 QBU. Further regulatory authority is provided in section 989(c). The adjustments required under section 987(3) include sourcing gain or loss recognized on a remittance by reference to the QBU's historical earnings under section 987(3)(B). This sourcing rule serves to characterize the adjustments to income under section 987(3) in the same way as the QBU's underlying income. Similarly, when a QBU's income is taken into account in determining the owner's subpart F income, proper adjustments must necessarily include adjustments to that type of income. Therefore, section 987 gain or loss must be characterized as foreign personal holding company income or other types of income described in section 952(a), in appropriate circumstances, to effectuate the intent of Congress reflected in the broader statutory scheme.

2. Election To Treat Certain Section 987 Gain or Loss as Foreign Currency Gain or Loss Attributable to Section 988 Transactions

In the case of section 987 gain or loss that would otherwise be characterized as passive foreign personal holding company income, the final regulations provide an election to treat the section 987 gain or loss as foreign currency gain or loss of the CFC-owner that is attributable to section 988 transactions not directly related to the business needs of the CFC (the “section 988 characterization election”).

See

§ 1.987-6(b)(2)(i)(C)(

1

). This election is intended to benefit taxpayers because it would generally allow section 987 gains and losses assigned to passive foreign personal holding company income groups, which would otherwise be treated as separate items (or as allocable to separate items) of passive foreign personal holding company income under the rules in § 1.954-1(c)(1)(iii)(B), to be treated as part of (or allocable to) a single item of income. This would generally facilitate some netting of the CFC-owner's section 987 gains and losses (because they would be assigned to the same item of income) and would also generally permit a CFC-owner to net its foreign currency gains and losses from section 988 transactions with the section 987 gain or loss from its QBUs (to the extent both comprise passive foreign personal holding company income). Similarly, the section 988 characterization election should, in many cases, reduce the number of recognition groupings under § 1.987-11(f), thereby simplifying the application of the loss-to-the-extent-of-gain rule and minimizing the tracking burden with respect to any suspended losses.

Section 987 gain or loss subject to the section 988 characterization election is not eligible for the business needs exception under § 1.954-2(g)(2) because this election applies only to section 987 gain or loss that would otherwise be characterized by reference to assets that give rise to passive foreign personal holding company income. The business needs exception is available only for foreign currency gain or loss arising from a transaction or property that does not give rise to subpart F income (which includes foreign personal holding company income).

See

§ 1.954-1(g)(2)(ii)(B)(

1

)(

ii

).

Similarly, section 987 gain or loss subject to the section 988 characterization election is not eligible for the election in § 1.954-2(g)(3) (election to characterize foreign currency gain or loss that arises from a specific category of subpart F income as gain or loss in that category). The § 1.954-2(g)(3) election applies only to gain or loss that is related to income categories described in the foreign base company income groups of § 1.954-1(c)(1)(iii)(A)(

1

) or (

2

) or the other subpart F income categories described in section 952(a); it does not apply to gain or loss related to passive foreign personal holding company income.

4

By contrast, the section 988 characterization election applies only to section 987 gain or loss that would otherwise be characterized by reference to assets that give rise to passive foreign personal holding company income. Thus, the two elections are mutually exclusive by their terms.

4

While § 1.954-1(c)(1)(iii)(A)(

1

) includes categories of foreign personal holding company income, it expressly excludes passive foreign personal holding company income, which is described in § 1.954-1(c)(1)(iii)(B). Therefore, the two elections apply to mutually exclusive income groups.

Finally, section 987 gain or loss subject to the section 988 characterization election is not eligible for the election in § 1.954-2(g)(4) (election to treat all foreign currency gains or losses as foreign personal holding company income). Extending the § 1.954-2(g)(4) election to section 987 gain or loss could permit inappropriate use of section 987 losses and would be inconsistent with the limited purpose of the section 988 characterization election. Therefore, if an election is in effect under § 1.954-2(g)(3) or (4), the foreign currency gain or loss to which the election applies is simply determined without regard to the section 987 gain or loss treated as foreign currency gain or loss attributable to a section 988 transaction by reason of the section 988 characterization election.

C. GILTI High-Tax Exclusion

Under the 2023 proposed regulations, for purposes of applying the high-tax exclusion in § 1.951A-2(c)(7) (the “GILTI HTE”), all section 987 gain and loss in a tentative tested income group that is recognized by a CFC in a taxable year is treated as a single tentative tested income item that is treated as recognized by a tested unit separate from the CFC's other tested units. Proposed § 1.987-6(b)(2)(iii). As a result, section 987 gain or loss is not taken into account in applying the GILTI HTE with respect to the CFC's other items of tentative tested income. Instead, the GILTI HTE is applied separately to section 987 gain and loss and, as a result, section 987 gain or loss generally will not be eligible for the GILTI HTE unless the CFC is subject to foreign tax on currency gain recognized with respect to its interest in the QBU under the applicable foreign tax rules.

See

proposed § 1.987-6(b)(3).

Some comments noted that these rules would preclude the application of the GILTI HTE with respect to section 987 gain of a CFC even if the CFC's section 987 QBUs are operating in jurisdictions subject to a high foreign tax rate. Another comment noted that the proposed rules would treat section 987 gain or loss differently from currency gain or loss recognized under section 988 (for example, section 988 gain or loss on a net investment hedge with respect to the section 987 QBU) and would make it difficult to project a

taxpayer's effective tax rate due to the unpredictability of exchange rate fluctuations. This comment recommended that proposed § 1.987-6(b)(2)(iii) be modified to provide that (i) section 987 gain and loss is taken into account in determining the effective tax rate under § 1.951A-2(c)(7)(vi) and (ii) section 987 gain or loss associated with highly taxed tested units is excluded from the computation of tested income.

The final regulations retain the rule that section 987 gain or loss is treated as a single tentative tested income item that is separate from the CFC's other tested units.

See

§ 1.987-6(b)(2)(iii). Although section 987 gain or loss is characterized by reference to the historical earnings of the section 987 QBU, which may correspond to one or more tested units, it is not equivalent to current year income or loss attributable to a tested unit. Section 987 gain or loss is not properly attributable to the tested unit that corresponds to the section 987 QBU or to the CFC tested unit, because in most cases neither the tested unit's country of residence nor the CFC's country of residence will take the section 987 gain or loss into account in determining foreign gross income. Therefore, attributing section 987 gain or loss to either tested unit would tend to be distortive and generally would not further the goals of the high-tax exclusion.

5

5

While the legislative history relating to the GILTI high-tax exclusion indicates that high-taxed income does not present base erosion concerns, the policy rationale underlying that view does not extend to excluding low-taxed income from GILTI merely because it may be earned by an entity that also earns high-taxed income.

See

S. Comm. on the Budget, Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Print. No. 115-20, at 371 (2017) (“The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI [regime], either because they should be exempt from U.S. tax—as they are generally not the type of income that is the source of the base erosion concerns—or are already taxed currently by the United States. Items of income excluded from GILTI because they are exempt from U.S. tax under the bill include foreign oil and gas extraction income (which is generally immobile) and income subject to high levels of foreign tax.”).

In addition, treating section 987 gain or loss as a single item of tentative tested income, as if it were attributable to a separate tested unit (distinct from the section 987 QBU), is consistent with the determination that a branch comprises a separate tested unit, even if it is not a tax resident of the foreign country in which it is located, if the income of the branch is subject to an exclusion, exemption, or other similar relief (such as a preferential rate) in the CFC's country of tax residence.

See

§ 1.951A-2(c)(7)(iv)(A)(

3

). Section 987 gain or loss is currency gain or loss of the owner of the QBU, and these gains and losses are generally not subjected to residency-based taxation in either the country of the QBU or the country in which the CFC is a resident. Therefore, the section 987 gains and losses of the CFC are functionally equivalent to gain or loss of a branch that is not a tax resident in any country and whose income is not subject to residency-based taxation in the CFC's country of tax residence.

