[Federal Register Volume 81, Number 236 (Thursday, December 8, 2016)]
[Rules and Regulations]
[Pages 88806-88852]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-28381]



[[Page 88805]]

Vol. 81

Thursday,

No. 236

December 8, 2016

Part III





Department of the Treasury





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Internal Revenue Service





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 26 CFR Parts 1 and 602





Income and Currency Gain or Loss With Respect to a Section 987 QBU; 
Final Rule

Federal Register / Vol. 81 , No. 236 / Thursday, December 8, 2016 / 
Rules and Regulations

[[Page 88806]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9794]
RIN 1545-AM12


Income and Currency Gain or Loss With Respect to a Section 987 
QBU

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance 
under section 987 of the Internal Revenue Code (Code) regarding the 
determination of the taxable income or loss of a taxpayer with respect 
to a qualified business unit (QBU) subject to section 987, as well as 
the timing, amount, character, and source of any section 987 gain or 
loss. Taxpayers affected by these regulations are corporations and 
individuals that own QBUs subject to section 987. In addition, 
published elsewhere in this issue of the Federal Register, temporary 
and proposed regulations (the temporary regulations) are being issued 
under section 987 to address aspects of the application of section 987 
not addressed in these final regulations.

DATES: Effective date: These regulations are effective on December 7, 
2016.
    Applicability dates: For dates of applicability, see Sec.  1.987-
11.

FOR FURTHER INFORMATION CONTACT: Sheila Ramaswamy at (202) 317-6938 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-2265. Responses to this collection 
of information are mandatory.
    The collection of information in these final regulations is in 
Sec. Sec.  1.987-1(b)(2)(ii), 1.987-1(c)(1)(ii), 1.987-1(c)(1)(iii), 
1.987-1(g)(3)(i)(A), 1.987-1(g)(3)(i)(B), 1.987-1(g)(3)(i)(C), 1.987-
1(g)(3)(i)(D), 1.987-3(c)(2)(iv)(B), 1.987-9, and 1.987-10(e). This 
collection of information is required to establish the taxable income 
or loss of a taxpayer with respect to a QBU subject to section 987, as 
well as the timing, amount, character, and source of any section 987 
gain or loss and the exchange rates used for foreign currency 
translation purposes.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books and records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains final regulations relating to the 
determination of the taxable income or loss of a taxpayer with respect 
to a QBU subject to section 987 of the Code, as well as the timing, 
amount, character, and source of any section 987 gain or loss. The 
final regulations also amend existing regulations under sections 861, 
985, 988, and 989.
    On September 6, 2006, the Treasury Department and the IRS published 
a notice of proposed rulemaking (REG-208270-86, 71 FR 52876) that 
proposed new regulations under section 987 (the 2006 proposed 
regulations) and withdrew proposed regulations under section 987 
published on September 25, 1991 (INTL-965-86, 56 FR 48457) (the 1991 
proposed regulations). The Treasury Department and the IRS received 
many written comments in response to the 2006 proposed regulations. 
After consideration of all the comments, the 2006 proposed regulations, 
as revised by this Treasury decision, are adopted as final regulations. 
Temporary regulations (TD 9795) and proposed regulations (REG-128276-
12) under section 987 are being published contemporaneously with these 
final regulations.

Summary of Comments and Explanation of Revisions

I. Background

    Section 987 generally provides that, when a taxpayer owns one or 
more QBUs with a functional currency other than the U.S. dollar and 
such functional currency is different than that of the taxpayer, the 
taxable income or loss of the taxpayer with respect to each QBU is 
determined by computing the taxable income or loss of each QBU 
separately in its functional currency and translating such income or 
loss at the appropriate exchange rate. Section 987 further requires the 
taxpayer to make ``proper adjustments'' (as prescribed by the 
Secretary) for transfers of property between QBUs having different 
functional currencies, including by treating post-1986 remittances from 
each such QBU as made on a pro rata basis out of post-1986 accumulated 
earnings and by treating section 987 gain or loss as ordinary income or 
loss and sourcing such gain or loss by reference to the source of the 
income giving rise to post-1986 accumulated earnings.\1\ Section 
989(b)(4) provides that, ``[e]xcept as provided in regulations,'' the 
appropriate exchange rate with respect to a QBU means ``the average 
exchange rate for the taxable year'' of the QBU. Additionally, section 
989(c)(5) directs the Secretary to ``prescribe such regulations as may 
be necessary or appropriate to carry out the purposes of [subpart J], 
including regulations . . . providing for the appropriate treatment of 
related party transactions (including transactions between qualified 
business units of the same taxpayer) . . . .''
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    \1\ The legislative history of section 987 is discussed 
extensively in the preamble to the 2006 proposed regulations. See 71 
FR 52876.
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A. 1991 Proposed Regulations

    The 1991 proposed regulations generally provided that the net 
income of a QBU with a functional currency other than that of the 
taxpayer was determined annually. Such determination was based on the 
profit and loss appearing on the QBU's books and records, adjusted to 
conform to U.S. tax principles, and translated into the functional 
currency of the taxpayer using the weighted average exchange rate for 
the taxable year. The 1991 proposed regulations also provided for the 
recognition of exchange gain or loss upon a remittance from the QBU's 
equity pool. In general, the equity pool consisted of the contributed 
capital and earnings of the QBU, reduced by remittances, determined in 
the QBU's functional currency. The 1991 proposed regulations also 
provided for a basis pool, which consisted of the basis of the capital 
and earnings in the equity pool, expressed in the functional currency 
of the taxpayer. The portion of the basis pool that was attributable to 
a remittance generally was determined according to the following 
formula:

[[Page 88807]]

[GRAPHIC] [TIFF OMITTED] TR08DE16.002

    Under the 1991 proposed regulations, section 987 gain or loss was 
the difference between the value of the remittance from the QBU, 
translated into the taxpayer's functional currency at the spot rate on 
the date of the remittance, and the basis associated with the 
remittance.
    One important consequence of the equity pool paradigm was that all 
branch equity gave rise to exchange gain or loss, regardless of whether 
the equity was invested in assets that actually exposed the QBU's owner 
to currency fluctuations. For example, both cash denominated in the 
QBU's functional currency and mobile equipment equally gave rise to 
exchange gain or loss. As a result, under the 1991 proposed 
regulations, exchange rate changes that, at most, had only an uncertain 
and remote effect on the economic results experienced by the owner of a 
QBU gave rise to substantial exchange gains and losses that taxpayers 
selectively could recognize by strategically timing remittances or 
causing a termination of the QBU. Given these distortions, the Treasury 
Department and the IRS withdrew the 1991 proposed regulations and 
proposed new regulations on September 6, 2006.

B. 2006 Proposed Regulations

    The 2006 proposed regulations adopted a different paradigm referred 
to as the foreign exchange exposure pool (FEEP) method. In general, the 
FEEP method provides that, as under the 1991 proposed regulations, the 
income of a QBU that is subject to section 987 (a section 987 QBU) is 
determined by reference to the items of income, gain, deduction, and 
loss booked to the section 987 QBU in its functional currency, adjusted 
to reflect U.S. tax principles. Items of income and deduction generally 
are translated, consistent with the 1991 proposed regulations, into the 
functional currency of the section 987 QBU's owner at the average 
exchange rate for the year. However, the basis of certain ``historic 
assets'' and the deductions for depreciation, depletion, and 
amortization of such assets are translated at the historic rates for 
such assets. Translating these items at historic rates represents a 
major difference from the 1991 proposed regulations and prevents the 
imputation of foreign currency gains or losses to such assets. 
Additionally, the 2006 proposed regulations required the adjusted basis 
and amount realized with respect to marked assets to be translated 
using a spot rate, which for assets acquired in a prior taxable year 
would be the spot rate for the closing balance sheet of the prior 
taxable year.
    Consistent with the 1991 proposed regulations, the FEEP method uses 
a balance sheet approach to determine exchange gain or loss, which is 
not recognized until the section 987 QBU makes a remittance. Under the 
FEEP method, exchange gain or loss with respect to ``marked items'' is 
determined annually but is pooled and deferred until a remittance is 
made. A marked item generally is defined under the 2006 proposed 
regulations as an asset (marked asset) or liability (marked liability) 
that would generate section 988 gain or loss if such asset or liability 
were held or entered into directly by the owner of the section 987 QBU. 
The balance sheet approach, together with the use of historic rates for 
historic items (generally defined as an asset or liability that is not 
a marked item), allows taxpayers and the IRS to distinguish between 
items whose value is highly responsive to changes in the functional 
currency of the owner and items for which exchange rate changes have no 
effect on value, or only an uncertain or remote effect that is more 
appropriately recognized upon a realization event with respect to the 
item.
    The 2006 proposed regulations define a remittance as a net transfer 
of amounts from a section 987 QBU to its owner during a taxable year, 
determined in the owner's functional currency. When a section 987 QBU 
makes a remittance, a portion of the pooled exchange gain or loss is 
recognized. In general, the amount taken into account equals the 
section 987 QBU's net unrecognized exchange gain or loss multiplied by 
the owner's remittance proportion. The owner's remittance proportion 
generally equals the amount of the remittance divided by the aggregate 
basis of the section 987 QBU's gross assets reflected on its year-end 
balance sheet, determined in the owner's functional currency, without 
reduction for the remittance.

II. Summary of Comments and Changes

    Many comments were received in response to the 2006 proposed 
regulations. This Part II discusses those comments and the changes made 
in response to them. Certain comments received in response to the 2006 
proposed regulations are addressed in the temporary regulations and are 
discussed in the preamble to the temporary regulations rather than in 
this preamble.

A. General Comments Regarding the FEEP Method, Including Regarding 
Administrability

    A number of comments suggested that the FEEP method, in particular 
Sec. Sec.  1.987-3 and -4 of the 2006 proposed regulations, would be 
difficult to administer. Some of those comments expressed a preference 
to more closely align regulations under section 987 with the financial 
accounting rules under Accounting Standards Codification, Foreign 
Currency Matters, section 830 (ASC 830).\2\
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    \2\ ASC 830 codifies Financial Accounting Standard No. 52.
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    ASC 830 adopts a functional currency paradigm in which assets, 
liabilities, and operations of a foreign entity are measured using the 
entity's functional currency \3\ and then translated into the reporting 
currency (generally, the U.S. dollar) of a U.S. enterprise using a 
current exchange rate.\4\ Thus, revenues, expenses, gains, and losses 
of the foreign entity, translated into U.S. dollars using a weighted 
average exchange rate for the reporting period, are included in the 
consolidated profit and loss statement of the U.S. enterprise,\5\ and 
the assets and liabilities of the foreign entity, translated into U.S. 
dollars using the spot rate on the balance sheet date, are included in 
the consolidated balance sheet of the U.S. enterprise.\6\ Foreign 
currency ``translation'' gain or loss of a foreign entity with a 
functional currency other than the U.S. dollar is determined with 
respect to all assets and liabilities on the entity's balance sheet at 
the end of a

[[Page 88808]]

reporting period and reported in the cumulative translation adjustment 
(CTA) account. The CTA account is a sub-account in the equity section 
of the balance sheet.\7\ It is not reflected in profit or loss until 
the occurrence of a sale or a complete or substantially complete 
liquidation of the entity.\8\ ASC 830 \9\ explains the rationale for 
accounting for translation gain or loss in equity and not income:
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    \3\ The functional currency of a foreign entity is defined in 
ASC 830 as the currency of the primary economic environment in which 
the entity operates.
    \4\ ASC 830-30-45-3.
    \5\ ASC 830-10-55-10-11,830-30-45-3.
    \6\ ASC 830-30-45-3.
    \7\ ASC 830-30-45-12.
    \8\ ASC 830-30-40-1.
    \9\ ASC 830-230-45-1.

    Translation adjustments are solely a result of the translation 
process and have no direct effect on reporting currency cash flows. 
Exchange rate changes have an indirect effect on the net investment 
that may be realized upon sale or liquidation, but that effect is 
related to the net investment and not to the operations of the 
investee. Prior to sale or liquidation, that effect is so uncertain 
and remote as to require that translation adjustments arising 
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currently should not be reported as part of operating results.

    The treatment of translation gains and losses can be contrasted 
with the financial accounting treatment of transactions denominated in 
a currency other than the entity's functional currency. Changes in 
exchange rates between the functional currency of the foreign entity 
and the currency in which such transactions are denominated give rise 
to changes in expected cash flows in the functional currency, resulting 
in ``transaction'' gains or losses. The financial accounting rules 
require the inclusion of transaction gains and losses in net income for 
the period in which the exchange rate changes occur.\10\ The category 
of foreign currency transactions that give rise to transaction gains 
and losses under generally accepted accounting principles overlaps 
considerably with the definition of a section 988 transaction for tax 
purposes.
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    \10\ ASC 830-20-35-1.
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    Some comments suggested that, in enacting section 987, Congress 
intended to substantially adopt the financial accounting rules for 
foreign currency translation for tax purposes. The Treasury Department 
and the IRS do not find support for this position in the legislative 
history to section 987 and, to the contrary, find the position belied 
by the significant discontinuities between section 987 and the 
financial accounting rules, particularly regarding the recognition of 
foreign currency gains and losses. Under Financial Accounting Standard 
No. 52 (FAS 52), translation gain or loss is deferred in an equity 
account until a sale or liquidation of the foreign entity, at which 
point the economic effects of the aggregate translation gain or loss 
can be measured against a real economic event. The ``equity pool'' 
paradigm of the 1991 proposed regulations determined the amount of 
section 987 gain or loss in a manner that was similar to the 
determination of translation gain or loss under FAS 52 by imputing 
foreign currency gain or loss to all assets and liabilities on the 
balance sheet. In contrast with the accounting rules under FAS 52, 
however, the translation gain or loss was not sequestered in an equity 
account but rather was included in income upon a remittance as required 
by the section 987 statute, making the consequences of imputing foreign 
currency gain or loss to all assets and liabilities substantially 
greater.
    As expressed in the preamble to the 2006 proposed regulations, the 
administrative convenience achieved by generally adopting the FAS 52 
computational methodology in the 1991 proposed regulations gave rise to 
many cases in which the section 987 gain or loss taken into account on 
a remittance deviated substantially from the economic results 
experienced by the QBU. For example, currency loss was imputed with 
respect to assets (such as a commercial building or an oil rig) for 
which, due to the mobility of investment capital or the assets 
themselves, exchange rate fluctuations would have, at most, only a 
remote and uncertain effect on asset value. Moreover, because 
remittances could be funded from other assets, such loss could be 
recognized without regard to any realization event with respect to the 
assets that gave rise to the speculative or noneconomic section 987 
loss.
    Given the inappropriate economic and timing results attributable to 
adopting the FAS 52 translation methodology in the 1991 proposed 
regulations and the significant differences between the purposes of the 
FAS 52 computation of CTA and the computation of unrecognized section 
987 gain or loss, the Treasury Department and the IRS remain of the 
view that the FAS 52 model is not appropriate for tax purposes. 
Similarly, the Treasury Department and the IRS have determined that an 
approach based on consistency with FAS 52 computations modified to 
address abuses, as suggested in some comments, is inappropriate because 
such a system would impute foreign currency gain or loss to all assets 
and liabilities on the balance sheet and generally allow for the 
recognition of such gains and losses based on remittances without 
regard to the owner's actual economic exposure to the QBU's functional 
currency. Rather, the Treasury Department and the IRS have determined 
that an approach premised on consistency with section 988, modified to 
take into account administrability and policy considerations unique to 
section 987, will carry out the purposes of section 987 most 
appropriately.
    Other comments recommended a hybrid approach that would combine the 
methodology of the 1991 proposed regulations for computing a section 
987 QBU's net income with the methodology of the 2006 proposed 
regulations for computing section 987 gain or loss. Under the proposed 
hybrid approach, section 987 gain or loss generally would be determined 
under the method of the 2006 proposed regulations, but taxable income 
or loss would be translated into the owner's functional currency at the 
yearly average exchange rate without any adjustments. A consequence of 
this hybrid approach is that a different exchange rate would be used to 
translate recovered basis with respect to historic assets in 
determining taxable income or loss than would be used to translate such 
basis to determine section 987 gain or loss. These comments generally 
favored the FEEP method for determining section 987 gain or loss 
because it avoids imputing section 987 gain or loss to all assets and 
liabilities on the balance sheet, as under the 1991 proposed 
regulations, but asserted that determining taxable income or loss in 
the functional currency of the section 987 QBU and translating that 
amount into the owner's functional currency at the yearly average 
exchange rate without any adjustments is more administrable and more 
consistent with sections 987(1) and (2) and the legislative history of 
section 987.
    The Treasury Department and the IRS have concluded that the 
proposed hybrid approach would not achieve the goal of ensuring 
remittances trigger only ``exchange gain or loss inherent in 
accumulated earnings or branch capital,'' as contemplated by Congress, 
and inappropriately would cause offsetting exchange rate effects to be 
reflected in section 987 taxable income or loss and in the FEEP. (H.R. 
Conf. Rep. No. 99-841, at 675 (1986)). Although a hybrid approach would 
simplify the calculation of section 987 taxable income or loss, the 
simplification would cause basis recovery deductions with respect to 
depreciable and amortizable assets that are included in section 987 
taxable income or loss to reflect exchange rate fluctuations with 
respect to the asset (for which exchange rate fluctuations may have, at 
most, only a remote and uncertain effect on value). If the asset is 
retained on the closing

[[Page 88809]]

balance sheet, the FEEP would reflect equal and offsetting exchange 
rate fluctuations with respect to the asset, to the extent of any 
accumulated depreciation or amortization that was included in taxable 
income and translated at current exchange rates. This is because, in 
determining section 987 gain or loss under Sec.  1.987-4 of the 2006 
proposed regulations, section 987 taxable income or loss is subtracted 
from the change in the owner functional currency net value (OFCNV) of 
the section 987 QBU, which is determined using historic exchange rates 
for historic items. Accordingly, the distortion in the determination of 
section 987 taxable income or loss with respect to historic assets 
would cause an offsetting distortion in the FEEP.
    An example illustrates the equal and offsetting exchange rate 
effects that can arise with respect to a historic asset under the 
hybrid approach. Consider the situation of a section 987 QBU (euro QBU) 
that has the euro as its functional currency and that has an owner that 
has the dollar as its functional currency. If euro QBU acquires 
depreciable equipment for [euro]100 on the last day of year 1, when the 
historic exchange rate is [euro]1 = $1, and takes into account [euro]10 
of depreciation with respect to the equipment in year 2, when the 
yearly average exchange rate is [euro]1 = $1.50, the [euro]10 of 
depreciation would be translated at the year 2 average exchange rate 
into $15 under the hybrid approach rather than $10, as would happen if 
depreciation were translated at the [euro]1 = $1 historic rate under 
the 2006 proposed regulations. As a result, section 987 taxable income 
of euro QBU is $5 lower under the hybrid approach than it would be 
under the 2006 proposed regulations.
    In this example, the FEEP, in turn, would be higher by $5 under the 
hybrid approach than it would be under the 2006 proposed regulations. 
This is because, in determining the change to the FEEP for a taxable 
year, section 987 taxable income is subtracted from the change in OFCNV 
of euro QBU, which is computed by translating the adjusted basis of 
historic assets using the historic exchange rate for each asset. For 
euro QBU, solely with reference to the depreciable equipment, year 2 
depreciation causes a $10 reduction in OFCNV, because in computing the 
change in OFCNV, the [euro]10 change in equipment basis during year 2 
is translated at the [euro]1 = $1 historic rate (year 2 closing balance 
sheet of $90 adjusted basis, less year 1 closing balance sheet of $100 
adjusted basis). In order to compute the change to the FEEP for year 2 
with respect to the depreciable equipment, section 987 taxable income 
with respect to the equipment is subtracted from the $10 reduction in 
OFCNV. Thus, the net effect of the depreciation in the FEEP is to 
increase section 987 gain reflected in the FEEP by $5 (negative $10 
change in OFCNV, less $15 depreciation deduction).
    Considering all of these effects together, under the hybrid 
approach, the appreciation of the euro decreases section 987 taxable 
income by $5 and increases section 987 gain reflected in the FEEP by 
$5. In other words, the FEEP reflects currency gain or loss with 
respect to the depreciable asset that is offset by an amount that was 
included in section 987 taxable income. This effect on the FEEP 
persists even after the asset is sold.
    The Treasury Department and the IRS have determined that the 
offsetting effects in section 987 taxable income or loss and in the 
FEEP under the hybrid approach raise concerns similar to the concerns 
that Congress addressed, albeit in a different context, in enacting 
section 1092. In particular, section 1092 reflects a policy concern 
regarding inconsistent timing of recognition of gains and losses from 
offsetting positions. Under the hybrid approach, the exchange rate 
effect with respect to historic assets would be reflected in section 
987 taxable income or loss to the extent of any cost recovery 
deductions with respect to those assets, but equal and offsetting 
amounts would be reflected in the FEEP and would not be recognized 
until there are remittances. Thus, offsetting effects arising from a 
single asset would be taken into account at different times. 
Accordingly, the Treasury Department and the IRS have determined that 
it would be inappropriate for regulations under section 987 to permit 
distortions to section 987 taxable income or loss, for the sake of 
enhancing administrability, that have the effect of causing offsetting 
amounts of gain or loss to be reflected in the FEEP with respect to the 
same asset, where the latter amounts would be recognized only upon 
voluntary remittances from the QBU. Rather, consistent with the 
discussion in the preamble to the 2006 proposed regulations, the 
Treasury Department and the IRS have determined that, in order to carry 
out the purposes of section 987(3) as indicated by the legislative 
history, as well as sections 987(1) and (2), and taking into account 
the authority granted in sections 989(b) and (c), it is appropriate to 
account for recovered basis for historic assets at the relevant 
historic rate in determining taxable income or loss of a section 987 
QBU. This result could be accomplished by translating recovered basis 
at the historic rate in the first instance or by translating taxable 
income or loss determined in the section 987 QBU's functional currency 
at the yearly average exchange rate and adjusting that amount to 
properly account for recovered basis, as under the simplified inventory 
method described in Part II.A.3 of this preamble.
    Nonetheless, the Treasury Department and the IRS acknowledge the 
observations about the complexity and administrability of the 2006 
proposed regulations that underlie the recommendation of the hybrid 
approach. The concerns about offsetting amounts recognized at different 
times under the hybrid approach would not arise for taxpayers that make 
the deemed annual termination election set forth in Sec.  1.987-8T(d) 
of the temporary regulations. Accordingly, as described in the preamble 
to the temporary regulations, a taxpayer that makes the deemed annual 
termination election may also elect under Sec.  1.987-3T(d) to apply 
the hybrid approach. Additionally, the Treasury Department and the IRS 
have made several changes in these final regulations in response to 
comments expressing concern about the complexity and administrability 
of the 2006 proposed regulations.
    In addition to the comments recommending a hybrid approach under 
which taxable income would be translated at a single exchange rate 
without any adjustments, other comments expressed more particular 
concerns regarding the complexity and administrability of the FEEP 
paradigm specifically with respect to inventory and certain other high-
volume, low-value assets. Comments suggested that treating items that 
turn over quickly, such as inventory, or that have low value as marked 
items would facilitate administration and compliance while introducing 
little distortion into the FEEP calculation. The Treasury Department 
and the IRS do not agree with these specific recommendations to expand 
the scope of marked assets, because even assets that turn over quickly 
or have low-value individually could inappropriately give rise to 
significant amounts of section 987 gain or loss in the aggregate over 
time. The Treasury Department and the IRS do, however, acknowledge the 
general points about complexity and administrability reflected in these 
suggestions, which are similar to the concerns expressed in the 
comments recommending the hybrid approach.
    In order to reduce complexity and improve administrability, the 
final