Accordingly, it is appropriate to test the effective rate of foreign tax on section 987 gains and losses as a separate item of tentative tested income. The alternative approach recommended by a comment (which would incorporate section 987 gain or loss in the tested units that correspond to the section 987 QBU) would distort the effective tax rate computation with respect to a CFC's other income because section 987 gain or loss typically is not subject to foreign tax. These distortions could be favorable or unfavorable to taxpayers, depending on the circumstances. Moreover, the comment's recommended approach would complicate the ordering rules and mechanics needed to apply the loss-to-the-extent-of-gain rule of § 1.987-11(e) with respect to section 987 gain or loss assigned to a tested income group, which would increase the administrative and compliance burden of the section 987 regulations.

The approach set forth in the proposed regulations is also most consistent with the policy underlying the determination of an appropriate “item” of income for purposes of applying the high-tax exception under section 954(b)(4) as is reflected in the legislative history to that section, which directs the Treasury Department and the IRS to allow reasonable groupings of items of income that are substantially taxed at the same rate in a single country.

See

H.R. Rept. No. 99-426, at 400-01 (1985) (“Although this rule applies separately with respect to each `item of income' received by a [CFC], the committee expects that the Secretary will provide rules permitting reasonable groupings of items of income that bear substantially equal effective rates of tax in a given country. For example, all interest income received by a [CFC] from sources within its country of incorporation may reasonably be treated as a single item of income for purposes of this rule, if such interest is subject to uniform taxing rules in that country.”). The Treasury Department and the IRS have determined that section 987 gains and losses are likely to be taxed at a different rate of tax than other income generally subject to tax either in the country of the tested unit or in the country of residence of the CFC and therefore should reasonably be grouped and tested as a separate “item” of income for this purpose.

As noted in a comment, for purposes of the GILTI HTE, the final regulations treat section 987 gain or loss differently from section 988 gain or loss on a net investment hedge. However, the new hedging rule in § 1.987-14 will enable taxpayers to account for the hedge as an adjustment to unrecognized section 987 gain or loss, as described in part V.B of this Summary of Comments and Explanation of Revisions.

VIII. Comments and Changes to Proposed §§ 1.987-7A, 1.987-7B, and 1.987-7C—Partnerships

A. Partnership Rules Under the 2023 Proposed Regulations

The 2023 proposed regulations (and the 2016 final regulations) generally would apply aggregate theory to partnerships wholly owned by related persons (“section 987 aggregate partnerships”).

See

proposed § 1.987-7B. Under proposed § 1.987-1(b)(5)(ii), each partner in a section 987 aggregate partnership would be treated as an indirect owner of the partnership's eligible QBUs (and a section 987 aggregate partnership is not itself a QBU under section 989(a)). Thus, exchange gain or loss under section 987 would be measured from the perspective of the partners (rather than the partnership). The aggregate approach would serve to prevent a group of related parties from holding an eligible QBU through a partnership (rather than owning it directly) in order to change the section 987 treatment of the eligible QBU without meaningfully altering the group's economic position.

The 2023 proposed regulations would provide a different set of rules for partnerships that are not wholly owned by related partners.

See

proposed § 1.987-7A. For these partnerships, the 2023 proposed regulations would apply a hybrid approach to entity theory, under which unrecognized section 987 gain or loss of the partnership's eligible QBUs for a taxable year is determined at the partnership level and then allocated to the partners for purposes of computing the pool of net unrecognized section 987 gain or loss. Any section 987 gain or loss would be recognized and taken into account at the partner level.

The preamble to the 2023 proposed regulations notes that the Treasury Department and the IRS considered whether it would be appropriate to apply a hybrid approach to all

partnerships, regardless of whether the partners are related. 88 FR 78147 through 78148. The preamble explains that such an approach might reduce the complexity and compliance burden of the section 987 regulations, but that it could permit taxpayers to manipulate the application of section 987 by holding a section 987 QBU through a partnership rather than holding it directly.

Id.

at 78148.

The 2023 proposed regulations would not provide rules relating to a partner's application of section 987 with respect to a partnership that uses a different functional currency (which creates a separate layer of currency exposure). However, the preamble to the 2023 proposed regulations discusses alternative methodologies under which the partners could determine and recognize section 987 gain or loss with respect to their partnership interests. 88 FR 78148 through 78149.

B. Partnership Rules in the Final Regulations

1. In General

The Treasury Department and the IRS continue to study the appropriate treatment of partnerships for purposes of section 987 and, accordingly, the final regulations do not provide detailed rules concerning the determination of section 987 taxable income or loss and section 987 gain or loss in the case of a partnership. The final regulations also reserve on the treatment of a partnership as a QBU under section 989(a) and § 1.989(a)-1(b)(2)(i).

See

§ 1.989(a)-1(b)(2)(i)(C).

Only one comment regarding partnerships was received in response to the 2023 proposed regulations. The portions of the comment that relate to partnership rules that are not included in the final regulations have not been adopted because they are outside the scope of these regulations. The Treasury Department and the IRS expect to address these issues in future guidance.

Pending future guidance, taxpayers must apply sections 987 and 989(a) with respect to partnerships using a reasonable method consistent with the statute. For example, if a domestic corporation owns an interest in a foreign partnership (which would use the euro as its functional currency if it is treated as a QBU under section 989(a)), and the partnership owns an eligible QBU that uses the Swiss franc as its functional currency, the domestic corporation may apply section 987 to the eligible QBU under an aggregate approach. Alternatively, under an entity approach, the partnership could be treated as a section 987 QBU of the domestic corporation, and the eligible QBU could be treated as a section 987 QBU of the partnership. The domestic corporation could also apply a hybrid approach under the principles of the 2023 proposed regulations. However, taxpayers will not be considered to have applied a reasonable method unless they apply the same method consistently from year to year with respect to a particular partnership or eligible QBU. Members of a controlled group that are partners in the same partnership must apply the same method with respect to a particular partnership or eligible QBU, but unrelated partners are not subject to a consistency requirement.

See

§ 1.987-7(b).

2. Application of the Final Regulations to Partnerships

Although section 987 applies to partnerships, only certain parts of the final regulations apply to partnerships.

See

§ 1.987-7(b) and (c). In particular, the rules relating to suspended section 987 loss in §§ 1.987-11 and 1.987-13 apply to partnerships, and the deferral rules of § 1.987-12 continue to apply to partnerships, with certain modifications.

See

§ 1.987-7(c)(2)(i) and (d). These rules are needed to prevent the selective recognition of losses. In addition, the final regulations provide that an annual recognition election and a section 988 mark-to-market election can be made with respect to a partnership (whether an aggregate or entity approach is applied).

See

§ 1.987-7(c)(2)(ii) and (iii). These elections are expected to reduce the compliance burden of applying section 987 in the partnership context.

Similarly, the rules for determining the source and character of section 987 gain or loss under § 1.987-6 apply to partnerships, in order to facilitate application of the loss-to-the-extent-of-gain rule.

See

§ 1.987-7(c)(2)(i). A comment suggested that special rules should apply to determine the source and character of section 987 gain or loss recognized in connection with the sale or redemption of a partnership interest under the principles of § 1.864(c)(8)-1. The final regulations do not adopt this approach because it would be inconsistent with section 987(3)(B) (under which section 987 gain or loss is sourced by reference to historical earnings) and could allow taxpayers to manipulate the source and character of section 987 gain or loss.

Because the section 987 regulations generally do not apply to partnerships, the general rules of the section 987 regulations must be adapted as necessary to apply § 1.987-7 and the other applicable provisions to partnerships.

See

§ 1.987-7(c)(3). The rules must also be applied in this manner to an S corporation, which is treated the same way as a partnership for purposes of the section 987 regulations.

See

§ 1.987-7(f).

3. Loss Suspension Rule

Under the final regulations, the general loss suspension rule in § 1.987-11(c)(1) does not apply to partnerships.

See

§ 1.987-7(d)(1)(i). Instead, section 987 loss generally will be suspended in the taxable year in which it would otherwise be recognized under the method used by the taxpayer to apply section 987 with respect to the partnership.

See

§ 1.987-7(d)(1)(ii). The loss suspension rule of § 1.987-7(d)(1)(ii) applies to an eligible QBU that is directly owned by a partnership, regardless of whether an aggregate approach, an entity approach, or a hybrid approach is applied.

See

§ 1.987-7(d)(1)(ii)(A). However, if a partnership is itself treated as a section 987 QBU of its partners under an entity approach, the loss suspension rule applies only if at least 95% of the capital and profits interests in the partnership are owned by related persons.

See

§ 1.987-7(d)(1)(ii)(B). This limitation is intended to reduce the complexity and compliance burden of the section 987 regulations for partnerships owned by unrelated persons.

The final regulations provide several other exceptions to the loss suspension rule of § 1.987-7(d)(1)(ii). First, section 987 loss with respect to an eligible QBU owned by a partnership is not suspended if section 987 is consistently applied using a method under which section 987 gain or loss does not arise with respect to historic items (for example, a method that follows the principles of §§ 1.987-3 through 1.987-5, under which historic items are assigned a historic rate, such that their balance sheet value does not change in response to changes in the value of the section 987 QBU's functional currency).

See

§ 1.987-7(d)(2)(i). Second, section 987 loss is not suspended if an annual recognition election is in effect.

See

§ 1.987-7(d)(2)(ii). Finally, section 987 loss is not suspended if the de minimis rule in § 1.987-11(c)(2) applies (that is, if the amount of section 987 loss subject to suspension does not exceed the lesser of $3 million or two percent of gross income, as described in part X.A.1 of this Summary of Comments and Explanation of Revisions).

See

§ 1.987-7(d)(2)(iii). These rules generally align with the scope of the loss suspension rule in § 1.987-11(c)(1).

4. Adjustments to the Basis of a Partner's Interest in the Partnership

The proposed regulations would provide that a partner's basis in a partnership is adjusted when the partner recognizes section 987 gain or loss, defers section 987 gain or loss, or suspends section 987 loss attributable to the partnership. Proposed § 1.987-7A(e). This rule is intended to avoid duplication of section 987 gain or loss (for example, when the partnership interest is sold). The final regulations retain this rule for taxpayers that apply section 987 using a method that results in recognition, deferral, or suspension of section 987 gain or loss at the partner level. Under § 1.987-7(e), the partner's basis in its partnership interest is adjusted under the principles of section 705 as though the section 987 gain or loss was part of the partner's distributive share of partnership items.

See

§ 1.987-7(e).

A commenter requested clarification concerning the interaction of this basis adjustment rule with section 704(d). Section 704(d)(1) provides that a partner's distributive share of partnership loss (including capital loss) shall be allowed only to the extent of the basis of that partner's interest in the partnership at the end of the partnership year in which such loss occurred. Section 704(d)(2) provides for the carryover of the excess of any loss over such basis to the next taxable year. To the extent that basis is available in the next taxable year, the partner is able to take the loss into account. Relatedly, the partner will decrease the adjusted basis in its partnership interest to the extent that any loss carryover is taken into account within the taxable year.

See

section 705(a)(2).

The final regulations clarify that the principles of section 704(d) are applied as though items of section 987 loss, deferred section 987 loss, or suspended section 987 loss were part of the partner's distributive share of partnership items.

See

§ 1.987-7(e). The basis adjustment rule in § 1.987-7(e) is intended to replicate the basis adjustments that would occur if the relevant section 987 gain or loss was taken into account as part of the partner's distributive share of partnership income or loss (including the effects of section 704(d)).

5. Other Special Rules for Partnerships

The final regulations contain several other rules that facilitate the application of section 987 to partnerships. If a partner in a partnership is treated as the owner of a section 987 QBU directly owned by the partnership (for example, under an aggregate approach), § 1.987-7(c)(3)(ii) provides a special rule that is used to determine the members of the owner's controlled group for purposes of §§ 1.987-12 and 1.987-13. Under this rule, any member of the partnership's controlled group is treated as a member of the partner's controlled group so long as the partner continues to be a partner in the partnership. Thus, for example, if the partnership contributes the section 987 QBU's assets to a wholly owned subsidiary of the partnership, the subsidiary will be treated as a member of the partner's controlled group and the contribution may be treated as a deferral event for purposes of § 1.987-12.

When a partnership is itself treated as a QBU of a partner that is subject to section 987, and the partnership is not engaged in any trade or business (for example, a partnership that functions as a holding company), the rules of § 1.987-13(b) through (d) do not apply. Those rules are designed to attribute suspended section 987 loss to a successor suspended loss QBU if the assets of a section 987 QBU continue to be used in the same trade or business by a member of the controlled group, and they trigger the recognition of suspended section 987 loss if the section 987 QBU terminates without a successor. However, when a QBU that has suspended section 987 loss is not engaged in any trade or business, the rules of § 1.987-13(b) through (d) would not result in the appropriate recognition of suspended section 987 loss and could be prone to manipulation. Accordingly, the suspended section 987 loss can be recognized only under the loss-to-the-extent-of-gain rule of § 1.987-11(e).

The transition rules in § 1.987-10 do not apply to partnerships. Instead, the applicable rules of the section 987 regulations take effect on the transition date with respect to section 987 gain or loss determined and recognized under the taxpayer's existing method. In addition, taxpayers may not apply the fresh start transition method with respect to a partnership. As explained in the preamble to the 2023 proposed regulations, the fresh start transition method is no longer available because that method results in the elimination of pretransition gain or loss, and (if it were available) it could be opportunistically used by taxpayers to eliminate their pretransition gain. 88 FR 78150 and 78156.

The final regulations also clarify that the rule in § 1.988-1(a)(10)(i), which provides that transactions between a taxpayer and its QBU generally are not section 988 transactions, applies only to disregarded transactions. Thus, a nonfunctional currency transaction between a partner and a partnership could be treated as a section 988 transaction even though the partnership is treated as a QBU subject to section 987.

IX. Comments and Changes to Proposed § 1.987-10: Transition Rules

Proposed § 1.987-10 would provide transition rules for the first year in which the section 987 regulations are applicable. In particular, proposed § 1.987-10(e) would provide rules for determining and recognizing pretransition gain or loss with respect to each of a taxpayer's QBUs.

A. Computation of Pretransition Gain or Loss

1. Taxpayers That Applied Section 987 Using an Eligible Pretransition Method

Under the 2023 proposed regulations, the computation of pretransition gain or loss would differ depending on how the taxpayer applied section 987 before the transition date. If the taxpayer applied section 987 to a section 987 QBU using an eligible pretransition method (as described in part IX.B of this Summary of Comments and Explanation of Revisions), the owner would use that method to compute pretransition gain or loss. Proposed § 1.987-10(e)(2). The owner's pretransition gain or loss would be equal to the amount of section 987 gain or loss that it would have recognized under the eligible pretransition method if the QBU terminated on the day before the transition date, with certain adjustments. Proposed § 1.987-10(e)(2)(i)(A).

Under proposed § 1.987-10(e)(2)(i)(B), the amount of pretransition gain or loss would be increased or reduced by the owner functional currency net value adjustment (“OFCNV adjustment”), which reflects any change to the basis of the section 987 QBU's assets (net of liabilities) that occurs as a result of the transition. For example, if a taxpayer applied an earnings only method under which currency gain or loss on the QBU's capital was not recognized at the time of a remittance but was separately tracked and accounted for in determining the basis of distributed assets, the currency gain or loss on capital would be accounted for as part of the OFCNV adjustment.