[[Page 88810]]

regulations modify the 2006 proposed regulations in several significant 
ways, including by permitting more items to be treated as section 987 
marked items, simplifying the treatment of marked items so that net 
income attributable to such items is translated at the average exchange 
rate, and simplifying the adjustments that are required to translate 
basis recovery for historic items at the historic rate. These changes 
balance the administrability benefits of simplifying the final 
regulations and bringing them into closer conformity with financial 
accounting rules against the need to minimize the distortions that 
would result from permitting taxpayers to include uncertain and remote 
foreign currency gains and losses in taxable income. In particular, the 
final regulations allow taxpayers to (a) use the yearly average 
exchange rate as the historic rate, (b) treat prepaid expenses and 
liabilities for advance payments of unearned income as section 987 
marked items, (c) apply a simplified method with respect to inventory, 
and (d) translate both basis recovery and amount realized with respect 
to marked assets at the yearly average exchange rate. Additionally, as 
described in the preamble to the temporary regulations, the temporary 
regulations treat certain section 988 transactions as marked items and 
permit taxpayers to elect to more closely conform the treatment of 
certain section 988 transactions entered into by a section 987 QBU with 
their treatment for financial accounting purposes.
1. Yearly Average Exchange Rate as the Historic Rate
    Under Sec. Sec.  1.987-1(c)(3)(i) and 1.987-2(d) of the 2006 
proposed regulations, the historic rate used to translate the basis of 
historic assets was the spot rate on the date on which the asset was 
transferred to, or otherwise acquired by, a section 987 QBU. Thus, when 
assets were acquired by a section 987 QBU on multiple days during a 
single taxable year, the 2006 proposed regulations required taxpayers 
to track multiple historic spot rates. A comment observed that taxpayer 
systems often only identify the date an asset is placed in service and 
recommended that taxpayers be permitted to use a yearly average 
exchange rate in lieu of a spot rate in translating historic items.
    The Treasury Department and the IRS agree that using the yearly 
average exchange rate rather than a spot rate to translate historic 
items would reduce complexity and improve administrability without 
introducing significant distortions into the determination of section 
987 taxable income or loss or section 987 gain or loss. Accordingly, 
Sec.  1.987-1(c)(3)(i) generally provides that the historic rate is the 
yearly average exchange rate for the taxable year when a historic asset 
is acquired, or a historic liability is incurred, by a section 987 QBU. 
Taxpayers that prefer to use the spot rate as the historic rate, as 
under the 2006 proposed regulations, may so elect under Sec.  1.987-
1(c)(1)(iii). A taxpayer that makes this election is deemed to also 
make the historic inventory election under Sec.  1.987-3(c)(2)(iv)(B) 
that is described in Part II.A.3 of this preamble.
    In addition, to further improve administrability, Sec.  1.987-
1(c)(3)(iii) permits a section 987 QBU that acquires depreciable or 
amortizable property in one year and places the asset in service in 
another year to determine the historic rate for the property based on 
the date the property is placed in service rather than the year the 
property was acquired, provided that this convention is consistently 
applied for all such property attributable to that section 987 QBU.
2. Prepaid Expenses and Liabilities Treated as Section 987 Marked Items
    Comments suggested that prepaid expenses and liabilities for 
advance payments of unearned income should be treated as section 987 
marked items because they typically have a short duration and often 
concern small amounts. The Treasury Department and the IRS have 
determined that treating these items as marked items generally would 
promote administrability without introducing significant distortions in 
the determination of section 987 gain or loss. Accordingly, the 
definition of marked item under Sec.  1.987-1(d) includes prepaid 
expenses and liabilities for an advance payment of unearned income 
where such items have an original term of one year or less.
3. Cost of Goods Sold/Inventory
    Under the 2006 proposed regulations, inventory was treated as a 
historic item. As a result, to determine section 987 taxable income or 
loss with respect to a section 987 QBU under proposed Sec.  1.987-3, 
cost of goods sold (COGS) had to be translated at a historic spot rate 
that corresponded to the date the liquidated inventory was acquired or 
manufactured. A historic spot rate also had to be used to determine the 
OFCNV of the QBU under proposed Sec.  1.987-4 with respect to inventory 
that was reflected on the section 987 QBU's year-end balance sheet. For 
these purposes, the cost basis of inventory purchased for resale 
generally would have been translated into the owner's functional 
currency at the spot rate on the date of purchase. With respect to 
inventory that was manufactured by the section 987 QBU, it would have 
been necessary to translate individually the various components of COGS 
at the appropriate historic spot rate for each cost component, 
resulting in an effective historic rate for manufactured inventory that 
was a blend of the historic rates applicable to such components. That 
is, labor, materials and other inventoriable costs would have been 
translated at the spot rate on the date the cost was incurred or, in 
the case of depreciation, the date the relevant depreciable asset was 
acquired. Comments suggested that translating inventoriable costs at 
their historic spot rates presented significant administrative 
difficulties. In addition to the comments requesting that certain high 
volume property be treated as a marked asset, one comment requested 
that a simplified method be provided to deal with the administrative 
difficulties in applying the 2006 proposed regulations to inventory.
    In response to comments, these final regulations simplify the 
translation of COGS and ending inventory in two significant ways. 
First, the use under Sec.  1.987-1(c)(3) of the yearly average exchange 
rate rather than a spot rate as the historic rate will significantly 
simplify the translation of COGS and ending inventory. This change 
makes it possible to translate all inventory purchased in a given year, 
and all costs incurred in the production of inventory in a given year 
(other than depreciation, which is always translated at the historic 
rate for the year the depreciated property was acquired or placed in 
service, regardless of whether it is an inventoriable cost), using a 
single exchange rate. Second, Sec.  1.987-3(c)(2)(iv)(A) prescribes a 
simplified inventory method under which (i) COGS is translated into the 
functional currency of the section 987 QBU's owner at the yearly 
average exchange rate for the current taxable year with a requirement 
to make only two discrete adjustments to the translated COGS amount, 
and (ii) a simplified historic rate is used for purposes of determining 
the OFCNV under Reg. Sec.  1.987-4 for inventory to which the 
simplified inventory method applies. A taxpayer that prefers the 
inventory method under the 2006 proposed regulations can elect under 
Sec.  1.987-3(c)(2)(iv)(B) to translate inventoriable costs that are 
included in COGS or ending inventory at the historic rate for each such 
cost and, if they wish, can further elect under

[[Page 88811]]

Sec.  1.987-1(c)(1)(iii) to use the spot rate as the historic rate.
a. Translation of COGS Under the Simplified Inventory Method
    Under the simplified inventory method, a section 987 QBU determines 
COGS in its functional currency and translates that amount at the 
yearly average exchange rate for the taxable year rather than 
translating each inventoriable cost at the appropriate historic rate. 
Taxpayers applying the simplified inventory method must make two 
adjustments to COGS described in Sec.  1.987-3(c)(3). These adjustments 
mitigate the consequences of translating COGS at the yearly average 
exchange rate, as if inventory were a marked asset, rather than 
translating the inventoriable costs reflected in inventory sold during 
the taxable year at the appropriate historic rates, as under the 2006 
proposed regulations. In particular, the adjustments generally prevent 
inventory from giving rise to section 987 gain or loss reflected in the 
FEEP. The adjustments also cause section 987 taxable income or loss to 
correspond over time to the section 987 taxable income or loss that 
would have resulted if inventoriable costs were translated at historic 
rates.
    The first adjustment requires the translated COGS amount to be 
adjusted to reverse the effect of translating (as part of the 
translation of COGS) cost recovery deductions treated as inventoriable 
costs at the current yearly average exchange rate rather than at the 
appropriate historic rates. For a particular cost recovery deduction, 
this adjustment is calculated as the portion of the deduction treated 
as an inventoriable cost, computed in the functional currency of the 
QBU, multiplied by the amount (whether positive or negative) that is 
determined by subtracting the yearly average exchange rate at which 
COGS was translated from the historic rate applicable to the property 
whose cost is being recovered. For example, in a period in which the 
functional currency of a section 987 QBU has strengthened against its 
owner's functional currency, the adjustment would reduce the amount of 
COGS determined in the owner's functional currency to correspond to the 
amount that would have been determined if cost recovery deductions that 
are inventoriable costs had been translated at the historic rate, as 
other cost recovery deductions are translated. To enhance 
administrability and respond to comments received, this adjustment is 
taken into account in determining COGS in full in the taxable year in 
which the inventoriable cost recovery deductions are allowed, 
regardless of whether a portion of such costs is capitalized into 
ending inventory.
    The second adjustment required under the simplified inventory 
method differs for inventory accounted for under the last-in, first-out 
(LIFO) method and for non-LIFO inventory, to reflect the different cost 
flow assumptions under these accounting methods. For both non-LIFO and 
LIFO inventory, the adjustment generally causes the amount of section 
987 taxable income or loss taken into account by the owner of a section 
987 QBU to correspond over time to the amount that would be taken into 
account if inventoriable costs were translated at their respective 
historic rates rather than at the yearly average exchange rate. For 
non-LIFO inventory, the adjustment is made on an annual basis with 
respect to beginning inventory. For LIFO inventory, the adjustment is 
made only when a LIFO layer is liquidated or partially liquidated.
i. Adjustment for Non-LIFO Inventory
    For non-LIFO inventory, the second adjustment required under the 
simplified inventory method is an adjustment with respect to beginning 
inventory. The adjustment, which must be made annually, corrects the 
distortion that arises from translating beginning inventory at the 
current yearly average exchange rate as part of translating COGS, after 
the same inventory was translated in the immediately preceding year 
(when the inventory represented ending inventory in the cost of goods 
calculation) at the yearly average exchange rate for that year. This 
adjustment to COGS is calculated as the amount of beginning inventory, 
computed in the functional currency of the QBU, multiplied by the 
amount (whether positive or negative) that is determined by subtracting 
the yearly average exchange rate for the current taxable year from the 
yearly average exchange rate for the immediately preceding taxable 
year. For example, in a period in which the functional currency of a 
section 987 QBU has strengthened against the owner's functional 
currency, this adjustment would reduce the amount of COGS determined in 
the owner's functional currency by the difference between beginning 
inventory translated at the current yearly average exchange rate and at 
the yearly average exchange rate for the immediately preceding taxable 
year.
    Over time, this adjustment generally causes the owner of a section 
987 QBU to take into account the same amount of section 987 taxable 
income or loss as would have occurred under the 2006 proposed 
regulations if the yearly average exchange rate had been used as the 
historic rate. Additionally, because this adjustment is reflected in 
section 987 taxable income or loss, which is a component of the Sec.  
1.987-4 calculation of section 987 gain or loss with respect to the 
section 987 QBU, the adjustment ultimately has the effect of preventing 
non-LIFO inventory on the year-end balance sheet from giving rise to 
section 987 gain or loss, notwithstanding that the historic rate at 
which it is translated each year is the yearly average exchange rate.
ii. Adjustment for LIFO Inventory
    For LIFO inventory, the second adjustment required under the 
simplified inventory method is an adjustment with respect to LIFO 
layers liquidated in whole or part during the year. The adjustment, 
which must be made only in taxable years in which a LIFO layer is 
partially or fully liquidated, compensates for the translation of COGS 
attributable to a liquidated LIFO layer at the current yearly average 
exchange rate rather than at the historic rate associated with the 
taxable year in which the inventory layer arose. The adjustment is 
calculated as the amount of each LIFO layer that has been fully or 
partially liquidated during the year multiplied by the amount (whether 
positive or negative) that is determined by subtracting the yearly 
average exchange rate for the current taxable year from the yearly 
average exchange rate for the taxable year to which the liquidated 
layer relates.
    As a result of this adjustment, each LIFO layer is treated as 
having a single historic rate, which is the yearly average exchange 
rate for the taxable year in which the layer arose.
b. Determination of the OFCNV of Inventory Under the Simplified Method
    For purposes of determining section 987 gain or loss under Sec.  
1.987-4 with respect to inventory that is reflected on the section 987 
QBU's year-end balance sheet, Sec.  1.987-1(c)(3)(i)(B) provides a 
simplified historic rate for inventory to which the simplified 
inventory method applies. Under Sec.  1.987-1(c)(3)(i)(B), the 
simplified historic rate for inventory differs depending on whether the 
inventory is accounted for under the LIFO method. If the inventory is 
accounted for under the LIFO method, the historic rate is the average 
exchange rate for the taxable year in which the relevant LIFO layer 
arose. If the

[[Page 88812]]

inventory is accounted for under a non-LIFO method, the historic rate 
is the average exchange rate for the taxable year for which the 
determination of the historic rate is relevant. Accordingly, for 
purposes of determining section 987 gain or loss with respect to non-
LIFO inventory reflected on a section 987 QBU's year-end balance sheet, 
the inventory is translated at the average exchange rate for that 
taxable year. Thus, although non-LIFO inventory subject to the 
simplified method is nominally a historic asset, it is translated at a 
current exchange rate each year similar to a marked asset, but using 
the yearly average exchange rate rather than the year-end spot rate.
4. Translation Rates Used for the Sale of a Marked Asset by a Section 
987 QBU
    The 2006 proposed regulations provided special rules for 
translating the adjusted basis and amount realized upon a disposition 
of a marked asset. For a marked asset that was held by a section 987 
QBU on the first day of a taxable year, the required translation rate 
for the adjusted basis and amount realized with respect to the asset 
was the rate used to translate the basis of such asset from the section 
987 QBU's functional currency into the owner's functional currency in 
determining the owner functional currency net value of the section 987 
QBU for the preceding taxable year under Sec.  1.987-4. For a marked 
asset acquired during the taxable year, the adjusted basis and amount 
realized were translated at the spot rate on the date the asset was 
acquired. In response to general comments on the complexity of 
administering the 2006 proposed regulations, and considering the 
relatively minor distortion that would arise from eliminating these 
special translation rules, the final regulations do not include a 
special rule for translating the adjusted basis or amount realized with 
respect to marked assets. Accordingly, the gain or loss on marked 
assets generally is determined in the functional currency of the 
section 987 QBU and translated into the owner's functional currency at 
the yearly average exchange rate for the year of disposition.

B. Excluded Entities

    The 2006 proposed regulations provided that banks, insurance 
companies, and similar financial entities would not be subject to the 
regulations. In addition, the 2006 proposed regulations identified 
leasing companies, finance coordination centers, regulated investment 
companies, and real estate investment trusts as ``similar financial 
entities.'' A comment requested that the final regulations clarify the 
meaning of ``similar financial entities.'' Comments also suggested 
excluding entities from the scope of ``similar financial entity'' (and 
therefore making such entities subject to the final regulations) if 
they primarily engage in transactions with related parties that are not 
themselves financial entities. A comment noted that it would be 
anomalous to apply the final regulations with respect to all of the 
operating entities transacting with a related finance coordination 
center but not apply the final regulations to the center itself.
    The Treasury Department and the IRS agree that the reference to 
``similar financial entities'' in the 2006 proposed regulations is 
unclear and agree that entities primarily engaged in transactions with 
related persons that are not themselves financial entities should be 
subject to the final regulations. Accordingly, Sec.  1.987-1(b)(1)(ii) 
omits the reference to ``similar financial entities,'' and replaces it 
with specific references to the entities that the 2006 proposed 
regulations explicitly identified as ``similar financial entities.'' 
Additionally, the exception from the application of the final 
regulations is revised based on the comment received to not apply (such 
that the final regulations do apply) to entities that engage in 
transactions primarily with persons that are related within the meaning 
of sections 267(b) or 707(b) and that are not themselves entities 
identified in Sec.  1.987-1(b)(1)(ii).
    The preamble to the 2006 proposed regulations requested comments on 
the application of the FEEP method to entities excluded from the scope 
of the 2006 proposed regulations. The Treasury Department and the IRS 
are still considering how section 987 should apply to excluded entities 
and request additional comments regarding the appropriate design of 
rules applying section 987 to excluded entities in light of the rules 
contained in these final regulations and the temporary regulations. 
Until regulations providing rules for applying section 987 with respect 
to such excluded entities are effective, the excluded entities must use 
a reasonable method to comply with section 987 and cannot rely on these 
final regulations.

C. Election To Apply Section 988 in Lieu of Section 987

    A comment recommended allowing an owner of a section 987 QBU that 
has a relatively small amount of marked items to elect to not apply 
section 987 with respect to the QBU and instead to apply section 988 
with respect to the items that would be considered marked items of the 
QBU if section 987 applied. The same comment recommended that the 
Treasury Department and the IRS consider providing such an election 
more generally without regard to the relative amount of marked items 
held by an eligible QBU. The Treasury Department and the IRS have 
determined that the proposed election would create substantial 
administrative difficulties for the IRS, particularly given that an 
electing QBU would maintain books and records in its functional 
currency but would determine tax consequences by reference to the 
functional currency of the owner. Accordingly, the recommendation to 
allow an election not to apply section 987 has not been adopted.

D. Definition of Portfolio Stock

    Under Sec.  1.987-2(b)(2) of the 2006 proposed regulations, stock 
other than portfolio stock is not attributed to an eligible QBU even if 
it is reflected on the books and records of the eligible QBU. For this 
purpose, the 2006 proposed regulations provided that stock is portfolio 
stock if the owner of the eligible QBU owns (directly, indirectly, or 
constructively) less than 10 percent of the voting power or value of 
all classes of stock of the corporation. A comment recommended that 
this rule be based solely on value because voting power should not be a 
relevant factor in determining whether items of income, gain, 
deduction, and loss arising from stock are included in section 987 
taxable income or loss. The Treasury Department and the IRS agree with 
this recommendation, which is reflected in Sec.  1.987-2(b)(2).

E. Consistency of Attribution Rules and QBU Concept Across Subpart J

    A comment observed that the 2006 proposed regulations provide rules 
for attributing assets and liabilities, and items of income or expense, 
to an eligible QBU and that those rules should apply for purposes of 
sections 985, 987, and 989 to avoid inconsistencies across subpart J. 
Accordingly, Sec.  1.989(a)-1(d)(3) is revised to provide that the 
principles of Sec.  1.987-2(b) apply in determining whether an asset, 
liability, or item of income or expense is properly reflected on the 
books and records of a QBU.
    To further enhance consistency, the definition of an eligible QBU 
in Sec.  1.987-1(b)(3) is revised to cross-reference the QBU definition 
under Sec.  1.989-1(a). The 1991 proposed regulations generally would 
have applied to a QBU within the

[[Page 88813]]

meaning of Sec.  1.989(a)-1 that has a functional currency different 
than the functional currency of its owner. The 2006 proposed 
regulations, in contrast, did not refer directly to the Sec.  1.989-
1(a) QBU definition. Rather, the 2006 regulations generally defined an 
eligible QBU as activities that constitute a trade or business as 
defined in Sec.  1.989(a)-1(c) for which a separate set of books and 
records are maintained. By relying on the definition of a QBU in Sec.  
1.989(a)-1, as the 1991 proposed regulations did, the final regulations 
avoid inadvertently introducing inconsistencies across subpart J in the 
definition of a QBU.

F. Offsetting Positions

    Under Sec.  1.987-2(b)(3)(iii)(C) of the 2006 proposed regulations, 
if a principal purpose of recording (or failing to record) an item on 
the books and records of an eligible QBU was the avoidance of U.S. tax 
under section 987, the Commissioner could reallocate any item between 
or among the eligible QBU, its owner, and other persons, entities, or 
eligible QBUs. One relevant factor identified in the 2006 proposed 
regulations as indicating tax avoidance as a principal purpose of 
recording (or failing to record) an item on the books and records of an 
eligible QBU was the presence or absence of an item on such books and 
records that results in the taxpayer (or a person related to the 
taxpayer as defined in section 267(b) or 707(b)) having offsetting 
positions in the functional currency of a section 987 QBU. The 
``offsetting position'' concern might arise, for example, when a home 
office borrows funds denominated in the functional currency of a 
section 987 QBU and then onlends those funds to its section 987 QBU. 
Since the intra-taxpayer loan is not recognized, the funding 
transaction booked to the home office will be a section 988 transaction 
and the cash booked to the section 987 QBU derived from the funding 
transaction will be subject to section 987. A comment recommended that 
the Treasury Department and the IRS restrict the parameters of the 
``offsetting position'' factor, particularly in the context of banks.
    As discussed in Part II.B of this preamble, these regulations do 
not apply to banks. Accordingly, this comment will be reconsidered when 
regulations applying section 987 to banks and other financial entities 
are developed. Outside of the financial entity context, the Treasury 
Department and the IRS have determined that the ``offsetting position'' 
factor in Sec.  1.987-2(b)(3)(iii)(C) is necessary to prevent the use 
of transactions involving offsetting gains and losses to selectively 
recognize losses without recognition of gain. Accordingly, the 
recommendation to restrict the parameters of the ``offsetting 
position'' factor has not been adopted.

G. Exclusion of Ordinary-Course Transactions From the Definition of a 
Transfer

    Several comments recommended that transactions entered into between 
two section 987 QBUs of the same taxpayer, or by a section 987 QBU and 
its home office, in the ordinary course of business should not be 
considered ``transfers'' that are taken into account in determining the 
amount of a remittance. These comments noted the complexity associated 
with tracking a large number of ordinary-course transactions and 
contended that such transactions were not appropriate occasions to 
recognize section 987 gain or loss.
    The Treasury Department and the IRS have determined that it is not 
feasible to define the parameters of an ordinary-course exception to 
the definition of a transfer with sufficient clarity to avoid abuse and 
permit effective enforcement given the potentially high volume and 
variety of transactions between a section 987 QBU and its home office. 
More significantly, determining the net transfer to or from a section 
987 QBU, without regard to whether transfers occur in the ordinary 
course of business, is essential for appropriately determining section 
987 gain or loss under Sec.  1.987-4 because all transfers affect the 
OFCNV of the section 987 QBU. Furthermore, the Treasury Department and 
the IRS have determined that the annual netting convention of Sec.  
1.987-5, which simplifies the calculation of a remittance relative to 
the 1991 proposed regulations by taking into account only the net 
transfer to or from a section 987 QBU during a taxable year, 
appropriately limits the extent to which ordinary course transactions 
between a section 987 QBU and its home office give rise to a 
remittance. Accordingly, the recommendation to include an ordinary-
course exception to the definition of transfer has not been adopted.
    A comment also recommended that the final regulations permit 
taxpayers to elect to treat disregarded sales of property and services 
in the ordinary course of business as regarded transactions. The 
Treasury Department and the IRS have determined that this 
recommendation, which would result in income or loss recognition on 
intra-taxpayer transactions, is inconsistent with the paradigm of 
section 987 and the entity classification regulations under section 
7701. Accordingly, the recommendation has not been adopted.

H. Extension of the Grouping Rules

    Section 1.987-1(b)(2)(ii) of the 2006 proposed regulations allows a 
taxpayer to elect to treat all of its directly owned section 987 QBUs 
with the same functional currency as a single QBU for purposes of 
section 987. This rule, however, does not allow different members of a 
consolidated group to group their section 987 QBUs with the same 
currency into a single QBU. In the preamble to the 2006 proposed 
regulations, the Treasury Department and the IRS requested comments on 
whether a grouping election should be allowed with respect to section 
987 QBUs owned by different members of a consolidated group and how 
this election should be technically effectuated.
    Several comments recommended extending the grouping rules to 
corporations that file a consolidated return so that a consolidated 
group could make transfers among section 987 QBUs without causing a 
remittance. However, based on the comments received, the Treasury 
Department and the IRS have been unable to reconcile in a satisfactory 
manner the timing of section 987 gain or loss and section 987 taxable 
income or loss under the final regulations with the principles of Sec.  
1.1502-13, including separate entity accounting for consolidated group 
members. As a result, this recommendation has not been adopted in the 
final regulations. The Treasury Department and the IRS continue to 
welcome comments with specific recommendations regarding how grouping 
of section 987 QBUs owned by different consolidated group members could 
be achieved in a manner consistent with the consolidated return 
regulations.
    A comment requested an election to group section 987 QBUs that are 
directly owned with section 987 QBUs that are indirectly owned through 
section 987 aggregate partnerships. The Treasury Department and the IRS 
have determined that allowing grouping of directly and indirectly owned 
section 987 QBUs would be inconsistent with the treatment of 
transactions between a partnership and its partner (and between 
eligible QBUs of the partnership and of the partner) as regarded 
transactions for Federal income tax purposes. Additionally, it is 
unclear how the treatment of directly and indirectly owned section 987 
QBUs as a single section 987 QBU could be reconciled with the general 
requirement under sections 702 and 703 that a

[[Page 88814]]

partnership determine its income separately. Due to the uncertainties 
about how directly and indirectly owned section 987 QBUs could be 
grouped in a manner consistent with the principles of subchapter K, the 
recommendation has not been adopted.
    A comment requested that an owner be permitted to elect to group 
less than all of its section 987 QBUs with the same functional 
currency. The Treasury Department and the IRS observe that it is 
possible for an owner to have section 987 gain with respect to some of 
its section 987 QBUs and section 987 loss with respect to other section 
987 QBUs with the same functional currency. In light of this 
possibility, the Treasury Department and the IRS are concerned that the 
ability to group section 987 QBUs without the constraint of a 
consistency requirement for all section 987 QBUs with the same 
functional currency could inappropriately facilitate the recognition of 
section 987 losses coupled with the deferral of section 987 gains. 
Accordingly, the recommendation has not been adopted.