Two comments were received relating to the OFCNV adjustment. One comment requested that taxpayers be permitted to use the CTA prepared for financial accounting purposes rather than making the OFCNV adjustment. The comment asserted that taxpayers applying an earnings only method might

not have the information necessary to compute the OFCNV adjustment.

The final regulations do not permit taxpayers to use the CTA in lieu of making the OFCNV adjustment. As explained in part V.A.2 of this Summary of Comments and Explanation of Revisions, the CTA amount may be substantially different from the amount of section 987 gain or loss that is properly taken into account for tax purposes. Moreover, it should not be unduly burdensome for a taxpayer to compute the OFCNV adjustment because the relevant information is already needed to apply the taxpayer's existing pretransition method.

Another comment recommended that, in the case of taxpayers applying an earnings only method, currency gain or loss with respect to the QBU's capital should not be taken into account in determining pretransition gain or loss (which is ultimately recognized as section 987 gain or loss after the transition date). The comment noted that taxpayers may have adopted the earnings only method to reduce the size of their section 987 gain or loss pools and that the earnings only method serves to mitigate the potential for selective recognition of large section 987 losses. Therefore, the comment requested that the OFCNV adjustment instead be taken into account as an adjustment to asset basis.

The Treasury Department and the IRS agree that, for taxpayers applying an earnings only method, accounting for the OFCNV adjustment in determining the basis of a section 987 QBU's assets would produce a reasonable result that is consistent with these taxpayers' pretransition method. Accordingly, under the final regulations, if a taxpayer applied an earnings only method before the transition date and does not make a current rate election for the taxable year beginning on the transition date, the historic rate assigned to the section 987 QBU's historic assets (other than inventory) is equal to the exchange rate that would have been used to translate those assets if they had been distributed to the owner on the day before the transition date (the “pretransition translation rate”).

See

§ 1.987-10(d)(3)(ii). As a result, no OFCNV adjustment is made with respect to those assets, but currency gain or loss related to those assets will be accounted for as the assets are sold or depreciated under § 1.987-3. For taxpayers that make a current rate election (and thus will not take historic rates into account under § 1.987-3), currency gain or loss on the QBU's capital must be accounted for in determining pretransition gain or loss.

See

§ 1.987-10(d)(3)(i) and (e)(2)(i)(B).

A comment raised a question as to whether the delegation of regulatory authority under section 987(3) is self-executing. The comment suggested that, if section 987(3) is not self-executing, then it might not be appropriate to attribute pretransition gain or loss to taxpayers that have not accounted for section 987 gain or loss before the transition date. The Treasury Department and the IRS have concluded that section 987(3) is self-executing because it provides a mandatory delegation under which the Secretary is directed to determine how (rather than whether) the owner of a section 987 QBU should make proper adjustments in computing its taxable income.

See, e.g.,

15 W 17th St. LLC

v.

Commissioner,

147 T.C. 557 (2016) (articulating standard for determining whether a statute is self-executing in the absence of regulations);

Est. of Neumann

v.

Commissioner,

106 T.C. 216 (1996) (holding delegation was self-executing because it related to how, rather than whether, the statute applied). Therefore, taxpayers currently are obligated to determine section 987 gain or loss in a reasonable manner and must account for pretransition gain or loss once the regulations become applicable.

2. Taxpayers That Did Not Apply Section 987 Using an Eligible Pretransition Method

Under proposed § 1.987-10(e)(3), taxpayers that did not apply an eligible pretransition method would be required to determine pretransition gain or loss by applying a simplified version of the computation described in § 1.987-4(d) to determine unrecognized section 987 gain or loss (“annual unrecognized section 987 gain or loss”) for each taxable year since the section 987 QBU's inception. Proposed § 1.987-10(e)(3)(iii). Pretransition gain or loss would be reduced by any section 987 gain or loss recognized before the transition date. Proposed § 1.987-10(e)(3)(ii)(B).

Comments asserted that the method provided in proposed § 1.987-10(e)(3) could be burdensome to apply and difficult to administer. Some comments recommended that taxpayers should not be required to compute annual unrecognized section 987 gain or loss for each taxable year since the QBU's inception. Instead, the comments suggested that the final regulations provide a reasonable cutoff date before which pretransition gain or loss would not be computed. Another comment requested that taxpayers be permitted to determine pretransition gain or loss using the earnings and capital method described in the 1991 proposed regulations, as this would avoid the need to prepare tax basis balance sheets. A further comment recommended adoption of a de minimis rule for taxpayers with minimal pretransition gain or loss.

The Treasury Department and the IRS agree that, when a QBU has been operating for a long period, computing annual unrecognized section 987 gain or loss for all taxable years since the QBU's inception could be burdensome. Accordingly, the final regulations provide a cutoff date of September 7, 2006, which is the date on which proposed section 987 regulations were published in the

Federal Register

(71 FR 52876) (the “2006 proposed regulations”). Under the final regulations, taxpayers that did not apply an eligible pretransition method must compute pretransition gain or loss only for taxable years beginning on or after September 7, 2006. The publication date of the 2006 proposed regulations is an appropriate cutoff date for this purpose because the 2006 proposed regulations contained transition rules that were conditioned on the application of section 987 using a reasonable method.

See

§ 1.987-10(a)(2) of the 2006 proposed regulations.

The final regulations also provide a de minimis rule to reduce the compliance burden on small businesses that own section 987 QBUs.

6

Under the de minimis rule, a qualifying taxpayer may elect to treat all QBUs that fall below the de minimis threshold as having no pretransition gain or loss. To qualify for the de minimis rule, the owner of a section 987 QBU must have gross receipts that fall below the threshold for the small business exception in section 163(j)(3) (that is, the owner must have gross receipts of $25 million or less, indexed to inflation and averaged over the prior 3-year period). If this test is met, the de minimis rule applies to any section 987 QBU with gross assets of less than $10 million (averaged over the same 3-year period and taking into account the assets of all section 987 QBUs in the same country that are owned by the same owner or a member of its controlled group).

6

Although taxpayers that own section 987 QBUs generally are not small businesses, this rule is intended to limit the compliance burden for small businesses that may be affected.

The final regulations do not permit taxpayers to apply an earnings and capital method in lieu of computing annual unrecognized section 987 gain or loss under § 1.987-10(e)(3). However, as explained in part V.A.1 of this Summary

of Comments and Explanation of Revisions, the rules for computing unrecognized section 987 gain or loss for a taxable year under § 1.987-4(d) have been modified so that they can be applied without the need for tax basis balance sheets. As a result, the method provided in § 1.987-10(e)(3) can similarly be applied without tax basis balance sheets (that is, by computing QBU net value using the formula provided in § 1.987-4(e)(2)(iii)).

B. Definition of an Eligible Pretransition Method

Under the 2023 proposed regulations, an eligible pretransition method would be defined to include a reasonable application of the earnings and capital method described in the 1991 proposed regulations, any other reasonable method that produces the same total amount of income as the earnings and capital method over the life of the owner, or an earnings only method that does not produce the same total amount of lifetime income as an earnings and capital method (subject to certain restrictions, including a consistency requirement). Proposed § 1.987-10(e)(4)(i) through (iii). The owner must have applied the eligible pretransition method with respect to each taxable year beginning before the transition date in which it was the owner of the section 987 QBU. Proposed § 1.987-10(e)(4). For this purpose, a method under which the owner of a section 987 QBU defers the recognition of section 987 gain or loss until the section 987 QBU is terminated, sold, or liquidated is not a reasonable method. Proposed § 1.987-10(e)(4)(iv).