I. Adjustment of the Computation of Net Unrecognized Exchange Gain or 
Loss for Tax-Exempt Income and Non-Deductible Expenses

    Section 1.987-4 of the 2006 proposed regulations provided a seven-
step process for determining the unrecognized section 987 gain or loss 
of a section 987 QBU for a taxable year. Comments noted that this 
calculation did not take into account the effects of tax-exempt income 
and non-deductible expenses on a section 987 QBU's cash flows. The 
comments advised that this omission would introduce distortions into 
the calculation of unrecognized section 987 gain or loss for a taxable 
year since these items affect a section 987 QBU's balance sheet. In 
response to these comments, Sec.  1.987-4(d) reflects additional steps 
in the calculation of unrecognized section 987 gain or loss that 
account for nondeductible expenses (Step 7) and tax-exempt income (Step 
8). Step 7 also now explicitly accounts for foreign taxes claimed as a 
credit, which must be translated at the same rate at which such taxes 
were translated under section 986(a).

J. Clarification That the Rules of Sec. Sec.  1.987-3 and -4 Apply for 
Determining the E&P of a Corporation

    Comments indicated that the 2006 proposed regulations did not 
clearly specify whether the rules provided for determining section 987 
taxable income or loss applied for purposes of determining the earnings 
and profits of a foreign corporation. Accordingly, Sec.  1.987-3(a) 
clarifies that a foreign corporation that owns a section 987 QBU must 
apply Sec.  1.987-3 in determining earnings and profits with respect to 
the section 987 QBU.

K. FEEP Annual Calculation Requirement

    Section 1.987-4(a) of the 2006 proposed regulations required the 
determination of the net unrecognized section 987 gain or loss of a 
section 987 QBU by the owner annually. In addition, Sec.  1.987-9 of 
the 2006 proposed regulations required the taxpayer to keep annual 
records that are sufficient to establish each section 987 QBU's section 
987 gain or loss. A comment requested elimination of these annual 
calculations and recordkeeping requirements. The Treasury Department 
and the IRS remain of the view that the annual calculation and 
recordkeeping requirements are necessary for IRS examiners to verify 
taxpayer compliance with the final regulations. Based on its experience 
examining taxpayer positions that relate to events in prior years, the 
IRS has determined that contemporaneous recordkeeping and calculation 
requirements provide a significantly more reliable basis for verifying 
compliance than calculations performed years after the relevant events, 
which in many cases would be performed by individuals without direct 
access to the individuals most familiar with the underlying facts or 
responsible for producing and maintaining the records. Accordingly, the 
annual requirements have been retained.

L. Character and Source of Section 987 Gain or Loss

    Consistent with the 1991 proposed regulations, the 2006 proposed 
regulations required the owner of a section 987 QBU to determine the 
character and source of section 987 gain or loss for all purposes of 
the Code, including for determining the extent to which section 987 
gain or loss gives rise to subpart F income. In particular, Sec.  
1.987-6(b)(2) of the 2006 proposed regulations required the owner to 
use the asset method under Sec.  1.861-9T(g) in the year of a 
remittance to characterize and source section 987 gain or loss for all 
purposes by reference to the assets of the section 987 QBU.
    A comment recommended an exception that would allow a taxpayer to 
elect to trace identified amounts of section 987 gain or loss to 
particular assets or liabilities and to characterize such gain or loss 
by reference to the income or expense derived (or to be derived) from 
such items. The Treasury Department and the IRS have determined that 
tracing section 987 gain or loss to particular assets and liabilities 
is inconsistent with the FEEP method, which aggregates and pools 
section 987 gain and loss for all assets and liabilities and for all 
years prior to a remittance. Accordingly, the Treasury Department and 
the IRS decline to adopt this comment.
    A comment questioned whether section 987(3), which refers to 
sourcing section 987 gain or loss by reference to post-1986 accumulated 
earnings, provided a sufficient basis for characterizing section 987 
gain or loss as subpart F income. The comment recommended against 
treating section 987 gain as subpart F income but also recommended 
that, if it were so treated, the final regulations provide a business 
needs exception similar to that under section 954(c)(1)(D). Another 
comment acknowledged the Treasury Department's authority under section 
989(c)(5) to characterize section 987 gain as subpart F income but 
questioned the consistency of the requirement in the 2006 proposed 
regulations to use the asset method of Sec.  1.861-9T to characterize 
section 987 gain or loss with the reference in section 987(3) to 
sourcing section 987 gain or loss by reference to post-1986 accumulated 
earnings. The comment recommended that the character and source of 
section 987 gain or loss be determined by reference to post-1986 
accumulated earnings.
    The Treasury Department and the IRS have determined that sourcing 
and characterizing section 987 gain or loss with direct reference to 
post-1986 accumulated earnings would give rise to substantial 
complexity and compliance burdens, including the need to track earnings 
of a section 987 QBU in separate categories over a long period of time. 
This approach also presents conceptual difficulties, given that section 
987 gain or loss arises from marked assets and liabilities rather than 
accumulated earnings, and allows for planning opportunities if there 
are deficits in post-1986 accumulated earnings. The Treasury Department 
and the IRS continue to believe that, as noted in the preamble to the 
2006 proposed regulations, the average tax book value of assets is a 
reasonable proxy for post-1986 accumulated earnings in the context of 
section 987. For these reasons, the Treasury Department and the IRS 
decline to adopt this recommendation. Pursuant to sections 987(3) and 
989(c)(5), these regulations follow the approach of the 2006 proposed 
regulations in requiring the owner to use the asset method of Sec.  
1.861-9T(g) to characterize and source

[[Page 88815]]

section 987 gain or loss. The final regulations, however, do clarify 
that in applying the asset method, an owner must consistently determine 
the value of a section 987 QBU's assets on the basis of either the tax 
book value or the fair market value of the assets.
    Additionally, given the significant symmetry (other than timing) 
between the FEEP paradigm and section 988, the Treasury Department and 
the IRS have determined that, for purposes of determining the excess of 
foreign currency gains over foreign currency losses characterized as 
foreign personal holding company income under section 954(c)(1)(D), it 
is appropriate for taxpayers to treat section 987 gain or loss that is 
characterized by reference to assets that give rise to subpart F income 
as foreign currency gain or loss attributable to section 988 
transactions not directly related to the business needs of the 
controlled foreign corporation (CFC). This policy, which has been 
adopted in Sec.  1.987-6(b)(3), will allow taxpayers to offset a 
section 987 net loss characterized by reference to assets that give 
rise to subpart F income against a section 988 net gain, and vice 
versa, in determining subpart F income. Section 987 gain or loss 
characterized by reference to assets that give rise to subpart F income 
is treated as attributable to section 988 transactions not directly 
related to the business needs of the CFC because the Treasury 
Department and the IRS have determined that using the asset method of 
Sec.  1.861-9T(g) to characterize and source section 987 gain or loss 
effectively carries out the purpose of the business needs exclusion of 
section 954(c)(1)(D). In particular, because the asset method 
characterizes section 987 gain or loss based on whether assets give 
rise to subpart F income, section 987 gain or loss will not enter into 
the determination of foreign personal holding company income to the 
extent assets of the section 987 QBU do not give rise to subpart F 
income.

M. Partnerships

    The 2006 proposed regulations applied to all partnerships based on 
an approach (the aggregate approach) that treated a partnership as an 
aggregate of its partners, rather than as an entity separate from its 
partners. As explained in the preamble to the 2006 proposed 
regulations, the Treasury Department and the IRS proposed the aggregate 
approach because it appropriately determines section 987 gain or loss 
with respect to partnership assets and liabilities by reference to the 
functional currencies of the partners that ultimately bear the economic 
exposure to fluctuations in the exchange rate between their own 
functional currency and the functional currency of the activities of 
the partnership. Accordingly, under Sec. Sec.  1.989(a)-1(b)(2)(i) of 
the 2006 proposed regulations, a partnership itself was not treated as 
a section 987 QBU, but certain activities of a partnership that 
constituted a trade or business could qualify as a QBU that is an 
eligible QBU of a partner. Thus, a partner generally was treated as 
owning an eligible QBU consisting of a share of the assets and 
liabilities held in the partnership's trade or business. Such an 
eligible QBU could qualify as a section 987 QBU if it had a functional 
currency different from that of the partner.
    Comments requested that the Treasury Department and the IRS 
reconsider this aggregate approach and that final regulations instead 
treat a partnership as a separate entity with its own functional 
currency. The comments generally were premised on the concern that the 
aggregate approach was overly complex and that minority partners would 
not have the power to compel a partnership to provide them with the 
information needed to make the calculations required under the 
aggregate approach. One comment acknowledged the economic rationale for 
the aggregate approach but, in light of its complexity, recommended 
that it apply only in cases in which a partner's interest in 
partnership capital or profits exceeds a certain threshold, such as 10 
percent.
    The Treasury Department and the IRS acknowledge the concerns 
expressed about the complexity of applying the aggregate approach in 
the context of partnerships with partners that are unrelated to each 
other. Nonetheless, consistent with the comment recommending the 
aggregate approach for partners with substantial partnership interests, 
the Treasury Department and the IRS have determined that it is feasible 
to administer the aggregate approach with respect to a partnership that 
is wholly owned by related persons. Moreover, adopting the aggregate 
approach in that context is important for preventing planning 
opportunities that would arise if the interposition of a partnership 
within a group of related parties could significantly alter the results 
that the group otherwise would experience under section 987 without 
meaningfully altering the group's economic position. Accordingly, the 
final section 987 regulations retain the aggregate approach of the 2006 
proposed regulations only for so-called ``section 987 aggregate 
partnerships,'' which are defined in Sec.  1.987-1(b)(5) as 
partnerships for which all of the capital and profits interests are 
owned, directly or indirectly, by persons that are related within the 
meaning of section 267(b) or 707(b). The final regulations reflect a 
conforming amendment to the definition of a QBU at Sec.  1.989(a)-
1(b)(2)(i)(C), which now provides that a partnership, other than a 
section 987 aggregate partnership, is a QBU.
    The 2006 proposed regulations provided a rule for determining a 
partner's share of the assets and liabilities of an eligible QBU owned 
indirectly through a partnership. Specifically, Sec.  1.987-7(b) 
provided that a partner's share of assets and liabilities reflected on 
the books and records of the eligible QBU must be determined in a 
manner consistent with how the partners have agreed to share the 
economic benefits and burdens corresponding to partnership assets and 
liabilities, taking into account the rules and principles of subchapter 
K. One comment noted that this rule for allocating assets and 
liabilities to a partner's indirectly owned section 987 QBU was 
ambiguous and that the rules and principles of subchapter K do not 
provide sufficient guidance in this regard. Accordingly, as discussed 
in the preamble to the temporary regulations, the temporary regulations 
provide more specific rules for determining a partner's share of the 
assets and liabilities reflected on the books and records of an 
eligible QBU owned indirectly through a section 987 aggregate 
partnership.
    As previously discussed in this section, comments recommended that 
the Treasury Department and the IRS consider adopting an entity 
approach with respect to partnerships. Under the recommended entity 
approach, a partnership would have its own functional currency and 
would apply section 987 with respect to each of its section 987 QBUs to 
determine its taxable income or loss and section 987 gain or loss in 
that functional currency. Each partner then would be required to take 
into account its share of the section 987 taxable income or loss and 
section 987 gain or loss of the partnership, translated into the 
partner's functional currency at the average exchange rate for the 
partner's taxable year.
    Although the Treasury Department and the IRS have determined that 
the aggregate approach is appropriate for applying section 987 to 
section 987 aggregate partnerships, the Treasury Department and the IRS 
anticipate that regulations for applying section 987 to other 
partnerships (non-aggregate partnerships) will be developed under a 
separate project and may adopt a different approach. Accordingly, the

[[Page 88816]]

Treasury Department and the IRS request comments describing how an 
entity approach might apply to non-aggregate partnerships, including 
comments on (1) whether and how section 987 should apply to marked 
items denominated in the non-aggregate partnership's functional 
currency, (2) the information reporting that would be necessary to 
apply an entity approach, (3) whether a distinction should be made 
regarding how section 987 applies with respect to partnerships in which 
significant U.S. partners and CFCs together own more than 50 percent of 
the capital and profits interests in the partnership, and (4) the rules 
that would be needed to coordinate with subchapter K.

N. Terminations

    Under the 2006 proposed regulations, a section 987 QBU terminates 
when the activities of the section 987 QBU cease, substantially all of 
the assets of the section 987 QBU are transferred to its owner, a CFC 
owner of a section 987 QBU ceases being a CFC, or the owner of the 
section 987 QBU ceases to exist in a transaction other than certain 
liquidations and reorganizations described in section 381(a). The 
preamble to the 2006 proposed regulations requested comments on whether 
transfers of some or all of the assets of a section 987 QBU from one 
member of a consolidated group to another member of the group should 
result in a remittance or termination, respectively. Several comments 
supported a rule under which a section 351 transfer of some or all of 
the assets of a section 987 QBU to other members of a consolidated 
group would not cause a remittance or termination where those assets 
continue to be held in a section 987 QBU following the transaction.
    The Treasury Department and the IRS remain of the view that a 
transfer of substantially all of a section 987 QBU's assets and 
liabilities under section 351 should result in a termination under 
Sec.  1.987-8(b)(2) because the owner ceases to be subject to section 
987 with respect to the section 987 QBU and has no successor in a 
section 381(a) transaction. Nonetheless, the Treasury Department and 
the IRS agree that it is appropriate in certain circumstances to defer 
section 987 gain or loss that otherwise would be recognized as a result 
of certain transactions, including terminations, that result in deemed 
transfers from a section 987 QBU where some or all of the assets of the 
section 987 QBU continue to be reflected on the books and records of a 
section 987 QBU in the same controlled group. Additionally, the 
Treasury Department and the IRS have determined that combinations and 
separations of section 987 QBUs of the same owner generally should not 
result in recognition of section 987 gain or loss. As discussed in the 
preamble to the temporary regulations, the temporary regulations 
provide rules under which certain section 987 gain or loss that 
otherwise would be recognized upon a combination, separation, 
termination, or other event with respect to a section 987 QBU is 
deferred and recognized upon a subsequent event to the extent assets of 
the section 987 QBU continue to be reflected on the books and records 
of a section 987 QBU in the same controlled group. Under these rules, a 
section 351 transfer of some or all of the assets of a section 987 QBU 
within a consolidated group generally would not result in recognition 
of section 987 gain or loss, provided the transferred assets continue 
to be reflected on the books and records of a section 987 QBU.
    Comments recommended eliminating the rule in the 2006 proposed 
regulations under which a section 987 QBU terminates upon its owner 
ceasing to be a CFC. The comments indicated that the rule is 
inconsistent with the policy of subpart F and section 1248. One of the 
comments questioned the authority under subpart J for such a rule. A 
comment also recommended that the final regulations eliminate the rule 
under which a section 987 QBU terminates when it is acquired by a non-
CFC from a CFC owner in a reorganization in which the CFC owner goes 
out of existence but has a successor under section 381(a). The Treasury 
Department and the IRS acknowledge that the policy concern motivating 
these rules pertains primarily to situations in which a section 987 QBU 
ceases to be owned by a CFC but continues to be owned by related 
persons within the meaning of section 267(b). Accordingly, consistent 
with section 989(c)(5), a section 987 QBU will terminate under Sec.  
1.987-8(b)(3), (b)(4) and (c) only in that circumstance.
    Comments indicated that it was unclear under the 2006 proposed 
regulations whether a check-the-box election to treat a foreign 
disregarded entity that legally owns a section 987 QBU as a corporation 
for U.S. tax purposes would cause the section 987 QBU to terminate. To 
provide greater clarity, Example 6 in Sec.  1.987-8(f) illustrates that 
when a foreign disregarded entity that legally owns a section 987 QBU 
elects to be treated as a corporation under the check-the-box 
regulations in Sec.  301.7701-3, the section 987 QBU terminates due to 
the deemed transfer of assets from the section 987 QBU to the owner 
immediately prior to the deemed transfer of assets from the owner to 
the transferee corporation under section 351. Additionally, Sec.  
1.987-2(c)(2)(ii) clarifies that if an asset or liability of a section 
987 QBU is sold or exchanged (including in a nonrecognition 
transaction) for an asset or liability that is not attributable to the 
section 987 QBU immediately after the exchange (for example, non-
portfolio stock deemed to be received in a section 351 exchange), the 
exchanged asset is treated as transferred from the section 987 QBU to 
its owner in a disregarded transaction immediately before the exchange. 
This transfer would be taken into account in determining the amount of 
the remittance from the section 987 QBU under Sec.  1.987-5.
    Under the 2006 proposed regulations, a section 987 QBU terminates 
when its activities cease, such that it no longer meets the definition 
of an eligible QBU under Sec.  1.987-1(b)(3). For administrative 
convenience, Sec.  1.987-8(b)(1) reflects a new provision allowing the 
owner of a section 987 QBU that ceases its trade or business to 
continue to treat the section 987 QBU as a section 987 QBU for a 
reasonable period during the wind-up of the trade or business, which 
period may not exceed two years from the date the section 987 QBU 
ceases its activities carried on for profit.

O. Transition Rules

    Under the 2006 proposed regulations, a taxpayer that used a 
reasonable method to comply with section 987 prior to transitioning to 
the final regulations could choose between the deferral transition 
method and the fresh start transition method. The deferral transition 
method generally preserved section 987 gain or loss determined under 
the taxpayer's prior method, whereas the fresh start method did not.
    Under the deferral transition method, a taxpayer would determine 
section 987 gain or loss under the taxpayer's prior method as if all 
section 987 QBUs of the taxpayer terminated on the last day of the 
taxable year preceding the transition date. Such section 987 gain or 
loss was not recognized but rather was considered as net unrecognized 
section 987 gain or loss of new section 987 QBUs for purposes of 
applying section 987 to the taxable year that begins on the transition 
date. The owner of a section 987 QBU that was deemed terminated under 
this rule was treated as having transferred all of the assets and 
liabilities attributable to such section 987 QBU to the new section 987 
QBU on the transition date. Exchange rates for translating the amounts 
of assets and liabilities transferred to the

[[Page 88817]]

new section 987 QBU were determined with reference to the historic spot 
rates for such assets and liabilities, adjusted to take into account 
gain or loss determined on the deemed termination.
    Under the fresh start transition method, the same deemed 
transactions would be deemed to occur as under the deferral transition 
method, but no section 987 gain or loss would be determined upon the 
deemed termination. Exchange rates for translating the amounts of 
assets and liabilities deemed transferred to the new section 987 QBU 
were determined with reference to the historic spot rates for such 
assets and liabilities without adjustment. Accordingly, section 987 
gain or loss determined under the owner's prior method was not taken 
into account. Except to the extent of any previously recognized section 
987 gain or loss, the effect of the fresh start method is as if the 
assets and liabilities on the books and records of a section 987 QBU on 
the transition date had been the only assets and liabilities held by 
the QBU from its inception.
    The Treasury Department and the IRS received several comments 
recommending changes to the transition rules under Sec.  1.987-10 of 
the 2006 proposed regulations. One comment recommended that the 
deferral transition method be eliminated. The comment stated that the 
availability of two transition methods seemed overly generous to 
taxpayers and that the fresh start method was sufficient. The comment 
further noted that the effect of the elections made by taxpayers would 
be very one-sided in a manner detrimental to the fisc. Another comment 
recommended that taxpayers be permitted to elect a ``true fresh start'' 
method that would translate all assets and liabilities on the first 
opening balance sheet after the transition at the spot rate on the date 
of transition and therefore disregard any section 987 gain or loss 
attributable to the assets and liabilities of the QBU for periods prior 
to the transition date.
    The Treasury Department and the IRS agree with the comment that 
suggested that the fresh start method is sufficient and that the 
availability of an election between two different transition methods is 
unnecessary and detrimental to the fisc. By requiring the translation 
of assets and liabilities of transitioning QBUs at historic rates, 
unlike the ``true fresh start'' method suggested by a comment, the 
fresh start transition method appropriately takes into account the 
applicability of section 987 prior to the issuance of final 
regulations. Allowing an election to use the deferral method would 
allow taxpayers with substantial overall section 987 losses determined 
under their prior method, which may not correspond to economic losses, 
to preserve those losses while taxpayers with substantial overall 
section 987 gains determined under their prior method could avoid 
taking some of those gains into account by using the fresh start 
method. Such an election effectively would operate as a one-time 
election for certain taxpayers to reduce Federal income tax liability. 
Additionally, the Treasury Department and the IRS have determined that 
there would be considerable administrative difficulty, as well as 
potential for opportunistic planning, associated with determining the 
appropriate translation rates for transitioning under the deferral 
method from a section 987 method other than the method of the 1991 
proposed regulations. Accordingly, the final regulations do not include 
an election to use the deferral method. Additionally, the final 
regulations do not include an election to use a ``true fresh start'' 
method, since that method would fail to account in any way for the 
applicability of section 987 prior to the transition date with respect 
to assets and liabilities held by a section 987 QBU on the transition 
date.
    A comment recommended that the final regulations provide further 
guidance on the application of the fresh start method where a taxpayer 
cannot trace historic spot exchange rates. In response to this comment, 
Sec.  1.987-10(b)(3) provides that, if a taxpayer cannot reliably 
determine the historic rate for a particular asset or liability, the 
historic rate must be determined based on reasonable assumptions 
consistently applied. In addition, the general rules of Sec.  1.987-
1(c)(3)(i)(A) and (D) ease this burden by providing that the historic 
rate for assets and liabilities is the relevant yearly average exchange 
rate, rather than the spot rate.
    A comment recommended that taxpayers be permitted to elect 
retroactively to apply the final regulations to all open years. Such an 
election effectively would operate as one-time election to reduce 
Federal income tax liability. Additionally, consistent with the 
discussion in Part II.K of this preamble about the need for 
contemporaneous recordkeeping, the Treasury Department and the IRS have 
determined that retroactive application of the final regulations would 
present significant administrative and compliance difficulties, given 
that it would be necessary in many cases to make determinations under 
the final regulations based on facts that may not be readily 
ascertainable or verifiable in hindsight. Accordingly, this 
recommendation has not been adopted.
    A comment asserted that taxpayers that recognized section 987 gain 
or loss under the principles of the 1991 proposed regulations may be 
treated unfairly relative to taxpayers that did not follow those 
proposed regulations. To address this perceived unfairness, the comment 
recommended that taxpayers be permitted to elect to include a section 
481(a) adjustment to account for the difference between the amount of 
section 987 gain or loss that was taken into account under the 
taxpayer's prior method and the amount that would have been determined 
under the method in the final regulations. As an initial matter, it is 
not evident to the Treasury Department and the IRS that any inequity 
could result from a taxpayer's chosen method of applying section 987, 
given that, in the absence of applicable regulations, taxpayers have 
been permitted to apply section 987 using any reasonable method. 
Regardless of any perceived inequity, however, as discussed earlier in 
this Part II.O of the preamble, the Treasury Department and the IRS 
have determined that the fresh start transition method is the 
appropriate method for transitioning section 987 QBUs to the final 
regulations. Under the fresh start transition method, unrecognized 
section 987 gain or loss determined under a prior section 987 method is 
not taken into account, and marked assets and liabilities reflected on 
a section 987 QBU's balance sheet on the transition date are translated 
using a historic rate. These rules, together with the requirement under 
Sec.  1.987-10(d) to adjust unrecognized section 987 gain or loss to 
prevent double counting, have a similar effect as allowing a section 
481(a) adjustment with respect to section 987 gain or loss arising from 
assets and liabilities reflected on a section 987 QBU's transition date 
balance sheet. Additionally, it is unclear how a section 481(a) 
adjustment could apply with respect to section 987 gain or loss arising 
from assets and liabilities that are no longer on the balance sheet on 
the transition date, absent a requirement to redetermine section 987 
gain or loss as if the final regulations had applied from the inception 
of the QBU. For the reasons described in Part II.K of this preamble, 
the Treasury Department and the IRS have determined that such a 
requirement would be inadministrable. Furthermore, the Treasury 
Department and the IRS are concerned that an election to compute a full 
section 481(a) adjustment, like an election to use the

[[Page 88818]]

deferral method, effectively would operate as a one-time election to 
reduce Federal income tax liability. Accordingly, for the foregoing 
reasons, this recommendation has not been adopted.
    The Treasury Department and the IRS recognize that certain 
taxpayers have adopted a section 987 method based on a reasonable 
application of the 2006 proposed regulations (2006 method). Taxpayers 
that adopted the 2006 method generally already transitioned to that 
method in accordance with the principles Sec.  1.987-10 of the 2006 
proposed regulations. Because the final regulations adopt the 2006 
proposed regulations without fundamental changes, it is not necessary 
or appropriate for taxpayers to transition from the 2006 method to the 
final regulations under the fresh start method. However, Sec.  1.987-
10(c)(2) provides rules clarifying how net unrecognized section 987 
gain or loss with respect to a QBU that was subject to the 2006 method 
is determined under the final regulations. Additionally, because the 
2006 proposed regulations required the use of a spot rate for the 
historic rate and the final regulations specify as a general rule that 
the historic rate is the yearly average exchange rate, Sec.  1.987-
10(c)(3) permits taxpayers to use historic rates determined under their 
prior 2006 method for assets and liabilities reflected on the balance 
sheet of a transitioning QBU on the transition date.