Comments requested clarification concerning the definition of an eligible pretransition method. The comments noted that some taxpayers have applied the 1991 proposed regulations with modifications; for example, some taxpayers apply an annual netting convention to determine the amount of a remittance or treat a group of QBUs with the same functional currency as a single QBU. Other comments indicated that taxpayers may not account for frequently recurring intercompany transactions in computing their section 987 gain or loss.

One comment suggested that taxpayers should be treated as having applied an eligible pretransition method so long as they made a good faith effort to apply section 987 using a reasonable method. Another comment recommended that taxpayers that have consistently relied on their CTA account as an estimate of unrealized section 987 gain or loss should be considered to have applied an eligible pretransition method (and thus should be permitted to use their CTA account to determine the amount of pretransition gain or loss).

Another comment suggested that a CFC that has consistently applied a reasonable method since the enactment of the Tax Cuts and Jobs Act (“TCJA”), Public Law 115-97, 131 Stat. 2054 (2017), should be treated as having applied an eligible pretransition method, even if the method was not applied in previous taxable years. In particular, the comment recommended that an owner that began applying an earnings only method described in proposed § 1.987-10(e)(4)(iii) after the TCJA was enacted should be deemed to meet the consistency requirement of proposed § 1.987-10(e)(4)(iii)(B).

In response to these comments, the final regulations clarify and expand the definition of an eligible pretransition method under § 1.987-10(e)(4). The definition is intended broadly to include any method that complies with the statutory requirements of section 987 in a reasonable manner.

7

7

In certain instances, a method that does not constitute a reasonable application of section 987 is treated as an eligible pretransition method in order to reduce the compliance burden of transitioning onto the section 987 regulations.

1. Errors Made in Applying a Pretransition Method and Certain Consistent Practices That Are Not Treated as Errors

The final regulations provide that a taxpayer is treated as applying an eligible pretransition method even if the taxpayer made an error in the application of its method or did not apply the method in all taxable years in which it was the owner of the section 987 QBU. § 1.987-10(e)(4)(iv). However, taxpayers are required to compute pretransition gain or loss under § 1.987-10(e)(2) as though the eligible pretransition method had been applied without error for all prior taxable years. Thus, for example, if a taxpayer made an error in applying its method for a prior year, the deemed termination amount under § 1.987-10(e)(2)(i)(A) is equal to the amount of section 987 gain or loss the taxpayer would have recognized on termination if it had not made the error and its section 987 QBU terminated on the day before the transition date.

If a taxpayer consistently used a reasonable convention to apply section 987 before the transition date, the taxpayer must use the same convention in determining pretransition gain or loss under § 1.987-10(e)(2).

See

§ 1.987-10(e)(4)(v)(B)(

1

). Thus, unlike a taxpayer that made an error in applying its pretransition method, a taxpayer that used a reasonable convention would not be required to recompute pretransition gain or loss without regard to the convention. Similarly, if a taxpayer had a consistent practice under which it did not account for frequently recurring disregarded transactions in determining the amount of section 987 gain or loss recognized upon a remittance, this practice is not treated as an error.

See

§ 1.987-10(e)(4)(v)(B)(

2

). However, this rule does not apply unless the taxpayer reasonably accounted for the disregarded transactions in determining the amount of unrecognized section 987 gain or loss with respect to the section 987 QBU (for example, in the case of a taxpayer applying the 1991 proposed regulations, by adjusting the equity and basis pools to reflect the amount of each transfer).

2. Timing for Application of an Eligible Pretransition Method

The final regulations provide that a method of applying section 987 is not an eligible pretransition method unless it was applied on at least one tax return filed before November 9, 2023 (when the 2023 proposed regulations were filed with the

Federal Register

).

See

§ 1.987-10(e)(4). Thus, a taxpayer that first adopted a reasonable method in the first taxable year after the TCJA was enacted would be treated as applying an eligible pretransition method, but a method adopted after November 9, 2023, would not qualify. Similarly, the final regulations modify the consistency requirement for the earnings only method under § 1.987-10(e)(4)(iii)(B) to require consistent application for all taxable years since the first taxable year in which the owner applied an eligible pretransition method. As a result, an owner that began applying the earnings only method after the TCJA was enacted (and did not previously apply a different eligible pretransition method) would meet this requirement.

3. Reliance on the CTA

Under the final regulations, a method that relies on the CTA determined for financial accounting purposes would not qualify as an eligible pretransition method; thus, taxpayers relying on CTA computations must determine pretransition gain or loss using the method provided in § 1.987-10(e)(3). As discussed in part V.A.2 of this Summary of Comments and Explanation of Revisions, because the amount of the CTA can be substantially different from the amount of section 987 gain or loss properly computed for tax purposes, reliance on the CTA could result in the recognition of significant amounts of artificial pretransition gain or loss.

C. Recognition of Pretransition Gain or Loss

In general, under the proposed regulations, pretransition gain is treated as net unrecognized section 987 gain, while pretransition loss is treated as suspended section 987 loss. Proposed § 1.987-10(e)(5)(i)(A) and (B). This rule is intended to prevent taxpayers from selectively recognizing pretransition loss while deferring pretransition gain until the year of a remittance. Alternatively, taxpayers could elect to amortize pretransition gain or loss over a period of ten years beginning on the transition date. Proposed § 1.987-10(e)(5)(ii).

A comment recommended that pretransition loss should not be treated as suspended section 987 loss in the first taxable year in which the section 987 regulations apply. Instead, the comment recommended that pretransition loss should be treated as net unrecognized section 987 loss upon transition, which would later become suspended in the year of a remittance. The comment noted that this would create parity between pretransition loss and pretransition gain, which is treated as net unrecognized section 987 gain in the first taxable year in which the regulations apply.

Another comment recommended that, instead of determining pretransition gain or loss separately with respect to each QBU, the total amount of pretransition gain or loss in each category should be aggregated and netted among all QBUs of the same owner, with the net amounts reallocated to each QBU on a pro rata basis. In the case of a consolidated group or a group of related CFCs, the comment suggested further netting between all members of the consolidated group or group of related CFCs, respectively.

With respect to the amortization election under proposed § 1.987-10(e)(5)(ii), a comment suggested that taxpayers should be allowed to elect a shorter amortization period in which to recognize pretransition gain or loss (either four or five years), which would better align with certain taxpayers' internal forecasting and planning windows. A comment also requested clarification as to how the amortization election applies with respect to a terminating QBU (that is, a section 987 QBU that terminated after November 9, 2023, and before the taxable year in which the section 987 regulations are generally applicable).

The final regulations provide that, if a current rate election is in effect in the taxable year beginning on the transition date (and an annual recognition election is not in effect), pretransition gain or loss is treated as net unrecognized section 987 gain or loss. Thus, pretransition losses are treated the same way as pretransition gains. However, if a current rate election is not in effect (or an annual recognition election is in effect) in the taxable year beginning on the transition date, pretransition loss is treated as suspended section 987 loss upon transition. This rule is necessary to prevent pretransition loss from being recognized without limitation.

The final regulations do not permit aggregation and netting of pretransition gain or loss within the same category. Absent an amortization election, the source and character of pretransition gains and losses generally will not be assigned in the taxable year beginning on the transition date, so it would not be possible to net gains and losses separately within each recognition grouping. In addition, aggregation and netting would make the transition rules more complicated and would increase the burden of administering these rules. Finally, taxpayers that make the amortization election can, as a practical matter, achieve the effect of netting pretransition gains and losses, because those gains and losses will be recognized over the same ten-year period.