P. Elections

    Several elections have been included in the final regulations to 
mitigate potential complexity or administrative burden associated with 
complying with these regulations. Section 1.987-1(g) provides rules for 
making elections. As under the 2006 proposed regulations, elections 
must be made by the owner and must be made for the first taxable year 
in which the election is relevant in determining the section 987 
taxable income or loss or section 987 gain or loss of the section 987 
QBU. Elections may not be revoked or changed without the consent of the 
Commissioner or his delegate. A revocation will be considered if the 
taxpayer can demonstrate significantly changed circumstances or other 
circumstances that demonstrate a substantial non-tax business reason 
for revoking the election.
    A comment recommended that the final regulations allow a taxpayer, 
without the consent of the Commissioner, to adopt or change the 
translation conventions for any section 987 QBU acquired from an 
unrelated person in a transaction that does not cause the QBU to 
terminate. The Treasury Department and the IRS have determined that 
requiring Commissioner consent to change an election in this 
circumstance promotes the ability of the IRS to administer the final 
regulations and does not create an undue burden. Accordingly, this 
recommendation has not been adopted.
    With one exception, the elections under the final regulations are 
made on a QBU-by-QBU basis. As provided under the 2006 proposed 
regulations and described in Part II.H of this preamble, an owner must 
make the grouping election described in Sec.  1.987-1(b)(2)(ii) with 
respect to all of its section 987 QBUs that have the same functional 
currency.
    The 2006 proposed regulations described elections made under 
section 987 as methods of accounting but provided procedures for making 
and revoking such elections that were inconsistent with treating the 
elections as methods of accounting. This inconsistency is resolved in 
the final regulations, which do not follow the 2006 proposed 
regulations in identifying all section 987 elections as methods of 
accounting and clarify at Sec.  1.987-1(g)(4) that an election under 
section 987 is not governed by the general rules concerning changes in 
methods of accounting.
    Under Sec.  1.987-1(f) of the 2006 proposed regulations, an 
election was made by attaching a statement to the timely filed tax 
return for the first taxable year in which the owner intends the 
election to be effective. If the owner failed to make an election in a 
timely manner, the owner was considered to have satisfied the 
timeliness requirement if (1) the owner was able to demonstrate that 
the failure was due to reasonable cause and not willful neglect; and 
(2) once the owner became aware of the failure, the owner attached the 
election as well as a written statement setting forth the reasons for 
the failure to timely comply to an amended tax return. The Director of 
Field Operations had 120 days following the filing to respond if it 
determined that the failure to comply was not due to reasonable cause 
or if additional time was needed to make a determination. If the 
Director did not respond to the taxpayer within 120 days of filing, the 
owner was deemed to have demonstrated that such failure to timely file 
was due to reasonable cause.
    The Treasury Department and the IRS have determined, in part based 
on the experience of the IRS in administering other regulations, that 
the procedures described in the 2006 proposed regulations may 
inappropriately shift to the IRS a burden that arises in the first 
instance as a result of a taxpayer's failure to make a timely election. 
Accordingly, those procedures are not included in the final 
regulations, and taxpayers who fail to make a timely election may seek 
relief in accordance with the general rules described in Sec.  
301.9100-1 for requesting an extension of time to make an election.

Q. Other Changes

    The final regulations reflect other modifications to the language 
and structure of the 2006 proposed regulations, as well as the 
inclusion of additional examples, to enhance clarity. The Treasury 
Department and the IRS do not intend these changes to be interpreted as 
substantive changes to the 2006 proposed regulations.

Special Analyses

    Certain IRS regulations, including these, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory assessment is not 
required. It is hereby certified that these regulations will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6). Accordingly, a regulatory flexibility analysis is 
not required. This certification is based on the fact that these 
regulations will primarily affect U.S. corporations that have foreign 
operations, which tend to be larger businesses. Pursuant to section 
7805(f) of the Internal Revenue Code, the NPRM preceding this 
regulation was submitted to the Chief Counsel for Advocacy of the Small 
Business Administration for comment on its impact on small business.

Drafting Information

    The principal authors of these final regulations are Mark E. Erwin, 
Steven D. Jensen and Sheila Ramaswamy of the Office of Associate Chief 
Counsel (International). However, other personnel from the IRS and the 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendment to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

[[Page 88819]]


0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 987, 989(c), and 7805 * * *


0
Par. 2. Section 1.861-9T is amended by revising paragraph 
(g)(2)(ii)(A)(1) and adding paragraph (g)(2)(vi) to read as follows:


Sec.  1.861-9T  Allocation and apportionment of interest expense 
(temporary).

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (A) * * *
    (1) Section 987 QBU. In the case of a section 987 QBU (as defined 
in Sec.  1.987-1(b)(2)), the tax book value shall be determined by 
applying the rules of paragraphs (g)(2)(i) and (g)(3) of this section 
to the beginning-of-year and end-of-year functional currency amount of 
assets. The beginning-of-year functional currency amount of assets 
shall be determined by reference to the functional currency amount of 
assets computed under Sec.  1.987-4(d)(1)(i)(B) and (e) on the last day 
of the preceding taxable year. The end-of-year functional currency 
amount of assets shall be determined by reference to the functional 
currency amount of assets computed under Sec.  1.987-4(d)(1)(i)(A) and 
(e) on the last day of the current taxable year. The beginning-of-year 
and end-of-year functional currency amount of assets, as so determined 
within each grouping, must then be averaged as provided in paragraph 
(g)(2)(i) of this section.
* * * * *
    (vi) Effective/applicability date. Generally, paragraph 
(g)(2)(ii)(A)(1) of this section shall apply to taxable years beginning 
on or after one year after the first day of the first taxable year 
following December 7, 2016. If pursuant to Sec.  1.987-11(b) a taxpayer 
applies Sec. Sec.  1.987-1 through 1.987-11 beginning in a taxable year 
prior to the earliest taxable year described in Sec.  1.987-11(a), then 
paragraph (g)(2)(ii)(A)(1) of this section shall apply to taxable years 
beginning on or after the first day of such prior taxable year.
* * * * *

0
Par 3. Section 1.985-5 is revised to read as follows:


Sec.  1.985-5  Adjustments required upon change in functional currency.

    (a) In general. This section applies in the case of a taxpayer or 
qualified business unit (QBU) (including a section 987 QBU (as defined 
in Sec.  1.987-1(b)(2)) changing from one functional currency (old 
functional currency) to another functional currency (new functional 
currency). A taxpayer or QBU subject to the rules of this section shall 
make the adjustments set forth in the 3-step procedure described in 
paragraphs (b) through (e) of this section. Except as otherwise 
provided in this section, the adjustments shall be made on the last day 
of the last taxable year ending before the year of change (as defined 
in Sec.  1.481-1(a)(1)). Gain or loss required to be recognized under 
paragraphs (b), (d)(2), (e)(2), and (e)(4)(iii) of this section is not 
subject to section 481 and, therefore, the full amount of the gain or 
loss must be included in income on the last day of the last taxable 
year ending before the year of change.
    (b) Step 1--Taking into account exchange gain or loss on certain 
section 988 transactions. The taxpayer or QBU shall recognize or 
otherwise take into account for all purposes of the Internal Revenue 
Code the amount of any unrealized exchange gain or loss attributable to 
a section 988 transaction (as defined in section 988(c)(1)(A) through 
(C)) that, after applying section 988(d), is denominated in terms of or 
determined by reference to the new functional currency. The amount of 
such gain or loss shall be determined without regard to the limitations 
of section 988(b) (that is, whether any gain or loss would be realized 
on the transaction as a whole). The character and source of such gain 
or loss shall be determined under section 988.
    (c) Step 2--Determining the new functional currency basis of 
property and the new functional currency amount of liabilities and any 
other relevant items. Except as otherwise provided in this section, the 
new functional currency adjusted basis of property and the new 
functional currency amount of liabilities and any other relevant items 
(for example, items described in section 988(c)(1)(B)(iii)) shall equal 
the product of the old functional currency adjusted basis or liability 
and the new functional currency/old functional currency spot rate on 
the last day of the last taxable year ending before the year of change.
    (d) Step 3A--Additional adjustments that are necessary when a QBU 
changes functional currency--(1) QBU changing to a functional currency 
other than the owner's functional currency--(i) Rule. If a QBU changes 
its functional currency, and after the change the QBU is a section 987 
QBU that is subject to Sec. Sec.  1.987-1 through 1.987-11 pursuant to 
Sec.  1.987-1(b)(1), then the adjustments described in either paragraph 
(d)(1)(ii) or (d)(1)(iii) of this section shall be taken into account 
for purposes of section 987.
    (ii) QBU and the owner had different functional currencies prior to 
the change. If the QBU and the owner of the QBU had different 
functional currencies prior to the change and as a result the QBU was a 
section 987 QBU prior to the change, then the adjustments described in 
paragraphs (d)(1)(ii)(A) and (d)(1)(ii)(B) of this section shall be 
taken into account.
    (A) Determining new historic rates. The historic rate (as defined 
in Sec.  1.987-1(c)(3)) for the year of change and subsequent taxable 
years with respect to a historic item (as defined in Sec.  1.987-1(e)) 
reflected on the balance sheet of the section 987 QBU immediately prior 
to the year of change shall be equal to the historic rate prior to the 
year of change (that is, a rate that translates the section 987 QBU's 
old functional currency into the owner's functional currency) divided 
by the spot rate (as defined in Sec.  1.987-1(c)(1)) for translating an 
amount denominated in the section 987 QBU's old functional currency 
into the section 987 QBU's new functional currency on the last day of 
the last taxable year ending before the year of change. For example, if 
a taxpayer with a U.S. dollar (USD) functional currency owns a section 
987 QBU that changes from a British pound (GBP) functional currency to 
a euro (EUR) functional currency, the historic rate for translating a 
specific historic item of this section 987 QBU from GBP to USD is 1.50, 
and the spot rate for translating GBP to EUR on the last day of the 
last taxable year before the change is 1.30, then the new historic rate 
for translating this historic item from EUR to USD is 1.15 (1.50/1.30).
    (B) Determining the owner functional currency net value of the QBU 
on the last day of the last taxable year ending before the year of 
change under Sec.  1.987-4(d)(1)(i)(B). For purposes of determining the 
owner functional currency net value of the section 987 QBU on the last 
day of the last taxable year ending before the year of change under 
Sec.  1.987-4(d)(1)(i)(B) and Sec.  1.987-4(e), the section 987 QBU's 
marked items (as defined in Sec.  1.987-1(d)) shall be translated from 
the section 987 QBU's old functional currency into the owner's 
functional currency using the spot rate on the last day of the last 
taxable year ending before the year of change.
    (iii) QBU and the taxpayer had the same functional currency prior 
to the change. If a QBU that has the same functional currency as a 
taxpayer changes its functional currency to a new functional currency 
that is different

[[Page 88820]]

than the functional currency of the taxpayer, and as a result the 
taxpayer becomes an owner of a section 987 QBU (see Sec.  1.987-1), the 
taxpayer and section 987 QBU will become subject to section 987 for the 
year of change and subsequent years.
    (2) QBU changing to the owner's functional currency. If a section 
987 QBU changes its functional currency to the functional currency of 
its owner, the section 987 QBU shall be treated as if it terminated on 
the last day of the last taxable year ending before the year of change. 
See Sec. Sec.  1.987-5 and 1.987-8 for the effect of a termination of a 
section 987 QBU that is subject to Sec. Sec.  1.987-1 through 1.987-11.
    (e) Step 3B--Additional adjustments that are necessary when a 
taxpayer/owner changes functional currency--(1) Corporations. The 
amount of a corporation's new functional currency earnings and profits 
and the amount of its new functional currency paid-in capital shall 
equal the old functional currency amounts of such items multiplied by 
the spot rate for translating an amount denominated in the 
corporation's old functional currency into the corporation's new 
functional currency on the last day of the last taxable year ending 
before the year of change. The foreign income taxes and accumulated 
profits or deficits in accumulated profits of a foreign corporation 
that were maintained in foreign currency for purposes of section 902 
and that are attributable to taxable years of the foreign corporation 
beginning before January 1, 1987, also shall be translated into the new 
functional currency at the spot rate.
    (2) Collateral consequences to a United States shareholder of a 
corporation changing to the United States dollar as its functional 
currency. A United States shareholder (within the meaning of section 
951(b) or section 953(c)(1)(A)) of a controlled foreign corporation 
(within the meaning of section 957 or section 953(c)(1)(B)) changing 
its functional currency to the dollar shall recognize foreign currency 
gain or loss computed under section 986(c) as if all previously taxed 
earnings and profits, if any, (including amounts attributable to pre-
1987 taxable years that were translated from dollars into functional 
currency in the foreign corporation's first post-1986 taxable year) 
were distributed immediately prior to the change.
    (3) Taxpayers that are not corporations. [Reserved].
    (4) Adjustments to a section 987 QBU's balance sheet and net 
accumulated unrecognized section 987 gain or loss when an owner changes 
functional currency--(i) Owner changing to a functional currency other 
than the section 987 QBU's functional currency. If an owner of a 
section 987 QBU, subject to Sec. Sec.  1.987-1 through 1.987-11 
pursuant to Sec.  1.987-1(b)(1), changes to a functional currency other 
than the functional currency of the section 987 QBU, the adjustments 
described in paragraphs (e)(4)(i)(A) through (C) of this section shall 
be taken into account for purposes of section 987.
    (A) Determining new historic rates. The historic rate (as defined 
in Sec.  1.987-1(c)(3)) for the year of change and subsequent taxable 
years with respect to a historic item (as defined in Sec.  1.987-1(e)) 
reflected on the balance sheet of the section 987 QBU immediately prior 
to the year of change shall be equal to the historic rate prior to the 
year of change (that is, a rate that translates the section 987 QBU's 
functional currency into the owner's old functional currency) divided 
by the spot rate for translating an amount denominated in the owner's 
new functional currency into the owner's old functional currency on the 
last day of the last taxable year ending before the year of change. For 
example, if a taxpayer that owns a section 987 QBU with a British pound 
functional currency changes from a U.S. dollar functional currency to a 
euro functional currency, and the historic rate for translating a 
specific item of the section 987 QBU from GBP to USD is 1.50 and the 
spot rate for translating EUR to USD on the last day of the last 
taxable year before the change is 1.10, then the new historic rate for 
translating this historic item from GBP to EUR is 1.36 (1.50/1.10).
    (B) Determining the owner functional currency net value of the 
section 987 QBU on the last day of the last taxable year ending before 
the year of change under Sec.  1.987-4(d)(1)(i)(B). For purposes of 
determining the change in the owner functional currency net value of 
the section 987 QBU on the last day of the last taxable year preceding 
the year of change under Sec. Sec.  1.987-4(d)(1)(i)(B) and 1.987-4(e), 
the section 987 QBU's marked items shall be translated into the owner's 
new functional currency at the spot rate on the last day of the last 
taxable year ending before the year of change.
    (C) Translation of net accumulated unrecognized section 987 gain or 
loss. Any net accumulated unrecognized section 987 gain or loss 
determined under Sec.  1.987-4 shall be translated from the owner's old 
functional currency into the owner's new functional currency using the 
spot rate for translating an amount denominated in the owner's old 
functional currency into the owner's new functional currency on the 
last day of the last taxable year ending before the year of change.
    (ii) Taxpayer with the same functional currency as its QBU changing 
to a different functional currency. If a taxpayer with the same 
functional currency as its QBU changes to a new functional currency and 
as a result the taxpayer becomes an owner of a section 987 QBU (see 
Sec.  1.987-1), the taxpayer and the section 987 QBU shall become 
subject to section 987 for the year of change and subsequent years.
    (iii) Owner changing to the same functional currency as the section 
987 QBU. If an owner changes its functional currency to the functional 
currency of its section 987 QBU, the section 987 QBU shall be treated 
as if it terminated on the last day of the last taxable year ending 
before the year of change. See Sec. Sec.  1.987-5 and 1.987-8 for the 
consequences of a termination of a section 987 QBU that is subject to 
Sec. Sec.  1.987-1 through 1.987-11.
    (f) Example. The provisions of this section are illustrated by the 
following example:

    Example.  (i) Facts. FC, a foreign corporation, owns all of the 
stock of DC, a domestic corporation. The Commissioner granted 
permission to change FC's functional currency from the British pound 
to the euro beginning January 1, 2020. The EUR/GBP exchange rate on 
December 31, 2019, is [euro]1:[pound]0.50.
    (ii) Determining new functional currency basis of property and 
liabilities. The following table shows how FC must convert the items 
on its balance sheet from the British pound to the euro on December 
31, 2019.

------------------------------------------------------------------------
                                                GBP             EUR
------------------------------------------------------------------------
Assets:
    Cash on hand........................   [pound]40,000    [euro]80,000
    Accounts Receivable.................          10,000          20,000
    Inventory...........................         100,000         200,000
    [euro]100,000 Euro Bond                       50,000         100,000
     ([pound]100,000 historical basis)..
Fixed assets:

[[Page 88821]]

 
    Property............................         200,000         400,000
    Plant...............................         500,000       1,000,000
        Accumulated Depreciation........       (200,000)       (400,000)
    Equipment...........................       1,000,000       2,000,000
        Accumulated Depreciation........       (400,000)       (800,000)
                                         -------------------------------
            Total Assets................       1,300,000       2,600,000
Liabilities:
    Accounts Payable....................          50,000         100,000
    Long-term Liabilities...............         400,000         800,000
    Paid-in-Capital.....................         800,000       1,600,000
    Retained Earnings...................          50,000         100,000
                                         -------------------------------
                Total Liabilities and          1,300,000       2,600,000
                 Equity.................
------------------------------------------------------------------------

    (iii) Exchange gain or loss on section 988 transactions. Under 
paragraph (b) of this section, FC will recognize a [pound]50,000 
loss ([pound]50,000 current value minus [pound]100,000 historical 
basis) on the Euro Bond resulting from the change in functional 
currency because, after the change, the Euro Bond will no longer be 
an asset denominated in a non-functional currency. The amount of 
FC's retained earnings on its December 31, 2019, balance sheet 
reflects the [pound]50,000 loss on the Euro Bond.

    (g) Effective/applicability date. Generally, this regulation shall 
apply to taxable years beginning on or after one year after the first 
day of the first taxable year following December 7, 2016. If pursuant 
to Sec.  1.987-11(b) a taxpayer applies Sec. Sec.  1.987-1 through 
1.987-11 beginning in a taxable year prior to the earliest taxable year 
described in Sec.  1.987-11(a), then this section shall apply to 
taxable years of the taxpayer beginning on or after the first day of 
such prior taxable year.

0
Par. 4. Section 1.987-0 is added and Sec. Sec.  1.987-1 through 1.987-5 
are revised to read as follows:
* * * * *
Sec.
1.987- Section 987; Table of contents.
.987-1 Scope, definitions and special rules.
1.987-2 Attribution of items to eligible QBUs; definition of a 
transfer and related rules.
1.987-3 Determination of section 987 taxable income or loss of an 
owner of a section 987 QBU.
1.987-4 Determination of net unrecognized section 987 gain or loss 
of a section 987 QBU.
1.987-5 Recognition of section 987 gain or loss.
* * * * *


Sec.  1.987-0  Section 987; table of contents.

    This section lists captioned paragraphs contained in Sec. Sec.  
1.987-1 through 1.987-11.

Sec.  1.987-1 Scope, definitions and special rules.

    (a) In general.
    (b) Scope of section 987 and definitions.
    (1) Taxpayers subject to section 987.
    (2) Definition of section 987 QBU.
    (3) Definition of an eligible QBU.
    (4) Definition of owner.
    (5) Section 987 aggregate partnership.
    (6) [Reserved].
    (7) Examples illustrating paragraph (b) of this section.
    (c) Exchange rates.
    (1) Spot rate.
    (2) Yearly average exchange rate.
    (3) Historic rate.
    (d) Marked item.
    (e) Historic item.
    (f) [Reserved].
    (g) Elections.
    (1) In general.
    (2) Exceptions to the general rules.
    (3) Manner of making elections.
    (4) No change in method of accounting.
    (5) Revocation of an election.

Sec.  1.987-2 Attribution of items to eligible QBUs; definition of a 
transfer and related rules.

    (a) Scope and general principles.
    (b) Attribution of items to an eligible QBU.
    (1) General rules.
    (2) Exceptions for non-portfolio stock, interests in 
partnerships, and certain acquisition indebtedness.
    (3) Adjustments to items reflected on the books and records.
    (4) Assets and liabilities of a section 987 aggregate 
partnership or DE that are not attributed to an eligible QBU.
    (c) Transfers to and from section 987 QBUs.
    (1) In general.
    (2) Disregarded transactions.
    (3) Transfers of assets to and from section 987 QBUs owned 
through section 987 aggregate partnerships.
    (4) Transfers of liabilities to and from section 987 QBUs owned 
through section 987 aggregate partnerships.
    (5) Acquisitions and dispositions of interests in DEs and 
section 987 aggregate partnerships.
    (6) Changes in form of ownership.
    (7) Application of general tax law principles.
    (8) Interaction with Sec.  1.988-1(a)(10).
    (9) [Reserved].
    (10) Examples.
    (d) Translation of items transferred to a section 987 QBU.
    (1) Marked items.
    (2) Historic items.

Sec.  1.987-3 Determination of section 987 taxable income or loss of 
an owner of a section 987 QBU.

    (a) In general.
    (b) Determination of each item of income, gain, deduction, or 
loss in the section 987 QBU's functional currency.
    (1) In general.
    (2) Translation of items of income, gain, deduction, or loss 
that are denominated in a nonfunctional currency.
    (3) Determination in the case of a section 987 QBU owned through 
a section 987 aggregate partnership.
    (4) [Reserved].
    (c) Translation of items of income, gain, deduction, or loss of 
a section 987 QBU into the owner's functional currency.
    (1) In general.
    (2) Exceptions.
    (3) Adjustments to COGS required under the simplified inventory 
method.
    (d) [Reserved].
    (e) Examples.

Sec.  1.987-4 Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU.

    (a) In general.
    (b) Calculation of net unrecognized section 987 gain or loss.
    (c) Net accumulated unrecognized section 987 gain or loss for 
all prior taxable years.
    (1) In general.
    (2) [Reserved].
    (d) Calculation of unrecognized section 987 gain or loss for a 
taxable year.
    (1) Step 1: Determine the change in the owner functional 
currency net value of the section 987 QBU for the taxable year.
    (2) Step 2: Increase the amount determined in step 1 by the 
amount of assets transferred from the section 987 QBU to the owner.
    (3) Step 3: Decrease the amount determined in steps 1 and 2 by 
the amount of assets transferred from the owner to the section 987 
QBU.
    (4) Step 4: Decrease the amount determined in steps 1 through 3 
by the amount of liabilities transferred from the section 987 QBU to 
the owner.
    (5) Step 5: Increase the amount determined in steps 1 through 4 
by the amount of liabilities transferred from the owner to the 
section 987 QBU.
    (6) Step 6: Decrease or increase the amount determined in steps 
1 through 5 by the

[[Page 88822]]

section 987 taxable income or loss, respectively, of the section 987 
QBU for the taxable year.
    (7) Step 7: Increase the amount determined in steps 1 through 6 
by any expenses that are not deductible in computing the section 987 
taxable income or loss of the section 987 QBU for the taxable year.
    (8) Step 8: Decrease the amount determined in steps 1 through 7 
by the amount of any tax-exempt income.
    (e) Determination of the owner functional currency net value of 
a section 987 QBU.
    (1) In general.
    (2) Translation of balance sheet items into the owner's 
functional currency.
    (f) [Reserved].
    (g) Examples.

Sec.  1.987-5 Recognition of section 987 gain or loss.

    (a) Recognition of section 987 gain or loss by the owner of a 
section 987 QBU.
    (b) Remittance proportion.
    (c) Remittance.
    (1) Definition.
    (2) Day when a remittance is determined.
    (3) Termination.
    (d) Aggregate of all amounts transferred from the section 987 
QBU to the owner for the taxable year.
    (e) Aggregate of all amounts transferred from the owner to the 
section 987 QBU for the taxable year.
    (f) Determination of owner's adjusted basis in transferred 
assets.
    (1) In general.
    (2) Marked asset.
    (3) Historic asset.
    (g) Example.

Sec.  1.987-6 Character and source of section 987 gain or loss.

    (a) Ordinary income or loss.
    (b) Character and source of section 987 gain or loss.
    (1) In general.
    (2) Method required to characterize and source section 987 gain 
or loss.
    (3) Coordination with section 954.
    (c) Examples.

Sec.  1.987-7 Section 987 aggregate partnerships.

    (a) In general.
    (b) [Reserved].
    (c) Coordination with subchapter K.

Sec.  1.987-8 Termination of a section 987 QBU.

    (a) Scope.
    (b) In general.
    (1) Trade or business ceases.
    (2) Substantially all assets transferred.
    (3) Owner no longer a CFC.
    (4) Owner ceases to exist.
    (c) Transactions described in section 381(a).
    (1) Liquidations.
    (2) Reorganizations.
    (d) [Reserved].
    (e) Effect of terminations.
    (f) Examples.

Sec.  1.987-9 Recordkeeping requirements.
    (a) In general.
    (b) Supplemental information.
    (c) Retention of records.
    (d) Information on a dedicated section 987 form.

Sec.  1.987-10 Transition rules.
    (a) Scope.
    (b) Fresh start transition method.
    (1) In general.
    (2) Application of Sec.  1.987-4.
    (3) Determination of historic rate.
    (4) Example.
    (c) Transition of section 987 QBUs that applied the method set 
forth in the 2006 proposed section 987 regulations.
    (1) In general.
    (2) Application of Sec.  1.987-4.
    (3) Use of prior historic rate.
    (4) Example.
    (d) Adjustments to avoid double counting.
    (e) Reporting.
    (1) In general.
    (2) Attachments not required where information is reported on a 
form.

Sec.  1.987-11 Effective/applicability date.

    (a) In general.
    (b) Application of these regulations to taxable years beginning 
after December 7, 2016.
    (c) Transition date.


Sec.  1.987-1  Scope, definitions, and special rules.

    (a) In general. These regulations under section 987 (Sec. Sec.  
1.987-1 through 1.987-11) provide rules for determining the taxable 
income or loss of a taxpayer with respect to a section 987 QBU (as 
defined in paragraph (b)(2) of this section). Further, these 
regulations provide rules for determining the timing, amount, 
character, and source of section 987 gain or loss recognized with 
respect to a section 987 QBU. This section addresses the scope of these 
regulations and provides certain definitions, special rules, and the 
procedures for making the elections provided for in the regulations. 
Section 1.987-2 provides rules for attributing assets and liabilities 
and items of income, gain, deduction, and loss to an eligible QBU. It 
also provides rules regarding the translation of items transferred to a 
section 987 QBU. Section 1.987-3 provides rules for determining and 
translating the taxable income or loss of a taxpayer with respect to a 
section 987 QBU. Section 1.987-4 provides rules for determining net 
unrecognized section 987 gain or loss. Section 1.987-5 provides rules 
regarding the recognition of section 987 gain or loss. It also provides 
rules for determining an owner's basis in assets transferred from a 
section 987 QBU. Section 1.987-6 provides rules regarding the character 
and source of section 987 gain or loss. Section 1.987-7 provides rules 
with respect to section 987 aggregate partnerships. Section 1.987-8 
provides rules regarding the termination of a section 987 QBU. Section 
1.987-9 provides rules regarding the recordkeeping required under 
section 987. Section 1.987-10 provides transition rules. Section 1.987-
11 provides the effective/applicability date of these regulations.
    (b) Scope of section 987 and definitions--(1) Taxpayers subject to 
section 987--(i) In general. Except as provided in paragraphs 
(b)(1)(ii) and (b)(6) of this section, an individual or corporation is 
subject to these regulations under section 987 if such person is an 
owner (as defined in paragraph (b)(4) of this section) of an eligible 
QBU (as defined in paragraph (b)(3) of this section) that is a section 
987 QBU (as defined in paragraph (b)(2) of this section).
    (ii) Inapplicability to certain entities. Except as otherwise 
provided in paragraph (b)(1)(iii) of this section, these regulations 
under section 987 do not apply to specified entities described in this 
paragraph (b)(1)(ii), other than specified entities that engage in 
transactions primarily with related persons within the meaning of 
section 267(b) or section 707(b) that are not themselves specified 
entities. For this purpose, specified entities means banks, insurance 
companies, leasing companies, finance coordination centers, regulated 
investment companies, or real estate investment trusts. Further, except 
as otherwise provided in paragraph (b)(1)(iii) of this section, these 
regulations do not apply to trusts, estates, S corporations, and 
partnerships other than section 987 aggregate partnerships (as defined 
in paragraph (b)(5) of this section).
    (iii) [Reserved].
    (2) Definition of a section 987 QBU--(i) In general. A section 987 
QBU is an eligible QBU (as defined in paragraph (b)(3) of this section) 
that has a functional currency different from its direct owner. A 
section 987 QBU also includes the assets and liabilities of an eligible 
QBU that are considered under paragraph (b)(5)(ii) of this section to 
be a section 987 QBU of a partner in a section 987 aggregate 
partnership (as defined in paragraph (b)(5) of this section). A section 
987 QBU will continue to be treated as a section 987 QBU of the owner 
until a sale or other termination of the section 987 QBU as described 
in Sec.  1.987-8(b). Except as provided in paragraph (b)(2)(ii) of this 
section, the functional currency of an eligible QBU shall be determined 
under Sec.  1.985-1.
    (ii) Section 987 QBU grouping election--(A) In general. Except as 
provided in paragraph (b)(2)(ii)(B) of this section, an owner may elect 
to treat, solely for purposes of section 987, all section 987 QBUs with 
the same functional currency that it directly owns as a single section 
987 QBU.

[[Page 88823]]

    (B) Special grouping rules for section 987 QBUs owned indirectly 
through a section 987 aggregate partnership. An owner may elect to 
treat all section 987 QBUs with the same functional currency owned 
indirectly through a single section 987 aggregate partnership (as 
defined in paragraph (b)(5) of this section) as a single section 987 
QBU. An owner may not treat section 987 QBUs as a single section 987 
QBU if such QBUs are owned indirectly through different section 987 
aggregate partnerships. Additionally, an owner may not treat section 
987 QBUs that are owned both directly and indirectly through a section 
987 aggregate partnership as a single section 987 QBU.
    (3) Definition of an eligible QBU--(i) In general. Eligible QBU 
means a qualified business unit, as defined in Sec.  1.989(a)-1, that 
is not subject to the Dollar Approximate Separate Transactions Method 
rules of Sec.  1.985-3.
    (ii) Exclusion of certain entities. A corporation, partnership, 
trust, estate, or entity disregarded as an entity separate from its 
owner for Federal income tax purposes as described in Sec.  301.7701-
2(c)(2) (hereafter referred to as a ``DE'') is not an eligible QBU 
(even though such an entity may have activities that qualify as an 
eligible QBU).
    (4) Definition of owner. For purposes of these regulations under 
section 987, an owner is any person having direct or indirect ownership 
in an eligible QBU. Only an individual or corporation may be an owner 
of an eligible QBU. The term owner for section 987 purposes does not 
include an eligible QBU. For example, a section 987 QBU (QBU1) is not 
an owner of another section 987 QBU (QBU2) even if QBU1 owns the stock 
of QBU2.
    (i) Direct ownership. An individual or a corporation is a direct 
owner of an eligible QBU if the individual or corporation is the owner 
for Federal income tax purposes of the assets and liabilities of the 
eligible QBU.
    (ii) Indirect ownership. An individual or corporation that is a 
partner in a section 987 aggregate partnership (as defined in paragraph 
(b)(5) of this section) and is allocated, under Sec.  1.987-7, all or a 
portion of the assets and liabilities of an eligible QBU of such 
partnership is an indirect owner of the eligible QBU.
    (5) Section 987 aggregate partnership--(i) In general. A 
partnership is a section 987 aggregate partnership if:
    (A) All of the interests in partnership capital and profits are 
owned, directly or indirectly, by persons related to each other within 
the meaning of sections 267(b) or 707(b). For purposes of this 
paragraph (b)(5), ownership of an interest in partnership capital or 
profits is determined in accordance with the rules for constructive 
ownership provided in section 267(c), other than section 267(c)(3); and
    (B) The partnership has one or more eligible QBUs, at least one of 
which would be a section 987 QBU with respect to a partner if the 
partner owned the eligible QBU directly.
    (ii) Section 987 QBU of a partner. The assets and liabilities of an 
eligible QBU owned through a section 987 aggregate partnership and 
allocated to a partner under the principles of Sec.  1.987-7(b) are 
considered to be a section 987 QBU of such partner if the partner has a 
functional currency different from that of the eligible QBU.
    (iii) Certain unrelated partners disregarded. In determining 
whether a partnership is a section 987 aggregate partnership, the 
interest of an unrelated partner shall be disregarded if the 
acquisition of such interest has as a principal purpose the avoidance 
of this paragraph (b)(5).
    (6) [Reserved].
    (7) Examples illustrating paragraph (b) of this section. The 
following examples illustrate the principles of paragraph (b) of this 
section. U.S. Corp is a domestic corporation, has the U.S. dollar as 
its functional currency, and uses the calendar year as its taxable 
year. Except as otherwise provided, (i) Business A and Business B are 
eligible QBUs and have the euro and the Japanese yen, respectively, as 
their functional currencies and (ii) DE1 and DE2 are DEs, have no 
assets or liabilities, and conduct no activities.

    Example 1.  (i) Facts. U.S. Corp owns Business A and all of the 
interests in DE1. DE1 maintains a separate set of books and records 
that are kept in British pounds. DE1 owns pounds and all of the 
stock of a foreign corporation, FC. DE1 is liable to a lender on a 
pound-denominated obligation that was incurred to acquire the stock 
of FC. The FC stock, the pounds, and the liability incurred to 
acquire the FC stock are recorded on DE1's separate books and 
records. DE1 has no other assets or liabilities and conducts no 
activities (other than holding the FC stock and servicing its 
liability).
    (ii) Analysis. (A) Pursuant to paragraph (b)(4)(i) of this 
section, U.S. Corp is the direct owner of Business A because it is 
the owner of the assets and liabilities of Business A. Because 
Business A is an eligible QBU with a functional currency that is 
different from the functional currency of its owner, U.S. Corp, 
Business A is a section 987 QBU (as defined in paragraph (b)(2) of 
this section). As a result, U.S. Corp and its section 987 QBU, 
Business A, are subject to section 987.
    (B) Holding the stock of FC and pounds and servicing a liability 
does not constitute a trade or business within the meaning of Sec.  
1.989(a)-1(c). Because the activities of DE1 do not constitute a 
trade or business within the meaning of Sec.  1.989(a)-1(c), such 
activities are not an eligible QBU. In addition, pursuant to 
paragraph (b)(3)(ii) of this section, DE1 itself is not an eligible 
QBU. As a result, neither DE1 nor its activities qualify as a 
section 987 QBU of U.S. Corp. Therefore, neither the activities of 
DE1 nor DE1 itself is subject to section 987. For the foreign 
currency treatment of payments on DE1's pound-denominated liability, 
see Sec.  1.988-2(b).
    Example 2.  (i) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and all of the interests in DE2. The only 
activities of DE1 are Business A activities and holding the 
interests in DE2. DE2 owns Business B and Business C. For purposes 
of this example, Business B does not maintain books and records that 
are separate from its owner, DE2. Instead, the activities of 
Business B are reflected on the books and records of DE2, which are 
maintained in Japanese yen. In addition, Business C has the U.S. 
dollar as its functional currency, maintains books and records that 
are separate from the books and records of DE2, and is an eligible 
QBU.
    (ii) Analysis. (A) Pursuant to paragraph (b)(3)(ii) of this 
section, DE1 and DE2 are not eligible QBUs. Pursuant to paragraph 
(b)(3)(i) of this section, the Business B and Business C activities 
of DE2, and the Business A activities of DE1, are eligible QBUs. 
Moreover, pursuant to paragraph (b)(4) of this section, DE1 is not 
the owner of the Business A, Business B, or Business C eligible 
QBUs, and DE2 is not the owner of the Business B or Business C 
eligible QBUs. Instead, pursuant to paragraph (b)(4)(i) of this 
section, U.S. Corp is the direct owner of the Business A, Business 
B, and Business C eligible QBUs.
    (B) Because Business A and Business B are eligible QBUs with 
functional currencies that are different than the functional 
currency of U.S. Corp, Business A and Business B are section 987 
QBUs (as defined in paragraph (b)(2) of this section).
    (C) The Business C eligible QBU has the same functional currency 
as U.S. Corp. Therefore, the Business C eligible QBU is not a 
section 987 QBU.
    Example 3.  (i) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and Business B. For purposes of this 
example, assume Business B has the euro as its functional currency.
    (ii) Analysis. (A) Pursuant to paragraph (b)(3)(ii) of this 
section, DE1 is not an eligible QBU. Moreover, pursuant to paragraph 
(b)(4) of this section, DE1 is not the owner of the Business A or 
Business B eligible QBUs. Instead, pursuant to paragraph (b)(4)(i) 
of this section, U.S. Corp is the direct owner of the Business A and 
Business B eligible QBUs.
    (B) Business A and Business B constitute two separate eligible 
QBUs, each with the euro as its functional currency. Accordingly, 
Business A and Business B are section 987 QBUs of U.S. Corp. U.S. 
Corp may elect to treat Business A and Business B as a single 
section 987 QBU pursuant to paragraph (b)(2)(ii)(A) of this section. 
If such election is made, pursuant to paragraph (b)(4)(i) of this 
section, U.S. Corp would be the direct owner

[[Page 88824]]

of the Business AB section 987 QBU that would include the activities 
of both the Business A section 987 QBU and the Business B section 
987 QBU. In addition, pursuant to paragraph (b)(4) of this section, 
DE1 would not be treated as the owner of the Business AB section 987 
QBU.
    Example 4.  (i) Facts. U.S. Corp owns all the stock of Y, a U.S. 
corporation that is a member of U.S. Corp's consolidated group. U.S. 
Corp also owns all the stock of CFC, a controlled foreign 
corporation (as defined in section 957(a)) of U.S. Corp with the 
Japanese yen as its functional currency. Y and CFC are the only 
partners in P, a foreign partnership. P owns DE1 and Business A. DE1 
owns Business B.
    (ii) Analysis. (A) Under paragraph (b)(5)(i) of this section, P 
is a section 987 aggregate partnership because Y and CFC own all the 
interests in partnership capital and profits, Y and CFC are related 
within the meaning of section 267(b), and the requirements of Sec.  
1.987-1(b)(5)(i)(B) are satisfied. Pursuant to paragraph (b)(3)(ii) 
of this section, P and DE1 are not eligible QBUs. Moreover, pursuant 
to paragraph (b)(4) of this section, for purposes of section 987, 
neither P nor DE1 is the owner of the Business B eligible QBU, and P 
is not the owner of the Business A eligible QBU. Instead, pursuant 
to paragraph (b)(4)(ii) of this section, Y and CFC are indirect 
owners of the Business A eligible QBU and the Business B eligible 
QBU to the extent they are allocated the assets and liabilities of 
such businesses under Sec.  1.987-7.
    (B) Because Business A and Business B are eligible QBUs with 
different functional currencies than Y, the portions of Business A 
and Business B allocated to Y under Sec.  1.987-7 are section 987 
QBUs of Y.
    (C) Because the Business A eligible QBU has a different 
functional currency than CFC, the portion of Business A that is 
allocated to CFC under Sec.  1.987-7 is a section 987 QBU, and CFC 
and its section 987 QBU are subject to section 987. Because the 
Business B eligible QBU has the same functional currency as CFC, the 
portion of Business B that is allocated to CFC under Sec.  1.987-7 
is not a section 987 QBU of CFC.
    Example 5.  (i) Facts. U.S. Corp owns all of the interests in 
DE1. DE1 owns Business A and all of the interests in DE2. DE2 owns 
Business B and all of the interests in DE3, an entity disregarded as 
an entity separate from its owner. DE3 owns Business C, which is an 
eligible QBU with the Russian ruble as its functional currency.
    (ii) Analysis. Pursuant to paragraph (b)(3)(ii) of this section, 
DE1, DE2, and DE3 are not eligible QBUs, and the Business A, 
Business B, and Business C activities are eligible QBUs. Pursuant to 
paragraph (b)(4) of this section, an eligible QBU is not an owner of 
another eligible QBU. Accordingly, the Business A eligible QBU is 
not the owner of the Business B eligible QBU, and the Business B 
eligible QBU is not the owner of the Business C eligible QBU. 
Instead, pursuant to paragraph (b)(4) of this section, U.S. Corp is 
the direct owner of the Business A, Business B, and Business C 
eligible QBUs. Because each of the Business A, Business B, and 
Business C eligible QBUs has a different functional currency than 
U.S. Corp, such eligible QBUs are section 987 QBUs of U.S. Corp.

    (c) Exchange rates. Solely for purposes of section 987, the 
following definitions shall apply.
    (1) Spot rate--(i) In general. Except as otherwise provided in this 
section, the spot rate means the rate determined under the principles 
of Sec.  1.988-1(d)(1), (2), and (4) on the relevant date.
    (ii) Election to use a spot rate convention--(A) In general--spot 
rate convention. An owner may elect to use a spot rate convention that 
reasonably approximates the spot rate determined in paragraph (c)(1)(i) 
of this section in lieu of such spot rate. A spot rate convention may 
be determined with respect to a spot rate at the beginning of a 
reasonable period, the end of a reasonable period, as an average of 
spot rates for a reasonable period, or by reference to spot and forward 
rates for a reasonable period. For this purpose, a reasonable period 
shall not exceed three months. For example, in lieu of the spot rate 
determined in paragraph (c)(1)(i) of this section, the spot rate for 
all transactions during a monthly period can be determined pursuant to 
one of the following conventions: The spot rate at the beginning of the 
current month or at the end of the preceding month; the monthly average 
of daily spot rates for the current or preceding month; or an average 
of the beginning and ending spot rates for the current or preceding 
month. Similarly, in lieu of the spot rate determined in paragraph 
(c)(1)(i) of this section, the spot rate can be determined pursuant to 
an average of the spot rate and the 30-day forward rate on a day of the 
preceding month. Use of a spot rate convention that is consistent with 
the convention used for financial accounting purposes is presumed to 
reasonably approximate the rate in paragraph (c)(1)(i) of this section. 
The Commissioner can rebut this presumption if the Commissioner 
determines that the use of the convention would not clearly reflect 
income based on the facts and circumstances available at the time of 
the election.
    (B) [Reserved].
    (iii) Election to use spot rates in lieu of yearly average exchange 
rates. A taxpayer may elect under this paragraph (c)(1)(iii) to use 
spot rates in lieu of yearly average exchange rates (as defined in 
paragraph (c)(2) of this section) for certain purposes. In particular, 
a taxpayer that makes this election must use the spot rate for purposes 
of determining the historic rate, as provided in paragraph (c)(3)(ii) 
of this section, and for purposes of translating items of income, gain, 
deduction, or loss of a section 987 QBU into the owner's functional 
currency, as described in Sec.  1.987-3(c)(1). Additionally, a taxpayer 
that makes this election will be deemed also to elect to use the 
historic inventory method described in Sec.  1.987-3(c)(2)(iv)(B).
    (2) Yearly average exchange rate. For purposes of section 987, the 
yearly average exchange rate is a rate that represents an average 
exchange rate for the taxable year (or, if the relevant period is less 
than a full taxable year, such portion of the taxable year) computed 
under any reasonable method. For example, an owner may determine the 
yearly average exchange rate based on a daily, monthly or quarterly 
averaging convention, whether weighted or unweighted, and may take into 
account forward rates for a period not to exceed three months. Use of 
an averaging convention that is consistent with the convention used for 
financial accounting purposes is presumed to be a reasonable method. 
The Commissioner can rebut this presumption if the Commissioner 
determines that the use of the convention would not have been expected 
to clearly reflect income based on the facts and circumstances 
available at the time of the election.
    (3) Historic rate--(i) In general. Except as otherwise provided in 
these regulations, the historic rate is determined as described in 
paragraphs (c)(3)(i)(A) through (E) of this section.
    (A) Assets generally. In the case of an asset other than inventory 
that is acquired by a section 987 QBU (including through a transfer), 
the historic rate is the yearly average exchange rate applicable to the 
year of acquisition.
    (B) Inventory under the simplified inventory method. In the case of 
inventory with respect to which a taxpayer uses the simplified 
inventory method described in Sec.  1.987-3(c)(2)(iv)(A), the historic 
rate for inventory accounted for under the last-in, first-out (LIFO) 
method of accounting is the yearly average exchange rate applicable to 
the year in which the inventory's LIFO layer arose. The historic rate 
for all other inventory of such a taxpayer is the yearly average 
exchange rate for the taxable year for which the determination of the 
historic rate for such inventory is relevant.
    (C) Inventory under the historic inventory method. In the case of 
inventory with respect to which a taxpayer has elected under Sec.  
1.987- 3(c)(2)(iv)(B) to use the historic inventory method, each 
inventoriable cost with respect to such inventory may have a different 
historic rate. The