The final regulations retain the ten-year amortization period under § 1.987-10(e)(5)(ii) and do not permit taxpayers to elect a shorter amortization period. The Treasury Department and the IRS have determined that a uniform amortization period should apply to all electing taxpayers to prevent the potential for whipsaw that could result from taxpayers with losses electing shorter amortization periods than taxpayers with gains. In addition, a ten-year period is appropriate given the expected magnitude of the pretransition gains and losses that are subject to amortization. However, taxpayers that do not make the amortization election will retain some control over when gains and losses are recognized (by choosing whether or not to make remittances). The final regulations also expand the acceleration rule of § 1.987-10(e)(5)(ii)(B) to cover transactions entered into with a principal purpose of avoiding the recognition of pretransition gain that is subject to the amortization election.

See

§ 1.987-10(e)(5)(ii)(B)(

1

).

In addition, the final regulations clarify the application of the amortization election in the case of a terminating QBU. Under § 1.987-10(e)(5)(ii)(C), any deferred section 987 gain or suspended section 987 loss with respect to a terminating QBU that has not been recognized before the first taxable year in which the section 987 regulations are generally applicable is subject to amortization beginning in that year. However, the final regulations do not modify the treatment of section 987 gain or loss that has already been recognized before the transition date; thus, such section 987 gain or loss is not subject to amortization.

X. Comments and Changes to Proposed § 1.987-11: Suspended Section 987 Loss Relating to Certain Elections; Loss-to-the-Extent-of-Gain Rule

Proposed § 1.987-11 provides rules that suspend the recognition of section 987 loss in connection with certain elections and rules under which suspended section 987 loss is recognized to the extent of recognized section 987 gain (the “loss-to-the-extent-of-gain rule”).

A. Loss Suspension Rule

1. In General

Under proposed § 1.987-11(c), in a taxable year in which a current rate election is in effect (and an annual recognition election is not in effect), any section 987 loss that would otherwise be recognized as a result of a remittance or termination would be treated as suspended section 987 loss.

A comment requested that the loss suspension rule of § 1.987-11(c) be eliminated because it prevents taxpayers from recognizing section 987 losses in connection with legitimate commercial transactions. The comment noted that the recognition of section 987 loss often is not the primary factor in determining whether a taxpayer causes its branch to make a remittance.

The final regulations retain the loss suspension rule in § 1.987-11(c). Congress specifically authorized loss limitation rules to address the potential for selective recognition of losses.

See

section 989(c)(2). These rules are integral to the current rate election; without a loss limitation the current rate election would create opportunities for abuse. Although remittances are often made for non-tax reasons, taxpayers can cause section 987 QBUs to make otherwise disregarded transfers for the purpose of recognizing large section 987 losses, and taxpayers have the ability to structure transactions in ways that defer the recognition of section 987 gain.

However, the final regulations limit the scope of the loss suspension rule to cover transactions that would otherwise result in the recognition of substantial section 987 losses. Under § 1.987-11(c)(2), if a current rate election is in effect, section 987 loss is not suspended unless the amount of section 987 loss

subject to suspension in the taxable year exceeds the lesser of $3 million or two percent of the controlled group's gross income. This threshold is applied collectively to the section 987 loss of the owner and all members of the owner's controlled group. This rule is expected to reduce the compliance burden of tracking suspended section 987 losses, particularly for taxpayers with small section 987 QBUs.

2. Exception for QBUs With De Minimis Historic Assets

Comments requested an exception from the loss suspension rule for section 987 QBUs with minimal historic assets (such as financial institutions and insurance companies). Alternatively, a comment recommended that the loss suspension rule should apply solely to section 987 loss associated with historic items.

The final regulations do not provide an exception to the loss suspension rule for taxpayers with a de minimis amount of historic assets. Such an exception would be difficult to administer because it would require long-term tracking to ensure that the de minimis threshold was met in all prior taxable years over which the pool of net unrecognized section 987 gain or loss accrued. Further, for taxpayers with minimal historic assets, the compliance burden of applying the default rules of the final regulations (that is, the rules that apply in the absence of a current rate election) is expected to be more limited. A taxpayer that does not make a current rate election generally would not be subject to the loss suspension rule.

Similarly, under the final regulations, the loss suspension rule of § 1.987-11(c) is not limited to section 987 loss associated with historic items. Under § 1.987-4, the pool of net unrecognized section 987 gain or loss is determined with respect to a section 987 QBU as a whole. Separate computations of unrecognized section 987 loss associated with marked and historic items, respectively, would add significant complexity. Moreover, concerns related to selective recognition of section 987 loss can arise with respect to both marked and historic items.

B. Loss-to-the-Extent-of-Gain Rule

Under proposed § 1.987-11(e), an owner of a section 987 QBU recognizes suspended section 987 loss to the extent that it recognizes section 987 gain in the same recognition grouping (that is, section 987 gain that has the same source and character as the suspended section 987 loss) in the same taxable year. As explained in the preamble to the 2023 proposed regulations, this rule is intended to prevent taxpayers from selectively recognizing section 987 losses when a current rate election is in effect. 88 FR 78139.

1. Lookback Rule

The 2023 proposed regulations do not include a lookback rule under which suspended section 987 loss can be recognized to the extent of section 987 gain recognized in previous taxable years. The preamble to the 2023 proposed regulations expressed concern that taxpayers might exploit a lookback rule by selectively triggering the recognition of section 987 gain in a taxable year in which the gain could be offset by losses or in which a taxpayer had excess foreign tax credits. 88 FR 78139.

Several comments recommended adoption of a lookback rule. Alternatively, a comment recommended modifying proposed § 1.987-11(e) to permit taxpayers to carry back section 987 losses to earlier years. Comments posited that, even if section 987 gain recognized in a previous year is offset by a loss carryforward or other tax attribute, the section 987 gain would still have a net impact on U.S. tax because the attribute would no longer be available to be utilized in subsequent years. However, the same comment expressed a minority view that a lookback rule would afford some potential for abuse, and suggested consideration of an anti-abuse rule targeting remittances that do not have economic effect. One comment recommended that the lookback period for section 987 gains should include years ending before the transition date, while another comment suggested that the lookback period should include only post-transition years.

The Treasury Department and the IRS agree that a lookback rule would allow for more evenhanded treatment of section 987 gains and losses when section 987 gain is recognized in an earlier taxable year and that a lookback rule could be tailored to prevent abuse. Accordingly, the final regulations provide that suspended section 987 loss is recognized to the extent of net section 987 gain recognized in the current year and the three preceding taxable years.

See

§ 1.987-11(e)(3). Taxable years beginning before the transition date are not included in the lookback period, given the substantial flexibility taxpayers have had in determining the timing, amount, and character of section 987 gain or loss recognized before the applicability date of the final regulations.

Under an anti-abuse rule, section 987 gain is disregarded for purposes of the loss-to-the-extent-of-gain rule if it is recognized with a principal purpose of reducing U.S. Federal income tax liability, including over multiple taxable years.

See

§ 1.987-11(e)(3)(v). For example, this rule would apply if an owner recognizes section 987 gain in a taxable year (“year 1”) in which the section 987 gain is offset by a tax attribute that would not otherwise be used, the section 987 gain is recognized with a principal purpose of releasing suspended section 987 loss in a subsequent taxable year (“year 2”), and the net effect of recognizing both the section 987 gain and the suspended section 987 loss would reduce the combined U.S. Federal income tax liability for years 1 and 2. In determining whether such a principal purpose exists, one relevant factor is the extent to which a remittance does not result in a sustained economic contraction of the section 987 QBU (over a period of at least 12 months). Thus, for example, if a section 987 QBU makes a remittance giving rise to the recognition of section 987 gain, and the owner makes an offsetting contribution to the section 987 QBU within 12 months of the remittance, the section 987 gain may be disregarded for purposes of the loss-to-the-extent-of-gain rule.