[[Page 88825]]

historic rate for each inventoriable cost is the exchange rate at which 
such item would be translated under Sec.  1.987-3 if it were not an 
inventoriable cost.
    (D) Liabilities generally. In the case of a liability that is 
incurred or assumed by a section 987 QBU, the historic rate is the 
yearly average exchange rate applicable to the year the liability is 
incurred or assumed.
    (E) [Reserved].
    (ii) Historic rate when an election to use spot rates in lieu of 
yearly average exchange rates is in effect. A taxpayer that has elected 
under paragraph (c)(1)(iii) of this section to use spot rates in lieu 
of yearly average exchange rates must determine historic rates under 
paragraphs (c)(3)(i)(A) and (c)(3)(i)(D) of this section using the spot 
rate (as defined in paragraph (c)(1) of this section) for the date an 
asset is acquired by a section 987 QBU or a liability is assumed or 
incurred by a section 987 QBU in lieu of using the yearly average 
exchange rate.
    (iii) Date placed in service for depreciable or amortizable 
property. In the case of depreciable or amortizable property, an owner 
may determine the historic rate (whether a yearly average exchange rate 
or a spot rate, as applicable) by reference to the date such property 
is placed in service by the section 987 QBU rather than the date the 
property was acquired, provided that this convention is consistently 
applied for all such property attributable to that section 987 QBU.
    (iv) Changed functional currency. In the case of a section 987 QBU 
or an owner of a section 987 QBU that previously changed its functional 
currency, Sec.  1.985-5(d)(1)(ii)(A) and Sec.  1.985-5(e)(4)(i)(A), 
respectively, shall be taken into account in determining the historic 
rate for an item reflected on the balance sheet of the section 987 QBU 
immediately prior to the year of change.
    (d) Marked item. A marked item is an asset (marked asset) or 
liability (marked liability) that is properly reflected on the books 
and records of a section 987 QBU under Sec.  1.987-2(b) and that--
    (1) Is denominated in, or determined by reference to, the 
functional currency of the section 987 QBU, is not a section 988 
transaction of the section 987 QBU, and would be a section 988 
transaction if such item were held or entered into directly by the 
owner of the section 987 QBU;
    (2) Is a prepaid expense or a liability for an advance payment of 
unearned income, in either case having an original term of one year or 
less on the date the prepaid expense or liability for an advance 
payment of unearned income arises; or
    (3) [Reserved].
    (e) Historic item. A historic item is an asset (historic asset) or 
liability (historic liability) that is properly reflected on the books 
and records of a section 987 QBU under Sec.  1.987-2(b) and that is not 
a marked item (as defined in paragraph (d) of this section).
    (f) [Reserved].
    (g) Elections--(1) In general. This paragraph (g) provides rules 
for making elections under section 987. Except as otherwise provided in 
paragraph (g)(2) of this section, such elections--
    (i) May be made separately for each section 987 QBU;
    (ii) Are made by the owner of the section 987 QBU (as defined in 
paragraph (b)(4) of this section); and
    (iii) Must be made for the first taxable year in which the election 
is relevant in determining the section 987 taxable income or loss, or 
section 987 gain or loss, of the section 987 QBU and in which the 
regulations implementing the election are applicable with respect to 
the section 987 QBU.
    (2) Exceptions to the general rules--(i) Consistency and timeliness 
requirements for certain elections. Notwithstanding paragraph (g)(1)(i) 
of this section, the following consistency and timeliness requirements 
apply:
    (A) Section 987 grouping election. Elections made pursuant to 
paragraph (b)(2)(ii) of this section (regarding the grouping of section 
987 QBUs) are binding on all section 987 QBUs that are eligible to be 
grouped under the particular election (for example, election to group 
all euro QBUs owned by the same aggregate partnership), regardless of 
whether the section 987 QBU is established or acquired after the 
election is made and regardless of whether the section 987 QBU is 
identified on the election as required in paragraph (g)(3)(i)(A) of 
this section.
    (B) [Reserved].
    (ii) Persons making elections for QBUs owned by foreign 
corporations. Notwithstanding paragraph (g)(1)(ii) of this section, if 
a section 987 QBU is owned by a foreign corporation, elections shall be 
made in accordance with Sec.  1.964-1(c) by the foreign corporation's 
controlling domestic shareholders, as defined under Sec.  1.964-
1(c)(5)(i) (dealing with controlled foreign corporations) and Sec.  
1.964-1(c)(5)(ii) (dealing with noncontrolled section 902 
corporations).
    (3) Manner of making elections--(i) Election made by attaching 
statement to a return. Except as provided in paragraph (g)(3)(ii) of 
this section, elections shall be made under section 987 for each 
section 987 QBU by attaching a statement with the information required 
in this paragraph (g)(3)(i) to the timely filed tax return of the owner 
or, in the case of a foreign corporation, other applicable person for 
the first taxable year in which the election is required to be made 
under paragraph (g)(1)(iii) of this section.
    (A) Section 987 grouping election. The election provided in 
paragraph (b)(2)(ii) of this section must be titled ``Section 987 
Grouping Election Under Sec.  1.987-1(b)(2)(ii)'' and provide the 
following information:
    (1) The name, address, and functional currency of each section 987 
QBU that the taxpayer is grouping together; and
    (2) The owner's name and address.
    (B) Election to use a spot rate convention. An election under 
paragraph (c)(1)(ii) of this section to use a spot rate convention must 
be titled ``Section 987 Election to Use a Spot Rate Convention Under 
Sec.  1.987-1(c)(1)(ii)'' and provide the following information:
    (1) A description of the convention; and
    (2) The name and address of each section 987 QBU for which the 
election is being made.
    (C) Election to use spot rates in lieu of yearly average exchange 
rates. An election under paragraph (c)(1)(iii) of this section to use 
spot rates in lieu of yearly average exchange rates must be titled 
``Section 987 Election to Use Spot Rates in Lieu of Yearly Average 
Exchange Rates Under Sec.  1.987-1(c)(1)(iii)'' and provide the 
following information:
    (1) A description of the convention; and
    (2) The name and address of each section 987 QBU for which the 
election is being made.
    (D) Election to use the historic inventory method. An election 
under Sec.  1.987-3(c)(2)(iv)(B) to use the historic inventory method 
shall be titled ``Section 987 Election to Use the Historic Inventory 
Method Under Sec.  1.987-3(c)(2)(iv)(B)'' and must provide the name and 
address of each section 987 QBU for which the election is being made.
    (ii) Election made by filing a dedicated section 987 form. If the 
Commissioner publishes a form that provides the manner in which 
elections are made under section 987, the form shall govern the manner 
in which elections are made under section 987.
    (4) No change in method of accounting. An election under section 
987 is not governed by the general rules concerning changes in methods 
of accounting. See also paragraph (g)(5) of this section.
    (5) Revocation of an election. Elections under section 987 may not 
be

[[Page 88826]]

revoked without the consent of the Commissioner or his delegate. The 
Commissioner or his delegate will consider allowing a revocation of an 
election if the taxpayer can demonstrate significantly changed 
circumstances or such other circumstances that clearly demonstrate a 
substantial non-tax business reason for revoking the election.


Sec.  1.987-2  Attribution of items to eligible QBUs; definition of a 
transfer and related rules.

    (a) Scope and general principles. Paragraph (b) of this section 
provides rules for attributing assets and liabilities, and items of 
income, gain, deduction, and loss, to an eligible QBU. Assets and 
liabilities are attributed to a section 987 QBU for purposes of section 
987. Items of income, gain, deduction, and loss are attributed to a 
section 987 QBU for purposes of computing the section 987 taxable 
income of the section 987 QBU and of its owner. Paragraph (c) of this 
section defines a transfer to or from a section 987 QBU. Paragraph (d) 
of this section provides translation rules for transfers to a section 
987 QBU.
    (b) Attribution of items to an eligible QBU--(1) General rules. 
Except as provided in paragraphs (b)(2) and (3) of this section, items 
are attributable to an eligible QBU to the extent they are reflected on 
the separate set of books and records, as defined in Sec.  1.989(a)-
1(d), of the eligible QBU. In the case of a section 987 aggregate 
partnership, items reflected on the books and records of the 
partnership and deemed allocated to an eligible QBU of such partnership 
are considered to be reflected on the books and records of such 
eligible QBU. For purposes of this section, the term ``item'' refers to 
any asset or liability, and any item of income, gain, deduction, or 
loss. Items that are attributed to an eligible QBU pursuant to this 
section must be adjusted to conform to Federal income tax principles. 
Except as provided in Sec.  1.989(a)-1(d)(3), these attribution rules 
apply solely for purposes of section 987. For example, the allocation 
and apportionment of interest expense under section 864(e) is 
independent of the rules under section 987.
    (2) Exceptions for non-portfolio stock, interests in partnerships, 
and certain acquisition indebtedness. The following items shall not be 
considered to be on the books and records of an eligible QBU:
    (i) Stock of a corporation (whether domestic or foreign), other 
than stock of a corporation reflected on the books and records (within 
the meaning of paragraph (b)(1) of this section) of an eligible QBU if 
the owner of the eligible QBU owns less than 10 percent of the total 
value of all classes of stock of such corporation. For this purpose, 
section 318(a) applies in determining ownership, except that in 
applying section 318(a)(2)(C), the phrase ``10 percent'' is used 
instead of the phrase ``50 percent.''
    (ii) An interest in a partnership (whether domestic or foreign).
    (iii) A liability that was incurred to acquire stock described in 
paragraph (b)(2)(i) of this section or that was incurred to acquire a 
partnership interest described in paragraph (b)(2)(ii) of this section.
    (iv) Income, gain, deduction, or loss arising from the items 
described in paragraphs (b)(2)(i) through (iii) of this section. For 
example, a section 951 inclusion with respect to stock of a foreign 
corporation described in paragraph (b)(2)(i) of this section shall not 
be considered to be on the books and records of an eligible QBU.
    (3) Adjustments to items reflected on the books and records--(i) 
General rule. If a principal purpose of recording (or failing to 
record) an item on the books and records of an eligible QBU is the 
avoidance of Federal income tax under, or through the use of, section 
987, the item must be allocated between or among the eligible QBU, the 
owner of such eligible QBU, and any other persons, entities (including 
DEs), or other QBUs within the meaning of Sec.  1.989(a)-1(b) 
(including eligible QBUs) in a manner that reflects the substance of 
the transaction. For purposes of this paragraph (b)(3)(i), relevant 
factors for determining whether such Federal income tax avoidance is a 
principal purpose of recording (or failing to record) an item on the 
books and records of an eligible QBU shall include, but are not limited 
to, the factors set forth in paragraphs (b)(3)(ii) and (iii) of this 
section. The presence or absence of any factor or factors is not 
determinative. Moreover, the weight given to any factor (whether or not 
set forth in paragraphs (b)(3)(ii) and (iii) of this section) depends 
on the particular case.
    (ii) Factors indicating no tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that recording (or 
failing to record) an item on the books and records of an eligible QBU 
did not have as a principal purpose the avoidance of Federal income tax 
under, or through the use of, section 987 include the recording (or not 
recording) of an item:
    (A) For a significant and bona fide business purpose;
    (B) In a manner that is consistent with the economics of the 
underlying transaction;
    (C) In accordance with generally accepted accounting principles (or 
similar comprehensive accounting standard);
    (D) In a manner that is consistent with the treatment of similar 
items from year to year;
    (E) In accordance with accepted conditions or practices in the 
particular trade or business of the eligible QBU;
    (F) In a manner that is consistent with an explanation of existing 
internal accounting policies that is evidenced by documentation 
contemporaneous with the timely filing of a Federal income tax return 
for the taxable year; and
    (G) As a result of a transaction between legal entities (for 
example, the transfer of an asset or the assumption of a liability), 
even if such transaction is not regarded for Federal income tax 
purposes (for example, a transaction between a DE and its owner).
    (iii) Factors indicating tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that a principal 
purpose of recording (or failing to record) an item on the books and 
records of an eligible QBU is the avoidance of Federal income tax 
under, or through the use of, section 987 include:
    (A) The presence or absence of an item on the books and records 
that is the result of one or more transactions that are transitory, for 
example, due to a circular flow of cash or other property;
    (B) The presence or absence of an item on the books and records 
that is the result of one or more transactions that do not have 
substance;
    (C) The presence or absence of an item on the books and records 
that results in the taxpayer (or a person related to the taxpayer 
within the meaning of section 267(b) or section 707(b)) having 
offsetting positions with respect to the functional currency of a 
section 987 QBU; and
    (D) The absence of any or all of the factors listed in paragraph 
(b)(3)(ii) of this section.
    (4) Assets and liabilities of a section 987 aggregate partnership 
or DE that are not attributed to an eligible QBU. Neither a section 987 
aggregate partnership nor a DE is an eligible QBU and, thus, neither 
entity can be a section 987 QBU. See Sec.  1.987-1(b)(2) and (3). As a 
result, a section 987 aggregate partnership or DE may own assets and 
liabilities that are not attributed to an eligible QBU as provided 
under this paragraph (b) and, therefore, are not subject to section 
987. For the foreign

[[Page 88827]]

currency treatment of such assets or liabilities, see Sec.  1.988-
1(a)(4).
    (c) Transfers to and from section 987 QBUs--(1) In general. The 
following rules apply for purposes of determining whether there is a 
transfer of an asset or a liability from an owner to a section 987 QBU, 
or from a section 987 QBU to an owner. These rules apply solely for 
purposes of section 987.
    (2) Disregarded transactions--(i) General rule. An asset or 
liability shall be treated as transferred to a section 987 QBU from its 
owner (whether direct owner or indirect owner, as defined in Sec.  
1.987-1(b)(4)) if, as a result of a disregarded transaction (as defined 
in paragraph (c)(2)(ii) of this section), such asset or liability is 
reflected on the books and records of the section 987 QBU within the 
meaning of paragraph (b) of this section. Similarly, an asset or 
liability shall be treated as transferred from a section 987 QBU to its 
owner if, as a result of a disregarded transaction, such asset or 
liability is no longer reflected on the books and records of the 
section 987 QBU within the meaning of paragraph (b) of this section.
    (ii) Definition of a disregarded transaction. For purposes of this 
section, a disregarded transaction means a transaction that is not 
regarded for Federal income tax purposes (for example, any transaction 
between separate section 987 QBUs of the same owner). For purposes of 
this paragraph (c), a disregarded transaction shall be treated as 
including the recording of an asset or liability on the books and 
records of an eligible QBU (as defined in Sec.  1.987-1(b)(3)) of an 
owner, if the recording is the result of such asset or liability being 
removed from the books and records of a separate eligible QBU of the 
same owner, whether such separate eligible QBU is owned directly or is 
owned indirectly through the same entity (including through a DE or a 
section 987 aggregate partnership). Additionally, if an asset or 
liability that is attributable to a section 987 QBU within the meaning 
of paragraph (b) of this section is sold or exchanged (including in a 
nonrecognition transaction, such as an exchange under section 351) for 
an asset or liability that is not attributable to the section 987 QBU 
immediately after the sale or exchange, the sold or exchanged asset or 
liability that was attributable to the section 987 QBU immediately 
before the transaction shall be treated as transferred from the section 
987 QBU to its direct or indirect owner in a disregarded transaction 
immediately before the sale or exchange for purposes of section 987 
(including for purposes of recognizing section 987 gain or loss under 
Sec.  1.987-5) and subsequently sold or exchanged by the owner. The 
preceding sentence shall not apply with respect to an acquisition or 
disposition of an interest in a section 987 aggregate partnership or in 
a DE, as described in paragraph (c)(5) of this section.
    (iii) Items derived from disregarded transactions ignored. For 
purposes of section 987, disregarded transactions shall not give rise 
to items of income, gain, deduction, or loss that are taken into 
account in determining section 987 taxable income or loss under Sec.  
1.987-3.
    (3) Transfers of assets to and from section 987 QBUs owned through 
section 987 aggregate partnerships--(i) Contributions to section 987 
aggregate partnerships. Solely for purposes of section 987, an asset 
shall be treated as transferred by an indirect owner (as defined in 
Sec.  1.987-1(b)(4)(ii)) to a section 987 QBU of a partner (as defined 
in Sec.  1.987-1(b)(5)(ii)) to the extent the indirect owner 
contributes the asset to the section 987 aggregate partnership that 
carries on the activities of the section 987 QBU, provided that, 
immediately prior to the contribution, the asset is not reflected on 
the books and records of the section 987 QBU within the meaning of 
paragraph (b) of this section and the asset is reflected on the books 
and records of the section 987 QBU immediately following such 
contribution. For purposes of this paragraph (c)(3)(i), deemed 
contributions of money described under section 752 shall be 
disregarded. See paragraph (c)(4)(ii) of this section for rules 
governing the assumption by a partner of liabilities of a section 987 
aggregate partnership.
    (ii) Distributions from section 987 aggregate partnerships. Solely 
for purposes of section 987, an asset shall be treated as transferred 
from a section 987 QBU of a partner to its indirect owner to the extent 
the section 987 aggregate partnership that carries on the activities of 
the section 987 QBU distributes the asset to the indirect owner, 
provided that, immediately prior to such distribution, the asset is 
reflected on the books and records of the section 987 QBU within the 
meaning of paragraph (b) of this section, and the asset is not 
reflected on the books and records of the section 987 QBU immediately 
after such distribution. For purposes of this paragraph (c)(3)(ii), 
deemed distributions of money described under section 752 shall be 
disregarded. See paragraph (c)(4)(i) of this section for rules 
governing the assumption by a section 987 aggregate partnership of 
liabilities of a partner.
    (4) Transfers of liabilities to and from section 987 QBUs owned 
through section 987 aggregate partnerships--(i) Assumptions of partner 
liabilities. Solely for purposes of section 987, a liability of the 
owner of a section 987 aggregate partnership shall be treated as 
transferred to a section 987 QBU of a partner if, and to the extent, 
the section 987 aggregate partnership assumes such liability, provided 
that, immediately prior to the transfer, the liability is not reflected 
on the books and records of the section 987 QBU within the meaning of 
paragraph (b) of this section, and the liability is reflected on the 
books and records of the section 987 QBU immediately following the 
transfer.
    (ii) Assumptions of section 987 aggregate partnership liabilities. 
Solely for purposes of section 987, a liability of a section 987 
aggregate partnership shall be treated as transferred from a section 
987 QBU of a partner to its indirect owner if, and to the extent, the 
indirect owner assumes such liability of the section 987 aggregate 
partnership, provided that, immediately prior to such assumption, the 
liability is reflected on the books and records of the section 987 QBU 
within the meaning of paragraph (b) of this section, and the liability 
is not reflected on the books and records of the section 987 QBU 
immediately following the transfer.
    (5) Acquisitions and dispositions of interests in DEs and section 
987 aggregate partnerships. Solely for purposes of section 987, an 
asset or liability shall be treated as transferred to a section 987 QBU 
from its owner if, as a result of an acquisition (including by 
contribution) or disposition of an interest in a section 987 aggregate 
partnership or DE, such asset or liability is reflected on the books 
and records of the section 987 QBU. Similarly, an asset or liability 
shall be treated as transferred from a section 987 QBU to its owner if, 
as a result of an acquisition or disposition of an interest in a 
section 987 aggregate partnership or DE, the asset or liability is not 
reflected on the books and records of the section 987 QBU.
    (6) Changes in form of ownership. For purposes of this paragraph 
(c), mere changes in the form of ownership of an eligible QBU shall not 
result in a transfer to or from a section 987 QBU. Instead, the 
determination of whether a transfer has occurred in such case shall be 
made under paragraph (c)(5) of this section. For example, a transaction 
that causes a direct owner of an eligible QBU to become an indirect 
owner of the eligible QBU shall not, except to the extent provided in 
paragraph (c)(5) of this section, result in a transfer to or from a 
section 987 QBU. See, for example, Rev. Rul. 99-5 (1999-1 CB

[[Page 88828]]

434), Rev. Rul. 99-6 (1999-1 CB 432), Sec.  601.601(d)(2) of this 
chapter, and section 708 and the applicable regulations.
    (7) Application of general tax law principles. General tax law 
principles, including the circular cash flow, step-transaction, 
economic substance, and substance-over-form doctrines, apply for 
purposes of determining whether there is a transfer of an asset or 
liability under this paragraph (c), including a transfer of an asset or 
liability pursuant to a disregarded transaction (as defined in 
paragraph (c)(2)(ii) of this section).
    (8) Interaction with Sec.  1.988-1(a)(10). See Sec.  1.988-1(a)(10) 
for rules regarding the treatment of an intra-taxpayer transfer of a 
section 988 transaction.
    (9) [Reserved].
    (10) Examples. The following examples illustrate the principles of 
this paragraph (c). For purposes of the examples, X and Y are domestic 
corporations, have the U.S. dollar as their functional currency, and 
use the calendar year as their taxable years. Furthermore, except as 
otherwise provided, Business A and Business B are eligible QBUs that 
have the euro and the Japanese yen, respectively, as their functional 
currencies, and DE1 and DE2 are DEs. For purposes of determining 
whether any of the transfers in these examples result in remittances, 
see Sec.  1.987-5.

    Example 1. Transfer to a directly owned section 987 QBU. (i) 
Facts. X owns all of the interests in DE1. DE1 owns Business A, 
which is a section 987 QBU of X. X owns [euro]100 that are not 
reflected on the books and records of Business A. Business A is in 
need of additional capital and, as a result, X lends the [euro]100 
to DE1 for use in Business A in exchange for a note.
    (ii) Analysis. (A) The loan from X to DE1 is not regarded for 
Federal income tax purposes (because it is an interbranch 
transaction) and therefore is a disregarded transaction (as defined 
in paragraph (c)(2)(ii) of this section). As a result, the DE1 note 
held by X and the liability of DE1 under the note are not taken into 
account under this section.
    (B) As a result of the disregarded transaction, the [euro]100 is 
reflected on the books and records of Business A. Therefore, X is 
treated as transferring [euro]100 to its Business A section 987 QBU 
for purposes of section 987. This transfer is taken into account in 
determining the amount of any remittance for the taxable year under 
Sec.  1.987-5(c). See Sec.  1.988-1(a)(10)(ii) for the application 
of section 988 to X as a result of the transfer of non-functional 
currency to its section 987 QBU.
    Example 2. Transfer to a directly owned section 987 QBU. (i) 
Facts. X owns Business A and Business B, both of which are section 
987 QBUs of X. X owns equipment that is used in Business A and is 
reflected on the books and records of Business A. Because Business A 
has excess manufacturing capacity and X intends to expand the 
manufacturing capacity of Business B, the equipment formerly used in 
Business A is transferred to Business B for use by Business B. As a 
result of the transfer, the equipment is removed from the books and 
records of Business A and is recorded on the books and records of 
Business B.
    (ii) Analysis. The transfer of the equipment from the books and 
records of Business A to the books and records of Business B is not 
regarded for Federal income tax purposes (because it is an 
interbranch transaction), and therefore it is a disregarded 
transaction for purposes of this paragraph (c). Therefore, for 
purposes of section 987, the Business A section 987 QBU is treated 
as transferring the equipment to X, and X is subsequently treated as 
transferring the equipment to the Business B section 987 QBU. These 
transfers are taken into account in determining the amount of any 
remittance for the taxable year under Sec.  1.987-5(c).
    Example 3. Intracompany sale of property between two section 987 
QBUs. (i) Facts. X owns all of the interests in DE1 and DE2. DE1 and 
DE2 own Business A and Business B, respectively, both of which are 
section 987 QBUs of X. DE1 owns equipment that is used in Business A 
and is reflected on the books and records of Business A. For 
business reasons, DE1 sells a portion of the equipment used in 
Business A to DE2 in exchange for a fair market value amount of 
Japanese yen. The yen used by DE2 to acquire the equipment was 
generated by Business B and was reflected on Business B's books and 
records. Following the sale, the yen and the equipment will be used 
in Business A and Business B, respectively. As a result of such 
sale, the equipment is removed from the books and records of 
Business A and is recorded on the books and records of Business B. 
Similarly, as a result of the sale, the yen is removed from the 
books and records of Business B and is recorded on the books and 
records of Business A.
    (ii) Analysis. (A) The sale of equipment between DE1 and DE2 is 
a transaction that is not regarded for Federal income tax purposes 
(because it is an interbranch transaction). Therefore the 
transaction is a disregarded transaction for purposes of paragraph 
(c) of this section. As a result, the sale is not taken into account 
under this section and, pursuant to paragraph (c)(2)(iii) of this 
section, the sale does not give rise to an item of income, gain, 
deduction, or loss for purposes of determining section 987 taxable 
income or loss under Sec.  1.987-3. However, the yen and equipment 
exchanged by DE1 and DE2 in connection with the sale must be taken 
into account as a disregarded transaction under this paragraph (c).
    (B) As a result of the disregarded transaction, the equipment 
ceases to be reflected on the books and records of Business A and 
becomes reflected on the books and records of Business B. Therefore, 
the Business A section 987 QBU is treated as transferring the 
equipment to X, and X is subsequently treated as transferring such 
equipment to the Business B section 987 QBU.
    (C) Additionally, as a result of the disregarded transaction, 
the yen currency ceases to be reflected on the books and records of 
Business B and becomes reflected on the books and records of 
Business A. Therefore, the Business B section 987 QBU is treated as 
transferring the yen to X, and X is subsequently treated as 
transferring such yen from X to the Business A section 987 QBU. The 
transfers among Business A, Business B and X are taken into account 
in determining the amount of any remittance for the taxable year 
under Sec.  1.987-5(c).
    Example 4. Sale of property by a section 987 QBU to a 
corporation that is a member of the consolidated group. (i) Facts. X 
owns all of the stock of Y and all of the interests in DE1. DE1 owns 
Business A. X and Y file a consolidated return. Business A sells 
property to Y for [euro]100.
    (ii) Analysis. The sale of property by Business A to Y is not 
considered a transfer of property to X (and a corresponding transfer 
from X to Y) under paragraph (c) of this section because the 
transaction is regarded for Federal income tax purposes. Rather, for 
purposes of section 987, the transaction is considered to occur 
between Business A and Y.
    Example 5. Transactions of a section 987 QBU owned through an 
aggregate partnership. (i) Facts. (A) X owns all of the stock of Y 
and a 50 percent interest in the capital and profits of P, a 
partnership. Y owns the other 50 percent interest in P. P owns 100 
percent of the interests in DE1 and DE2. DE1 owns Business A and DE2 
owns Business B.
    (B) In connection with Business A, DE1 licenses intangible 
property to both DE2 and X. X enters into the license agreement in a 
transaction other than in its capacity as a partner of P and, 
therefore, the license is considered as occurring between P and one 
who is not a partner within the meaning of section 707(a). X uses 
the intangible property in its own trade or business in the U.S. DE2 
uses the intangible property in Business B. Pursuant to the license 
agreement, X and DE2 pay a [euro]30 and a [euro]50 royalty, 
respectively, to DE1.
    (ii) Analysis. (A) Under Sec.  1.987-1(b)(5)(i), P is a section 
987 aggregate partnership because X and Y own all the interests in 
partnership capital and profits, X and Y are related within the 
meaning of section 267(b), and the requirements of Sec.  1.987-
1(b)(5)(i)(B) are satisfied. X and Y each have a 50 percent 
allocable share of the assets and liabilities of Business A and 
Business B, as determined under Sec.  1.987-7. Under Sec.  1.987-
1(b)(5)(ii), the assets and liabilities of Business A allocated to X 
are a section 987 QBU of X, and the assets and liabilities of 
Business A allocated to Y are a section 987 QBU of Y. Likewise, the 
assets and liabilities of Business B allocated to X are a section 
987 QBU of X, and the assets and liabilities of Business B allocated 
to Y are a section 987 QBU of Y.
    (B) The license from DE1 to DE2 is not regarded for Federal 
income tax purposes (because it is an interbranch agreement) and, as 
a result, royalty payments under the license are disregarded 
transactions. Thus, pursuant to paragraph (c)(2)(iii) of this 
section, DE1's receipt of the royalty pursuant to the license 
agreement does not give rise to

[[Page 88829]]

an item of income, gain, deduction, or loss for purposes of 
determining section 987 taxable income or loss under Sec.  1.987-3. 
However, the [euro]50 that is paid from DE2 to DE1 pursuant to the 
license agreement must be taken into account under paragraph (c) of 
this section. Accordingly, [euro]50 ceases to be reflected on the 
books and records of Business B and becomes reflected on the books 
and records of Business A. As a result, a 50 percent allocable share 
of the [euro]50 royalty payment ([euro]25) is treated as transferred 
from each of the Business B section 987 QBUs of X and Y, to X and Y, 
respectively. And subsequently, X and Y are treated as transferring 
their respective receipts of [euro]25 to their respective Business A 
section 987 QBUs. These transfers are taken into account in 
determining the amount of any remittance to either of X or Y for the 
taxable year under Sec.  1.987-5(c).
    (C) The [euro]30 royalty payment from X to DE1 is regarded for 
Federal income tax purposes (because it is a payment from a 
partnership to a separate entity). Accordingly, the royalty payment 
is not a disregarded transaction for purposes of this paragraph (c) 
and is therefore not treated as a transfer of an asset from an owner 
to a section 987 QBU. As a result, the payment is not taken into 
account in determining the amount of any remittance for the taxable 
year under Sec.  1.987-5(c). Instead, the payment gives rise to an 
item of income and deduction that must be taken into account in 
computing section 987 taxable income or loss of Business A pursuant 
to Sec.  1.987-3.
    Example 6. Acquisition of an interest in a partnership. (i) 
Facts. (A) X owns all of the stock of Z, a domestic corporation with 
the dollar as its functional currency. X also owns all of the stock 
of Y and a 50 percent interest in the capital and profits of P, a 
partnership. Y owns the other 50 percent interest in P. P owns 
Business A, and P owns no other assets or liabilities other than 
those of Business A.
    (B) Z contributes cash to P in exchange for a 20 percent 
interest in the capital and profits of P. The cash Z contributes to 
P is used in Business A and is reflected on Business A's books and 
records.
    (ii) Analysis. (A) Under Sec.  1.987-1(b)(5)(i), P is a section 
987 aggregate partnership because X and Y own all the interests in 
partnership capital and profits, X and Y are related within the 
meaning of section 267(b), and the requirements of Sec.  1.987-
1(b)(5)(i)(B) are satisfied. Prior to the contribution to P by Z, X 
and Y each have a 50 percent allocable share of the assets and 
liabilities of Business A, as determined under Sec.  1.987-7. Under 
Sec.  1.987-1(b)(5)(ii), the assets and liabilities of Business A 
allocated to X are a section 987 QBU of X, and the assets and 
liabilities of Business A allocated to Y are a section 987 QBU of Y.
    (B) Following Z's acquisition of a 20 percent interest in P, P 
remains a section 987 aggregate partnership because X, Y and Z own 
all the interests in partnership capital and profits; X, Y, and Z 
are related within the meaning of section 267(b); and the 
requirements of Sec.  1.987-1(b)(5)(i)(B) are satisfied. Z acquires 
a 20 percent allocable share of the assets and liabilities of 
Business A, as determined under Sec.  1.987-7. Under Sec.  1.987-
1(b)(5)(ii), the assets and liabilities of Business A allocated to Z 
are a section 987 QBU of Z (because Z becomes an indirect owner of 
Business A and Z and Business A have different functional 
currencies).
    (C) As a result of Z's contribution of cash to Business A, 
through its contribution to P, each of X, Y, and Z are allocated a 
share of that Business A asset. Accordingly, under Sec.  1.987-
2(c)(5), Z is treated as contributing its allocable share of the 
cash to its Business A section 987 QBU. In addition, Z is treated as 
transferring X's and Y's respective allocable shares of the cash to 
X and Y, and X and Y are subsequently treated as transferring that 
cash to their respective Business A section 987 QBUs.
    (D) In addition, as a result of Z's acquisition of its interest 
in P and Z's consequent acquisition of a Business A section 987 QBU, 
Z's allocable portion of the assets and liabilities of Business A 
(other than the cash) cease being reflected on the books and records 
of the respective Business A section 987 QBUs of each of X and Y. 
Those allocable portions of assets and liabilities from the Business 
A section 987 QBUs of X and Y are treated as if they are transferred 
from such section 987 QBUs to their respective owners, X and Y. 
These assets and liabilities are consequently recorded on the books 
and records of Z's Business A section 987 QBU. Accordingly, X and Y 
are treated as transferring those assets and liabilities to Z, and Z 
is treated as contributing those assets and liabilities to its new 
Business A section 987 QBU.
    Example 7. Acquisition of an interest in a partnership. (i) 
Facts. The facts are the same as in Example 6, except that the cash 
that Z contributes to P in exchange for a 20 percent interest in P 
is not used in Business A and is not reflected on Business A's books 
and records. Instead, the cash is reflected on P's books and 
records.
    (ii) Analysis. (A) Following Z's acquisition of a 20 percent 
interest in P, P remains a section 987 aggregate partnership because 
X, Y and Z own all the interests in partnership capital and profits; 
X, Y, and Z are related within the meaning of section 267(b); and 
the requirements of Sec.  1.987-1(b)(5)(i)(B) are satisfied. Z 
acquires a 20 percent allocable share of the assets and liabilities 
of Business A, as determined under Sec.  1.987-7. Under Sec.  1.987-
1(b)(5)(ii), the assets and liabilities of Business A allocated to Z 
are a section 987 QBU of Z (because Z becomes an indirect owner of 
Business A and Z and Business A have different functional 
currencies).
    (B) As a result of Z's acquisition of its interest in P and Z's 
consequent acquisition of a Business A section 987 QBU, Z's 
allocable portion of the assets and liabilities of Business A cease 
being reflected on the books and records of the respective Business 
A section 987 QBUs of each of X and Y. Those allocable portions of 
assets and liabilities from the Business A section 987 QBUs of X and 
Y are treated as if they are transferred from such section 987 QBUs 
to their respective owners, X and Y. These assets and liabilities 
are consequently recorded on the books and records of Z's Business A 
section 987 QBU. Accordingly, X and Y are treated as transferring 
those assets and liabilities to Z, and Z is treated as contributing 
those assets and liabilities to its new Business A section 987 QBU.
    Example 8. Conversion of a DE to a partnership through a sale of 
an interest. (i) Facts. X owns all of the stock of Y and all of the 
interests in DE1. DE1 owns Business A. Y acquires 50 percent of the 
DE1 interests from X for cash.
    (ii) Analysis. (A) DE1 is converted to a partnership when Y 
purchases the 50 percent interest in DE1. For Federal income tax 
purposes, Y's purchase of 50 percent of X's interest in DE1 is 
treated as the direct purchase of 50 percent of the assets of 
Business A because DE1 is disregarded and Business A is treated as 
held directly by X. Immediately after the sale of 50 percent of 
Business A to Y, X and Y are treated as contributing their 
respective interests in the assets of Business A to a partnership. 
See Rev. Rul. 99-5 (1999-1 CB 434) (situation 1) and Sec.  
601.601(d)(2) of this chapter.
    (B) For purposes of this paragraph (c), these deemed 
transactions are disregarded transactions. Under Sec.  1.987-
1(b)(5)(i), the newly formed partnership is a section 987 aggregate 
partnership because X and Y own all the interests in partnership 
capital and profits, X and Y are related within the meaning of 
section 267(b), and the requirements of Sec.  1.987-1(b)(5)(i)(B) 
are satisfied. Because Y is a partner in a section 987 aggregate 
partnership that owns Business A and because Y and Business A have 
different functional currencies, Y's portion of the Business A 
assets and liabilities constitutes a section 987 QBU of Y.
    (C) As a result of the conversion of DE1 to a partnership, Y 
acquires an allocable share of 50 percent of the assets and 
liabilities of Business A, as determined under Sec.  1.987-7. 
Accordingly, 50 percent of the assets and liabilities of Business A 
cease being reflected on the books and records of X's section 987 
QBU. Under Sec.  1.987-2(b)(5), these amounts are treated as if they 
are transferred from X's section 987 QBU to X, and X is treated as 
transferring these assets and liabilities to Y. Accordingly, the 
assets and liabilities of Business A allocated to Y are treated as 
transferred by Y to Y's newly formed Business A section 987 QBU.
    Example 9. Conversion of a DE to a partnership through a 
contribution. (i) Facts. X owns all of the stock of Y and all of the 
interests in DE1. DE1 owns Business A. Y contributes property (that 
is not then attributed to a section 987 QBU of Y) to DE1 in exchange 
for an interest in DE1. The property transferred by Y to DE1 is used 
in Business A and is reflected on the books and records of Business 
A.
    (ii) Analysis. (A) DE1 is converted to a partnership when Y 
contributes property to DE1 in exchange for a 50 percent interest in 
DE1. For Federal income tax purposes, Y's contribution is treated as 
a contribution to a partnership in exchange for an ownership 
interest in the partnership. X is treated as contributing all of 
Business A to the partnership in exchange for a partnership 
interest. See Rev. Rul. 99-5 (situation 2), (1999-1 CB 434) and 
Sec.  601.601(d)(2) of this chapter.
    (B) For purposes of this paragraph (c), these deemed 
transactions are disregarded

[[Page 88830]]

transactions. Under Sec.  1.987-1(b)(5)(i), the newly formed 
partnership is a section 987 aggregate partnership because X and Y 
own all the interests in partnership capital and profits, X and Y 
are related within the meaning of section 267(b), and the 
requirements of Sec.  1.987-1(b)(5)(i)(B) are satisfied. Because Y 
is a partner in a section 987 aggregate partnership that owns 
Business A and because Y and Business A have different functional 
currencies, Y's portion of the Business A assets and liabilities 
constitutes a section 987 QBU of Y.
    (C) As a result of the conversion of DE1 to a partnership, Y 
acquires an allocable share of 50 percent of the assets and 
liabilities of Business A, as determined under Sec.  1.987-7. 
Accordingly, under Sec.  1.987-2(c)(5), Y is treated as contributing 
its allocable share of its contributed property to its Business A 
section 987 QBU. In addition, Y is treated as transferring X's 
allocable share of the contributed property to X, and X is 
subsequently treated as transferring that property to its Business A 
section 987 QBUs. In addition, Y's allocable share of the original 
(pre-conversion) assets and liabilities of Business A cease being 
reflected on the books and records of X's section 987 QBU. Under 
Sec.  1.987-2(b)(5), these amounts are treated as if they are 
transferred from X's section 987 QBU to X, and X is treated as 
transferring these assets and liabilities to Y. Y is subsequently 
treated as transferring these assets and liabilities to Y's Business 
A section 987 QBU.
    Example 10. Contribution of assets to a corporation. (i) Facts. 
X owns Business A. X forms Z, a domestic corporation, contributing 
50 percent of its Business A assets and liabilities to Z in exchange 
for all of the stock of Z. X and Z do not file a consolidated tax 
return.
    (ii) Analysis. Pursuant to paragraph (b)(2) of this section, the 
Z stock received in exchange for 50 percent of Business A's assets 
and liabilities is not reflected on the books and records of, and 
therefore is not attributable to, Business A for purposes of section 
987 immediately after the exchange. As a result, pursuant to 
paragraph (c)(2)(i) and (ii) of this section, 50 percent of the 
assets and liabilities of Business A are treated as transferred from 
Business A to X in a disregarded transaction immediately before the 
exchange. The result would be the same even if X and Z filed a 
consolidated return.
    Example 11. Circular transfers. (i) Facts. X owns Business A. On 
December 30, 2021, Business A purports to transfer [euro]100 to X. 
On January 2, 2022, X purports to transfer [euro]50 to Business A. 
On January 4, 2022, X purports to transfer another [euro]50 to 
Business A. As of the end of 2021, X has an unrecognized section 987 
loss with respect to Business A, such that a remittance, if 
respected, would result in recognition of a foreign currency loss 
under section 987.
    (ii) Analysis. Because the transfer by Business A to X is offset 
by the transfers from X to Business A that occurred in close 
temporal proximity, the Internal Revenue Service (IRS) may disregard 
the purported transfers to and from Business A for purposes of 
section 987 pursuant to general tax principles under paragraph 
(c)(7) of this section.
    Example 12. Transfers without substance. (i) Facts. X owns 
Business A and Business B. On January 1, 2021, Business A purports 
to transfer [euro]100 to X. On January 4, 2021, X purports to 
transfer [euro]100 to Business B. The account in which Business B 
deposited the [euro]100 is used to pay the operating expenses and 
other costs of Business A. As of the end of 2021, X has an 
unrecognized section 987 loss with respect to Business A, such that 
a remittance, if respected, would result in recognition of a foreign 
currency loss under section 987.
    (ii) Analysis. Because Business A continues to have use of the 
transferred property, the IRS may disregard the [euro]100 purported 
transfer from Business A to X for purposes of section 987 pursuant 
to general tax principles under paragraph (c)(7) of this section.
    Example 13. Offsetting positions in section 987 QBUs. (i) Facts. 
X owns Business A and Business B. Each of Business A and Business B 
has the euro as its functional currency. X has not made a grouping 
election under Sec.  1.987-1(b)(2)(ii). On January 1, 2021, X 
borrows [euro]1,000 from a third party lender, records the liability 
with respect to the borrowing on the books and records of Business 
A, and records the borrowed [euro]1,000 on the books and records of 
Business B. On December 31, 2022, when Business A has $100 of net 
unrecognized section 987 loss and Business B has $100 of net 
unrecognized section 987 gain resulting from the change in exchange 
rates with respect to the liability and the [euro]1,000, X 
terminates the Business A section 987 QBU.
    (ii) Analysis. Because Business A and Business B have offsetting 
positions in the euro, the IRS will scrutinize the transaction under 
paragraph (b)(3) of this section to determine if a principal purpose 
of recording the euro-denominated liability on the books and records 
of Business A and the borrowed euros on the books and records of 
Business B was the avoidance of tax under section 987. If such a 
principal purpose is present, the IRS may reallocate the items (that 
is, the euros and the euro-denominated liability) between Business 
A, Business B, and X, under paragraph (c)(7) of this section to 
reflect the substance of the transaction.
    Example 14. Offsetting positions with respect to a section 987 
QBU and a section 988 transaction. (i) Facts. X owns all of the 
interests in DE1, and DE1 owns Business A. On January 1, 2021, X 
borrows [euro]1,000 from a third party lender and records the 
liability with respect to the borrowing on its books and records. X 
contributes the [euro]1,000 loan proceeds to DE1 and the [euro]1,000 
are reflected on the books and records of Business A. On December 
31, 2022, when Business A has $100 of net unrecognized section 987 
loss resulting from the change in exchange rates with respect to the 
[euro]1,000 received from the borrowing, and when the euro-
denominated borrowing, if repaid, would result in $100 of gain under 
section 988, X terminates the Business A section 987 QBU.
    (ii) Analysis. Because X and Business A have offsetting 
positions in the euro, the IRS will scrutinize the transaction under 
paragraph (b)(3) of this section to determine whether a principal 
purpose of recording the borrowed euros on the books and records of 
Business A, or not recording the corresponding euro-denominated 
liability on the books and records of Business A, was the avoidance 
of tax under section 987. If such a principal purpose is present, 
the Commissioner may reallocate the items (that is, the euros and 
the euro-denominated liability) between Business A and X under 
paragraph (c)(7) of this section to reflect the substance of the 
transaction.
    Example 15. Offsetting positions with respect to a section 987 
QBU and a section 988 transaction. (i) Facts. X owns all of the 
stock of Y and all of the interests in DE1. DE1 owns Business A. X 
and Y file a consolidated return. On January 1, 2021, DE1 lends 
[euro]1,000 to Y. X records the receivable with respect to the loan 
on Business A's books and records. On December 31, 2022, when 
Business A has $100 of net unrecognized section 987 gain resulting 
from the loan, Y repays the [euro]1,000 liability. The repayment of 
the euro-denominated borrowing results in $100 of loss to Y under 
section 988. X claims a $100 loss on its consolidated return under 
section 988. Business A does not make any remittances to X in 2022, 
so the offsetting gain with respect to the loan receivable has not 
been recognized by X.
    (ii) Analysis. Y, a related party to X, and Business A have 
offsetting positions in the euro. The IRS will scrutinize the 
transaction under paragraph (b)(3) of this section to determine 
whether a principal purpose of recording the euro-denominated 
receivable on the books and records of Business A, rather than on 
the books and records of X, was to avoid tax through the use of 
section 987. If such a principal purpose is present, the IRS may 
reallocate the euro-denominated receivable between Business A and X 
under paragraph (c)(7) of this section to reflect the substance of 
the transaction. Other provisions may also apply to defer or 
disallow the loss.
    Example 16. Loan by section 987 QBU followed by immediate 
distribution to owner. (i) Facts. X owns all of the interests in 
DE1. DE1 owns Business A. On January 1, 2021, Business A borrows 
[euro]1,000 from a bank. On January 2, 2021, Business A distributes 
the [euro]1,000 it received from the bank to X. There are no other 
transfers between X and Business A during the year. At the end of 
the year, X has net unrecognized section 987 loss with respect to 
Business A such that a remittance would result in the recognition of 
foreign currency loss under section 987.
    (ii) Analysis. Because the proceeds from the loan to Business A 
are immediately transferred to X and the distribution from Business 
A to X could result in the recognition of section 987 loss, the IRS 
may scrutinize the recording of the loan on the books of Business A 
and move the loan onto the books of X, resulting in the transfer not 
being taken into account for purposes of section 987 under paragraph 
(b)(3) of this section.
    Example 17. Payment of interest by section 987 QBU on obligation 
of owner. (i) Facts. X owns all of the interests in DE1. DE1 owns 
business A. On January 1, X borrows [euro]1,000 from a bank. On July 
1, Business A pays [euro]20 in interest on X's [euro]1,000 
obligation to the bank.

[[Page 88831]]

    (ii) Analysis. Under general tax law principles as provided in 
paragraph (c)(7) of this section, on July 1, 2021, Business A is 
treated for purposes of section 987 as making a transfer of [euro]20 
to X, and X is treated as making a [euro]20 interest payment to the 
bank.

    (d) Translation of items transferred to a section 987 QBU--(1) 
Marked items. The adjusted basis of a marked asset, or the amount of a 
marked liability, transferred to a section 987 QBU shall be translated 
into the section 987 QBU's functional currency at the spot rate (as 
defined in Sec.  1.987-1(c)(1)) applicable to the date of transfer. If 
the asset or liability transferred is denominated in (or determined by 
reference to) the functional currency of the section 987 QBU (for 
example, cash or a note denominated in the functional currency of the 
section 987 QBU), no translation is required. See Sec.  1.988-
1(a)(10)(ii) for special rules regarding intra-taxpayer transfers.
    (2) Historic items. The adjusted basis of a historic asset, or the 
amount of a historic liability, transferred to a section 987 QBU shall 
be translated into the section 987 QBU's functional currency at the 
rate provided in Sec.  1.987-1(c)(3).


Sec.  1.987-3  Determination of section 987 taxable income or loss of 
an owner of a section 987 QBU.