The lookback period generally is limited to three years, because a longer lookback period would require additional tracking of section 987 gains recognized in prior taxable years and would increase the compliance and administrative burden of the section 987 regulations. In addition, this rule is consistent with other Code provisions that limit loss carryforward or carryback periods to a fixed number of years.

See, e.g.,

section 1212(a)(1) (generally permitting capital losses to be carried forward for five years and carried back for three years). Moreover, it may be difficult to enforce the anti-abuse rule in § 1.987-11(e)(3)(v) with respect to transactions occurring more than three years before the taxable year in which suspended section 987 loss is recognized.

The final regulations provide a different lookback period for taxpayers that make both an annual recognition election and a current rate election. For these taxpayers, the lookback period includes all taxable years in which both elections are continuously in effect.

See

§ 1.987-11(e)(3)(iv)(B). As a result, for purposes of applying the loss-to-the-extent-of-gain rule, the total amount of section 987 gain recognized under the annual recognition election for all

taxable years in which both elections are continuously in effect is offset by the total amount of section 987 loss recognized under the annual recognition election for all taxable years in which both elections are continuously in effect. As explained in the preamble to the proposed regulations, the Treasury Department and the IRS are concerned that, in the absence of such a rule, taxpayers would be able to recognize net losses on a cumulative basis for the taxable years to which the annual recognition election applies. 88 FR 78140. In addition, the tracking burden in this context should be more limited because losses generally are not suspended in taxable years in which an annual recognition election is in effect.

In general, following a transaction described in section 381(a), section 987 gain recognized by the transferor corporation in the three years preceding the transaction is taken into account for purposes of the lookback rule.

See

§ 1.987-11(e)(5)(i). However, this rule does not apply in the case of an inbound reorganization or liquidation.

See

§ 1.987-11(e)(5)(ii). Thus, section 987 gain recognized by the foreign transferor corporation (which may have been subject to a lower effective tax rate) cannot be used to release suspended section 987 loss of the domestic acquiring corporation.

2. Application of the Loss-to-the-Extent-of-Gain Rule at the Owner Level

Under proposed § 1.987-11(e), the loss-to-extent-of-gain rule is applied separately to each owner with respect to all of its section 987 QBUs. Comments asserted that the loss-to-the-extent-of-gain rule could produce harsh results when one CFC recognizes section 987 gain and a related CFC has suspended section 987 loss. One comment noted that concerns about selective recognition of section 987 loss should be mitigated to the extent that a different CFC in the same group recognizes section 987 gain.

Another comment recommended that, with respect to section 987 gain or loss that is characterized as tested income, the loss-to-the-extent-of-gain rule should be applied at the level of the U.S. shareholder with respect to all section 987 QBUs of CFCs owned by the U.S. shareholder, consistent with the general framework of section 951A. Under this approach, the excess of the U.S. shareholder's pro rata share of section 987 losses of any CFC attributable to a tested income group over its pro rata share of section 987 gains attributable to the same tested income group would be suspended (and available for recognition to the extent of the U.S. shareholder's pro rata share of section 987 gains recognized in future years). Another comment recommended that the loss-to-the-extent of gain rule should be applied to a group of related CFCs by treating the group as a single owner. Under this approach, one CFC could recognize suspended section 987 loss to the extent that another CFC recognized section 987 gain.

The final regulations generally apply the loss-to-the-extent of gain rule separately to each owner, taking into account section 987 gain or loss with respect to all of the owner's section 987 QBUs. The final regulations do not apply the loss-to-the-extent of gain rule at the level of the U.S. shareholder. Because section 987 gain or loss is a CFC-level income item that is taken into account in computing each CFC's taxable income and earnings and profits, a U.S. shareholder level loss limitation rule could reach inappropriate results for minority shareholders and would be difficult to administer. For example, if a CFC is owned by multiple U.S. shareholders, application of the loss-to-the-extent-of-gain rule at the U.S. shareholder level would require multiple separate computations to determine the suspended section 987 loss recognized by a single CFC.

Similarly, the final regulations do not treat a group of related CFCs as a single owner for purposes of the loss-to-the-extent-of-gain rule. A CFC grouping rule would make the loss-to-the-extent-of-gain-rule more complex and more difficult to administer. Moreover, under a CFC grouping rule, a CFC could recognize suspended section 987 loss as a result of a different CFC's recognition of section 987 gain in the same recognition grouping in a taxable year in which the loss cannot be utilized.

3. Expansion of the Loss-to-the-Extent-of-Gain Rule

A comment recommended expansion of the loss-to-the-extent-of-gain rule so that suspended section 987 loss could be recognized to the extent of any income recognized by the owner (including but not limited to section 987 gain) that has the same source and character as the suspended section 987 loss. Another comment recommended that suspended section 987 loss should be recognized to the extent of any section 987 gain recognized by the owner, even if the section 987 gain is in a different recognition grouping. The comment suggested that the requirement for section 987 gain to be in the same recognition grouping as suspended section 987 loss does not serve the policy goals of section 987, and that concerns relating to mismatches between the source and character of section 987 gains and losses are adequately policed by other provisions of the Code.

The final regulations do not expand the scope of the loss-to-the-extent of gain rule to cover taxable income other than section 987 gain. Taxable income other than section 987 gain does not release suspended section 987 loss under the loss-to-the-extent-of-gain rule because this rule is intended to target selective recognition of section 987 loss and deferral of section 987 gain.

In addition, the final regulations retain the rule that section 987 gain can only release suspended section 987 loss in the same recognition grouping. This rule ensures that the loss-to-the-extent-of-gain rule effectively limits selective recognition of losses pursuant to the authority provided in section 989(c)(2). In particular, it prevents taxpayers from avoiding the loss limitation by recognizing gains that are subject to a low rate of tax (or are not subject to U.S. tax).

As explained in part VII.B of this Summary of Comments and Explanation of Revisions, the final regulations allow section 987 gain or loss to be assigned to multiple subpart F income groups. Therefore, each separate subpart F income group (as defined in § 1.960-1(d)(2)(ii)(B)) constitutes a separate recognition grouping.

See

§ 1.987-11(f)(2)(ii). However, as explained in part VII.B.2 of this Summary of Comments and Explanation of Revisions, taxpayers can reduce the number of subpart F recognition groupings by making the section 988 characterization election provided in § 1.987-6(b)(2)(i)(C).

4. Application to Terminating QBUs

A comment requested clarification concerning the application of the loss-to-the-extent-of-gain rule in the case of a terminating QBU. The final regulations clarify that, when a terminating QBU has suspended section 987 loss in a taxable year before the final regulations are generally applicable, section 987 gain with respect to a taxpayer's other section 987 QBUs is assigned to a recognition grouping under the method applied by the taxpayer before the transition date. The owner recognizes suspended section 987 loss with respect to a terminating QBU only to the extent of its net section 987 gain in the same recognition grouping for the taxable year.

5. SRLY Rule Relating to Suspended Section 987 Losses

When a corporation that is the owner of a section 987 QBU joins a consolidated group, the corporation may have suspended section 987 losses that arose in earlier years. As explained in the preamble to the 2023 proposed regulations, the regulations issued under the authority of section 1502 generally limit a consolidated group's ability to use tax attributes generated in separate return years (as defined in § 1.1502-1(e)). 88 FR 78154. The Treasury Department and the IRS requested comments on how rules similar to the rules of § 1.1502-21(c) (limiting the use of net operating losses) should apply to suspended and deferred section 987 losses.

Id.

No comments were received in response to this request.

To prevent inappropriate trafficking of section 987 losses, § 1.987-11(e)(6)(ii) of the final regulations provides that the separate return limitation year (SRLY) limitation principles of § 1.1502-21(c) apply to suspended section 987 losses that arose in separate return years. The rule in § 1.987-11(e)(6)(ii) is based on the SRLY rules for capital loss carryovers in § 1.1502-22(c). To simplify the administration of this rule, when a corporation that is the owner of a section 987 QBU joins a consolidated group, the SRLY limitation is not applied separately to each recognition grouping determined under § 1.987-11(f), but rather to the corporation's section 987 losses overall.

Because deferred section 987 losses under § 1.987-12 are not subject to a loss-to-the-extent-of-gain rule, but rather are treated similarly under the section 987 regulations to other unrecognized section 987 losses, the SRLY limitation in § 1.987-11(e)(6)(ii) does not apply to such losses.

XI. Comments and Changes to Proposed § 1.987-13: Suspended Section 987 Loss Upon Terminations

Proposed § 1.987-13 would provide suspended loss rules that apply in connection with certain transactions in which a section 987 QBU or a successor suspended loss QBU terminates.

A. Successor Rules

Under the 2023 proposed regulations, if an owner has suspended section 987 loss with respect to a section 987 QBU that terminates, an eligible QBU that holds the assets of the section 987 QBU after the termination would be treated as a successor suspended loss QBU if it meets three requirements. Proposed § 1.987-13(b)(1)(i). First, a significant portion of the assets of the terminating section 987 QBU must be reflected on the books and records of the eligible QBU. Second, the eligible QBU must carry on a trade or business of the section 987 QBU. Finally, the eligible QBU must be owned by the owner of the section 987 QBU or by a member of its controlled group (the owner of the successor is referred to as the “successor suspended loss QBU owner”). Following a termination, if the terminated section 987 QBU has a successor, suspended section 987 loss with respect to the section 987 QBU would be attributed to the successor. Similar successor rules would apply upon termination of a successor suspended loss QBU. Proposed § 1.987-13(c)(1)(i).

If a section 987 QBU or successor suspended loss QBU terminates without a successor, the owner would recognize its cumulative suspended section 987 loss with respect to the QBU. Proposed § 1.987-13(b)(2) and (c)(2). Similarly, the cumulative suspended section 987 loss with respect to a successor suspended loss QBU would be recognized if the original suspended loss QBU owner ceases to be a member of the same controlled group as the successor suspended loss QBU owner due to the transfer of an ownership interest in the successor suspended loss QBU owner. Proposed § 1.987-13(d).

A comment recommended that the definition of a successor suspended loss QBU should be aligned with the definition of a successor deferral QBU as provided in proposed § 1.987-12(g)(2), so that the same definition would apply for both purposes. The final regulations generally retain the definition of a successor suspended loss QBU provided in the proposed regulations because this definition is needed to ensure that suspended section 987 loss can be recognized (in excess of section 987 gain) only when the trade or business of a section 987 QBU ceases to be operated by a member of the same controlled group. The successor rule in § 1.987-12(g)(2) (which requires the successor to itself be a section 987 QBU) would not serve this function, because it would require suspended section 987 loss to be recognized when a section 987 QBU is transferred to a related owner that has the same functional currency as the section 987 QBU.

B. Elimination or Limited Recognition of Suspended Section 987 Loss Following Certain Transactions

Proposed § 1.987-13(e), (f), and (g) would provide rules that eliminate or limit the recognition of suspended section 987 loss following certain transactions. First, under proposed § 1.987-13(e), if the original suspended loss QBU owner ceases to be a member of the same controlled group as the successor suspended loss QBU owner due to the transfer of an ownership interest in the original suspended loss QBU owner, the original suspended loss QBU owner's suspended section 987 loss would cease to be attributable to any section 987 QBU or successor suspended loss QBU. After the transaction, the owner's suspended section 987 loss can be recognized under § 1.987-11(e) to the extent that the owner recognizes section 987 gain; however, the suspended section 987 loss cannot be recognized under proposed § 1.987-13(b)(2), (c)(2), or (d). This rule would prevent taxpayers from transferring the stock of the original suspended loss QBU owner out of its controlled group for the purpose of selectively recognizing suspended section 987 loss, while retaining the assets and activities of the section 987 QBU in the hands of a different controlled group member.

Proposed § 1.987-13(f) would provide that, if an original suspended loss QBU owner ceases to exist as a result of a transaction in which there is no successor described in section 381(a) (for example, as a result of a section 331 liquidation), then any suspended section 987 loss that is not recognized after applying the loss-to-the-extent-of-gain rule cannot be recognized and is eliminated. This rule is intended to prevent taxpayers from entering into section 331 liquidations in order to trigger the recognition of suspended section 987 loss.

Similarly, under proposed § 1.987-13(g), if an owner of a section 987 QBU with suspended section 987 loss, or an original suspended loss QBU owner, ceases to exist in an inbound section 332 liquidation or in an inbound reorganization described in section 381(a)(2), then any suspended section 987 loss of the owner or original suspended loss QBU owner that is not recognized after application of the loss-to-the-extent-of-gain rule under proposed § 1.987-11(e) would be eliminated. This rule would prevent suspended section 987 loss that was generated offshore from being imported into the United States.

Several comments requested that the rules of proposed § 1.987-13(e) through (g) be replaced with anti-abuse rules tied to the purpose for which a taxpayer enters into the relevant transaction. One comment noted that if a CFC liquidates into its U.S. shareholder and a current rate election is not in effect, the transaction results in a termination of

the CFC's section 987 QBUs under § 1.987-8, and the CFC recognizes its net unrecognized section 987 gain or loss immediately before the liquidation. The comment proposed that suspended section 987 loss should similarly be recognized in connection with an inbound liquidation.

Other comments recommended that, following a section 331 liquidation or inbound transaction, suspended section 987 loss should be amortized over a ten-year period or added to the acquiring corporation's outside stock basis. One comment suggested that the suspended section 987 loss should be allocated pro rata among the U.S. shareholder's other foreign entities that own section 987 QBUs. Another comment requested that § 1.987-13(f) be modified to provide that suspended section 987 loss is recognized to the extent of the owner's overall gain (not limited to section 987 gain) recognized in connection with the section 331 liquidation. One comment suggested that, in connection with an inbound transaction, suspended section 987 loss could be recognized to the extent of the inbounded section 987 gain.

The Treasury Department and the IRS have determined that, in order to facilitate the current rate election (which can have the effect of enlarging the pools of unrecognized section 987 gain or loss), effective loss limitation rules are needed to prevent the selective recognition of section 987 losses by, for example, entering into a section 331 liquidation, inbound liquidation or reorganization, or a transfer of the original suspended loss QBU owner. Further, an anti-avoidance rule tied to the taxpayer's subjective purpose for entering into a particular transaction would be difficult to administer and, consequently, would not be an adequate safeguard against abuse given the critical function served by the loss limitation rules. A subjective anti-abuse rule would also provide less certainty for taxpayers and the IRS. Therefore, the final regulations generally retain the rules of proposed § 1.987-13(e) through (g).

The final regulations do not permit suspended section 987 loss to be amortized by the acquiring corporation over a ten-year period following an inbound transaction or section 331 liquidation because this would nevertheless facilitate loss importation (in the case of an inbound transaction), even though the benefit would only be recognized over time, or would allow for losses to be carried over to the acquirer in a transaction not described in section 381(a) (in the case of a section 331 liquidation). Similarly, reallocating losses to foreign entities other than the acquiring corporation would be inconsistent with the principles of section 381 and would be unduly complex. Adding suspended section 987 loss of a CFC to the outside basis of a domestic acquiring corporation's stock would have the same effect as loss importation (because the increased basis could reduce the taxable income of the domestic corporation's shareholders upon a sale of stock) and would also shift losses in a manner that is contrary to general tax principles.

The final regulations also do not permit suspended section 987 loss to be recognized to the extent of gain (other than section 987 gain) recognized in conne

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