    (a) In general. This section provides rules for determining the 
taxable income or loss, or the earnings and profits, of an owner of a 
section 987 QBU (hereafter, section 987 taxable income or loss). 
Paragraph (b) of this section provides rules for determining items of 
income, gain, deduction, and loss, which generally must be determined 
in the section 987 QBU's functional currency. Paragraph (c) of this 
section provides rules for translating each item determined under 
paragraph (b) of this section into the functional currency of the owner 
of the section 987 QBU, if necessary. Paragraph (e) of this section 
provides examples illustrating the application of the rules of this 
section.
    (b) Determination of each item of income, gain, deduction, or loss 
in the section 987 QBU's functional currency--(1) In general. Except as 
otherwise provided in this section, a section 987 QBU shall determine 
each item of income, gain, deduction, or loss of such section 987 QBU 
in its functional currency under Federal income tax principles.
    (2) Translation of items of income, gain, deduction, or loss that 
are denominated in a nonfunctional currency--(i) In general. Except as 
otherwise provided in paragraphs (b)(2)(ii) and (b)(4) of this section, 
an item of income, gain, deduction, or loss that is denominated in (or 
determined by reference to) a nonfunctional currency (including the 
functional currency of the owner) shall be translated into the section 
987 QBU's functional currency at the spot rate (as defined in Sec.  
1.987-1(c)(1)) on the date such item is properly taken into account, 
subject to the limitation under Sec.  1.987-1(c)(1)(ii)(B) regarding 
the use of a spot rate convention. Examples 1, 2 and 6 of paragraph (e) 
of this section illustrate the application of this paragraph (b)(2)(i).
    (ii) [Reserved].
    (3) Determination in the case of a section 987 QBU owned through a 
section 987 aggregate partnership--(i) In general. Except as otherwise 
provided in this paragraph (b)(3), the taxable income or loss of a 
section 987 aggregate partnership, and the distributive share of any 
owner that is a partner in such partnership, shall be determined in 
accordance with the provisions of subchapter K of the Internal Revenue 
Code.
    (ii) Determination of each item of income, gain, deduction, or loss 
in the eligible QBU's functional currency. A section 987 aggregate 
partnership generally shall determine each item of income, gain, 
deduction, or loss reflected on the books and records of each of its 
eligible QBUs under Sec.  1.987-2(b) in the functional currency of each 
such QBU.
    (iii) Allocation of items of income, gain, deduction, or loss of an 
eligible QBU. A section 987 aggregate partnership shall allocate the 
items of income, gain, deduction, or loss of each eligible QBU among 
its partners in accordance with each partner's distributive share of 
such income, gain, deduction, or loss as determined under subchapter K 
of the Internal Revenue Code.
    (iv) Translation of items into the owner's functional currency. To 
the extent the items referred to in paragraph (b)(3)(iii) of this 
section are allocated to a partner, the partner shall adjust the items 
to conform to Federal income tax principles and translate the items 
into the partner's functional currency as provided in paragraph (c) of 
this section.
    (4) [Reserved].
    (c) Translation of items of income, gain, deduction, or loss of a 
section 987 QBU into the owner's functional currency--(1) In general. 
Except as otherwise provided in this section, the exchange rate to be 
used by an owner in translating an item of income, gain, deduction, or 
loss attributable to a section 987 QBU into the owner's functional 
currency, if necessary, shall be the yearly average exchange rate (as 
defined in Sec.  1.987-1(c)(2)) for the taxable year. However, an owner 
of a section 987 QBU that has elected under Sec.  1.987-1(c)(1)(iii) to 
use spot rates in lieu of yearly average exchange rates must use the 
spot rate (as defined in Sec.  1.987-1(c)(1)) for the date each item is 
properly taken into account.
    (2) Exceptions--(i) Recovery of basis with respect to historic 
assets. Except as otherwise provided in this section, the exchange rate 
to be used by the owner in translating any recovery of basis (whether 
through a sale or exchange; deemed sale or exchange; cost recovery 
deduction such as depreciation, depletion or amortization; or 
otherwise) with respect to a historic asset (as defined in Sec.  1.987-
1(e)) shall be the historic rate as determined under Sec.  1.987-
1(c)(3) for the property to which such recovery of basis is 
attributable.
    (ii) [Reserved].
    (iii) Gain or loss on the sale, exchange or other disposition of an 
interest in a section 987 aggregate partnership. [Reserved].
    (iv) Cost of goods sold computation--(A) General rule--simplified 
inventory method. Cost of goods sold (COGS) for a taxable year shall be 
translated into the functional currency of the owner at the yearly 
average exchange rate (as defined in Sec.  1.987-1(c)(2)) for the 
taxable year and adjusted as provided in paragraph (c)(3) of this 
section.
    (B) Election to use the historic inventory method. In lieu of using 
the simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section, the owner of a section 987 QBU may elect under this 
paragraph (c)(2)(iv)(B) to translate inventoriable costs (including 
current-year inventoriable costs and costs that were capitalized into 
inventory in prior years) that are included in COGS at the historic 
rate as determined under Sec.  1.987-1(c)(3) for each such cost. As 
described in Sec.  1.987-1(c)(1)(iii), a taxpayer that elects to use 
spot rates in lieu of yearly average exchange rates as provided in that 
section will be deemed to have made the election described in this 
paragraph (c)(2)(iv)(B).
    (3) Adjustments to COGS required under the simplified inventory 
method--(i) In general. An owner of a section 987 QBU that uses the 
simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section must make the adjustment described in paragraph (c)(3)(ii) 
of this section. In addition, the owner must make the adjustment 
described in paragraph (c)(3)(iii) of this section with respect to any 
inventory for which the section 987 QBU does not use the LIFO inventory

[[Page 88832]]

method (as described in section 472) and must make the adjustment 
described in paragraph (c)(3)(iv) of this section with respect to any 
inventory for which the section 987 QBU uses the LIFO inventory method. 
An owner of a section 987 QBU that uses the simplified inventory method 
must make all of the applicable adjustments described in paragraphs 
(c)(3)(ii) through (iv) with respect to the section 987 QBU even in 
taxable years in which the amount of COGS is zero.
    (ii) Adjustment for cost recovery deductions included in 
inventoriable costs. The translated COGS amount computed under 
paragraph (c)(2)(iv)(A) of this section must be increased or decreased 
(as appropriate) to reflect the difference between the historic rates 
appropriate for translating cost recovery deductions attributable to 
other historic assets and the exchange rate used to translate COGS 
under paragraph (c)(2)(iv)(A) of this section, to the extent any such 
cost recovery deductions are included in inventoriable costs for the 
taxable year. The adjustment shall be included as an adjustment to 
translated COGS computed under paragraph (c)(2)(iv)(A) of this section 
in full in the year to which the adjustment relates and shall not be 
allocated between COGS and ending inventory. The adjustment for each 
cost recovery deduction shall be computed as the product of:
    (A) The cost recovery deduction, expressed in the functional 
currency of the section 987 QBU; and
    (B) The exchange rate specified in paragraph (c)(2)(i) of this 
section for translating the cost recovery deduction (that is, the 
historic rate for the property to which such deduction is attributable) 
less the exchange rate used to translate COGS under the simplified 
inventory method described in paragraph (c)(2)(iv)(A) of this section 
(that is, the yearly average exchange rate for the taxable year).
    (iii) Adjustment to beginning inventory for non-LIFO inventory. In 
the case of inventory with respect to which a section 987 QBU does not 
use the LIFO inventory method (non-LIFO inventory), the translated COGS 
amount computed under paragraph (c)(2)(iv)(A) of this section must be 
increased or decreased (as appropriate) by the product of:
    (A) The ending non-LIFO inventory included on the closing balance 
sheet for the preceding year, expressed in the functional currency of 
the section 987 QBU; and
    (B) The exchange rate described in Sec. Sec.  1.987-4(e)(2)(ii) and 
1.987-1(c)(3)(i)(C) that is used for translating ending inventory on 
the closing balance sheet for the preceding year (that is, the yearly 
average exchange rate for the preceding year) less the exchange rate 
used to translate COGS under paragraph (c)(2)(iv)(A) of this section 
(that is, the yearly average exchange rate for the taxable year).
    (iv) Adjustment for year of LIFO liquidation. In the case of 
inventory with respect to which a section 987 QBU uses the LIFO 
inventory method, for each LIFO layer liquidated in whole or in part 
during the taxable year, the translated COGS amount computed under 
paragraph (c)(2)(iv)(A) of this section must be increased or decreased 
(as appropriate) by the product of:
    (A) The amount of the LIFO layer liquidated during the taxable 
year, expressed in the functional currency of the section 987 QBU; and
    (B) The exchange rate described in Sec. Sec.  1.987-4(e)(2)(ii) and 
1.987-1(c)(3)(i)(C) that is used for translating such LIFO layer (that 
is, the yearly average exchange rate for the year such LIFO layer 
arose) less the exchange rate used to translate COGS under paragraph 
(c)(2)(iv)(A) of this section (that is, the yearly average exchange 
rate for the taxable year).
    (d) [Reserved].
    (e) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, U.S. Corp is a domestic 
corporation that uses the calendar year as its taxable year and has the 
U.S. dollar as its functional currency. Except as otherwise indicated, 
U.S. Corp is the owner of Business A, a section 987 QBU with the euro 
as its functional currency, and elects under paragraph (c)(2)(iv)(B) of 
this section to use the historic inventory method with respect to 
Business A but does not make any other elections under section 987. 
However, where it is specified that U.S. Corp elects to use spot rates 
in lieu of yearly average exchange rates under Sec.  1.987-
1(c)(1)(iii), U.S. Corp also elects under Sec.  1.987-1(c)(1)(ii) to 
use a spot rate convention. Under this convention, sales booked during 
a particular month are translated at the average of the spot rates on 
the first and last day of the preceding month (the ``convention 
rate''). Exchange rates used in these examples are selected for the 
purpose of illustrating the principles of this section. No inference 
(for example, whether a currency is hyperinflationary or not) is 
intended by their use. See Sec.  1.987-4(g) for an illustration of the 
simplified inventory method described in paragraphs (c)(2)(iv)(A) and 
(c)(3) of this section.

    Example 1. Business A properly accrues [pound]100 of income from 
the provision of services. Under paragraph (b)(2)(i) of this 
section, the [pound]100 is translated into [euro]90 at the spot rate 
(as defined in Sec.  1.987-1(c)(1)) on the date of accrual, without 
the use of a spot rate convention. In determining U.S. Corp's 
taxable income, the [euro]90 of income is translated into dollars at 
the rate provided in paragraph (c)(1) of this section.
    Example 2. Business A sells a historic asset consisting of non-
inventory property for [pound]100. Under paragraph (b)(2)(i) of this 
section, the [pound]100 amount realized is translated into [euro]85 
at the spot rate (as defined in Sec.  1.987-1(c)(1)) on the sale 
date without the use of a spot rate convention. In determining U.S. 
Corp's taxable income, the [euro]85 is translated into dollars at 
the rate provided in paragraph (c)(1) of this section. The euro 
basis of the property is translated into dollars at the rate 
provided in paragraph (c)(2)(i) of this section (that is, the 
historic rate as determined under Sec.  1.987-1(c)(3)).
    Example 3. (i) Business A uses a first-in, first-out (FIFO) 
method of accounting for inventory. Business A sells 1,200 units of 
inventory in 2021 for [euro]3 per unit. Business A's gross sales are 
translated under paragraph (c)(1) of this section at the yearly 
average exchange rate for the year of the sale. The yearly average 
exchange rate is [euro]1 = $1.02 for 2020 and [euro]1 = $1.05 for 
2021. Thus, Business A's dollar gross sales will be computed as 
follows:

                                                   Gross Sales
                                                     [2021]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Month                         Number  of       Amount in        yearly        Amount in $
                                                       units          [euro]       average rate
----------------------------------------------------------------------------------------------------------------
Jan.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Feb.............................................             200             600       [euro]1 =          630.00
                                                                                           $1.05
March...........................................               0               0       [euro]1 =               0
                                                                                           $1.05
April...........................................             200             600       [euro]1 =          630.00
                                                                                           $1.05
May.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
June............................................               0               0       [euro]1 =               0
                                                                                           $1.05

[[Page 88833]]

 
July............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Aug.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Sept............................................               0               0       [euro]1 =               0
                                                                                           $1.05
Oct.............................................               0               0       [euro]1 =               0
                                                                                           $1.05
Nov.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Dec.............................................             300             900       [euro]1 =          945.00
                                                                                           $1.05
                                                 ---------------------------------------------------------------
                                                           1,200  ..............  ..............        3,780.00
----------------------------------------------------------------------------------------------------------------

    (ii) The purchase price for each inventory unit was [euro]1.50. 
Under Sec.  1.987-1(c)(3)(i) and paragraph (c)(2)(iv)(B) of this 
section, the basis of each item of inventory is translated into 
dollars at the yearly average exchange rate for the year the 
inventory was acquired.

                                         Opening Inventory and Purchases
                                                     [2021]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Month                         Number  of      Amount  in        yearly        Amount in $
                                                       units          [euro]       average rate
----------------------------------------------------------------------------------------------------------------
Opening inventory (purchased in December 2020)               100             150       [euro]1 =          153.00
                                                                                           $1.02
Purchases in 2021:
    Jan.........................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    Feb.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    March.......................................               0               0       [euro]1 =               0
                                                                                           $1.05
    April.......................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    May.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    June........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    July........................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    Aug.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Sept........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Oct.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Nov.........................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    Dec.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
                                                 ---------------------------------------------------------------
                                                           1,200  ..............  ..............        1,890.00
----------------------------------------------------------------------------------------------------------------

    (iii) Because Business A uses a FIFO method for inventory, 
Business A is considered to have sold in 2021 the 100 units of 
opening inventory purchased in 2020 ($153.00), the 300 units 
purchased in January 2021 ($472.50), the 300 units purchased in 
April 2021 ($472.50), the 300 units purchased in July 2021 
($472.50), and 200 of the 300 units purchased in November 2021 
($315.00). Accordingly, Business A's translated dollar COGS for 2021 
is $1,885.50. Business A's opening inventory for 2022 is 100 units 
of inventory with a translated dollar basis of $157.50.
    (iv) Accordingly, for purposes of section 987 Business A has 
gross income in dollars of $1,894.50 ($3,780.00--$1,885.50).
    Example 4. (i) The facts are the same as in Example 3 except 
that U.S. Corp properly elects under paragraph Sec.  1.987-
1(c)(1)(iii) to use spot rates in lieu of yearly average exchange 
rates. As a result, under paragraph (c)(3) of this section, U.S. 
Corp uses the convention rate to translate items of income, gain, 
deduction, or loss where such rate is appropriate. Thus, Business 
A's dollar gross sales will be computed as follows:

                                                   Gross Sales
                                                     [2021]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Sales                         Number  of      Amount  in      convention      Amount in $
                                                       units          [euro]           rate
----------------------------------------------------------------------------------------------------------------
Jan.............................................             100             300       [euro]1 =             300
                                                                                           $1.00
Feb.............................................             200             600       [euro]1 =             630
                                                                                           $1.05
March...........................................               0               0       [euro]1 =               0
                                                                                           $1.03
April...........................................             200             600       [euro]1 =             612
                                                                                           $1.02
May.............................................             100             300       [euro]1 =             312
                                                                                           $1.04
June............................................               0               0       [euro]1 =               0
                                                                                           $1.05
July............................................             100             300       [euro]1 =             318
                                                                                           $1.06
Aug.............................................             100             300       [euro]1 =             315
                                                                                           $1.05
Sept............................................               0               0       [euro]1 =               0
                                                                                           $1.06
Oct.............................................               0               0       [euro]1 =               0
                                                                                           $1.07
Nov.............................................             100             300       [euro]1 =             324
                                                                                           $1.08
Dec.............................................             300             900       [euro]1 =             972
                                                                                           $1.08
                                                 ---------------------------------------------------------------

[[Page 88834]]

 
                                                           1,200  ..............  ..............           3,783
----------------------------------------------------------------------------------------------------------------

    (ii) As in Example 3, the purchase price for each inventory unit 
was [euro]1.50. Under Sec.  1.987-3(c)(2)(iv)(B), U.S. Corp uses the 
convention rate as the historic rate in determining COGS.

                                         Opening Inventory and Purchases
                                                     [2021]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Month                         Number  of      Amount  in      convention      Amount in $
                                                       units          [euro]           rate
----------------------------------------------------------------------------------------------------------------
Opening inventory (purchased in December 2020)               100             150       [euro]1 =             153
                                                                                           $1.02
Purchases in 2021:
    Jan.........................................             300             450       [euro]1 =             450
                                                                                           $1.00
    Feb.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    March.......................................               0               0       [euro]1 =               0
                                                                                           $1.03
    April.......................................             300             450       [euro]1 =             459
                                                                                           $1.02
    May.........................................               0               0       [euro]1 =               0
                                                                                           $1.04
    June........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    July........................................             300             450       [euro]1 =             477
                                                                                           $1.06
    Aug.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Sept........................................               0               0       [euro]1 =               0
                                                                                           $1.06
    Oct.........................................               0               0       [euro]1 =               0
                                                                                           $1.07
    Nov.........................................             300             450       [euro]1 =             486
                                                                                           $1.08
    Dec.........................................               0               0       [euro]1 =             486
                                                                                           $1.08
                                                 ---------------------------------------------------------------
                                                           1,200  ..............  ..............           1,872
----------------------------------------------------------------------------------------------------------------

    (iii) As set forth in (i), Business A's gross sales are $3,783.
    (iv) Because Business A uses a FIFO method for inventory, 
Business A is considered to have sold in 2021 the 100 units of 
opening inventory purchased in December 2020 ($150), the 300 units 
purchased in January 2021 ($450), the 300 units purchased in April 
2021 ($459), the 300 units purchased in July 2021 ($477), and 200 of 
the 300 units purchased in November 2021 ($324). Thus, Business A's 
COGS is $1,860.
    (v) Accordingly, Business A has gross income in dollars of 
$1,923 ($3,783 - $1,860).
    Example 5. The facts are the same as in Example 3 except that 
during 2021, Business A incurred [euro]100 of depreciation expense 
with respect to a truck. No portion of the depreciation expense is 
an inventoriable cost. The truck was purchased on January 15, 2020. 
The yearly average exchange rate for 2020 was [euro]1 = $1.02. Under 
paragraph (c)(2)(i) of this section, the [euro]100 of depreciation 
is translated into dollars at the historic rate. Under Sec.  1.987-
1(c)(3)(i), the historic rate is the yearly average rate for 2020. 
Accordingly, U.S. Corp takes into account depreciation of $102 with 
respect to Business A in 2021.
    Example 6. The facts are the same as in Example 5 except that 
the [euro]100 of depreciation expense incurred during 2021 with 
respect to the truck is an inventoriable cost. As a result, the 
depreciation expense is capitalized into the 1,200 units of 
inventory purchased by Business A in 2021. Of those 1,200 units, 
1,100 units are sold during the year, and 100 units become ending 
inventory. The portion of depreciation expense capitalized into 
inventory that is sold during 2021 is reflected in Business A's euro 
COGS and is translated at the [euro]1 = $1.02 yearly average 
exchange rate for 2020, the year in which the truck was purchased. 
The portion of the depreciation expense capitalized into the 100 
units of ending inventory is not taken into account in 2021 but, 
rather, will be taken into account in the year the ending inventory 
is sold, translated at the [euro]1 = $1.02 yearly average exchange 
rate for 2020.
    Example 7. Business A purchased raw land on October 16, 2020, 
for [euro]8,000 and sold the land on November 1, 2021, for 
[euro]10,000. The yearly average exchange rate was [euro]1 = $1.02 
for 2020 and [euro]1 = $1.05 for 2021. Under paragraph (c)(1) of 
this section, the amount realized is translated into dollars at the 
yearly average exchange rate for 2021 ([euro]10,000 x $1.05 = 
$10,500). Under paragraph (c)(2)(i) of this section, the basis is 
determined at the historic rate for 2020, which is the yearly 
average rate under section Sec.  1.987-1(c)(3)(i) for such year 
([euro]8,000 x $1.02 = $8,160). Accordingly, the amount of gain 
reported by U.S. Corp on the sale of the land is $2,340 ($10,500 - 
$8,160).
    Example 8. The facts are the same as in Example 7 except that 
Business A properly elects under paragraph Sec.  1.987-1(c)(1)(iii) 
to use spot rates in lieu of yearly average rates. Accordingly, the 
amount realized will be translated at the convention rate for the 
date of sale, and the basis will be translated at the convention 
rate for the date of purchase. The convention rate is [euro]1 = 
$1.01 for October 2020 and is [euro]1 = $1.08 for November 2021. 
Under these facts, the amount realized, translated into dollars at 
the convention rate for November 2021, is $10,800 ([euro]10,000 x 
$1.08), and the basis, translated at the convention rate for October 
2020, is $8,080 ([euro]8,000 x $1.01). The amount of gain reported 
by U.S. Corp on the sale of the land is $2,720 ($10,800 - $8,080).


Sec.  1.987-4  Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU.

    (a) In general. The net unrecognized section 987 gain or loss of a 
section 987 QBU shall be determined by the owner annually as provided 
in paragraph (b) of this section in the owner's functional currency. 
Only assets and liabilities reflected on the books and records of the 
section 987 QBU under Sec.  1.987-2(b) shall be taken into account.
    (b) Calculation of net unrecognized section 987 gain or loss. Net 
unrecognized section 987 gain or loss of a section 987 QBU for a 
taxable year shall equal the sum of:
    (1) The section 987 QBU's net accumulated unrecognized section 987 
gain or loss for all prior taxable years to

[[Page 88835]]

which these regulations apply as determined in paragraph (c) of this 
section, and
    (2) The section 987 QBU's unrecognized section 987 gain or loss for 
the current taxable year as determined in paragraph (d) of this 
section.
    (c) Net accumulated unrecognized section 987 gain or loss for all 
prior taxable years--(1) In general. A section 987 QBU's net 
accumulated unrecognized section 987 gain or loss for all prior taxable 
years is the aggregate of the amounts determined under Sec.  1.987-4(d) 
for all prior taxable years to which these regulations apply, reduced 
by the amounts taken into account under Sec.  1.987-5 upon remittances 
for all such prior taxable years.
    (2) [Reserved].
    (d) Calculation of unrecognized section 987 gain or loss for a 
taxable year. The unrecognized section 987 gain or loss of a section 
987 QBU for a taxable year shall be determined under paragraphs (d)(1) 
through (8) of this section.
    (1) Step 1: Determine the change in the owner functional currency 
net value of the section 987 QBU for the taxable year--(i) In general. 
The change in the owner functional currency net value of the section 
987 QBU for the taxable year shall equal--
    (A) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the taxable year; less
    (B) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the preceding taxable year. This 
amount shall be zero in the case of the section 987 QBU's first taxable 
year.
    (ii) Year section 987 QBU is terminated. If a section 987 QBU is 
terminated within the meaning of Sec.  1.987-8 during an owner's 
taxable year, the owner functional currency net value of the section 
987 QBU as provided in paragraph (d)(1)(i)(A) of this section shall be 
determined on the date the section 987 QBU is terminated.
    (2) Step 2: Increase the amount determined in step 1 by the amount 
of assets transferred from the section 987 QBU to the owner--(i) In 
general. The amount determined in paragraph (d)(1) of this section 
shall be increased by the total amount of assets described in paragraph 
(d)(2)(ii) of this section transferred from the section 987 QBU to the 
owner during the taxable year translated into the owner's functional 
currency as provided in paragraph (d)(2)(ii) of this section.
    (ii) Assets transferred from the section 987 QBU to the owner 
during the taxable year. The assets transferred from the section 987 
QBU to the owner for the taxable year shall equal the sum of:
    (A) The amount of the section 987 QBU's functional currency and the 
aggregate adjusted basis of all marked assets (as defined in Sec.  
1.987-1(d)), after taking into account Sec.  1.988-1(a)(10), 
transferred to the owner during the taxable year determined in the 
functional currency of the section 987 QBU and translated into the 
owner's functional currency at the spot rate (as defined in Sec.  
1.987-1(c)(1)) applicable to the date of transfer; and
    (B) The aggregate adjusted basis of all historic assets (as defined 
in Sec.  1.987-1(e)), after taking into account Sec.  1.988-1(a)(10), 
transferred to the owner during the taxable year determined in the 
functional currency of the section 987 QBU and translated into the 
owner's functional currency at the historic rate for each such asset 
(as defined in Sec.  1.987-1(c)(3)).
    (3) Step 3: Decrease the amount determined in steps 1 and 2 by the 
amount of assets transferred from the owner to the section 987 QBU--(i) 
In general. The aggregate amount determined in paragraphs (d)(1) and 
(d)(2) of this section shall be decreased by the total amount of assets 
transferred from the owner to the section 987 QBU during the taxable 
year determined in the functional currency of the owner as provided in 
paragraph (d)(3)(ii) of this section.
    (ii) Total of all amounts transferred from the owner to the section 
987 QBU during the taxable year. The total amount of assets transferred 
from the owner to the section 987 QBU for the taxable year shall equal 
the aggregate of:
    (A) The total amount of functional currency of the owner 
transferred to the section 987 QBU during the taxable year; and
    (B) The adjusted basis, determined in the functional currency of 
the owner, of any asset transferred to the section 987 QBU during the 
taxable year (after taking into account Sec.  1.988-1(a)(10)).
    (4) Step 4: Decrease the amount determined in steps 1 through 3 by 
the amount of liabilities transferred from the section 987 QBU to the 
owner. The aggregate amount determined in paragraphs (d)(1) through (3) 
of this section shall be decreased by the aggregate amount of 
liabilities transferred from the section 987 QBU to the owner during 
the taxable year. The amount of such liabilities shall be translated 
into the functional currency of the owner at the spot rate (as defined 
in Sec.  1.987-1(c)(1)) applicable on the date of transfer.
    (5) Step 5: Increase the amount determined in steps 1 through 4 by 
the amount of liabilities transferred from the owner to the section 987 
QBU. The aggregate amount determined in paragraphs (d)(1) through (4) 
of this section shall be increased by the aggregate amount of 
liabilities transferred by the owner to the section 987 QBU during the 
taxable year. The amount of such liabilities shall be translated into 
the functional currency of the owner at the spot rate (as defined in 
Sec.  1.987-1(c)(1)) applicable on the date of transfer.
    (6) Step 6: Decrease or increase the amount determined in steps 1 
through 5 by the section 987 taxable income or loss, respectively, of 
the section 987 QBU for the taxable year. The aggregate amount 
determined in paragraphs (d)(1) through (5) of this section shall be 
decreased or increased by the section 987 taxable income or loss, 
respectively, computed under Sec.  1.987-3 for the taxable year.
    (7) Step 7: Increase the amount determined in steps 1 through 6 by 
any expenses that are not deductible in computing the section 987 
taxable income or loss of the section 987 QBU for the taxable year. The 
aggregate amount determined under paragraphs (d)(1) through (6) shall 
be increased by the amount of any expense or loss attributable to a 
section 987 QBU for the taxable year that is not deductible in 
computing the section 987 QBU's taxable income or loss for the year, 
including any foreign income taxes incurred by the section 987 QBU with 
respect to which the owner claims a credit (translated at the same rate 
at which such taxes were translated under section 986(a)).
    (8) Step 8: Decrease the amount determined in steps 1 through 7 by 
the amount of any tax-exempt income. The aggregate amount determined 
under paragraphs (d)(1) through (7) shall be decreased by the amount of 
any income or gain attributable to a section 987 QBU for the taxable 
year that is not included in computing the section 987 QBU's taxable 
income or loss for the year.
    (e) Determination of the owner functional currency net value of a 
section 987 QBU--(1) In general. The owner functional currency net 
value of a section 987 QBU on the last day of a taxable year shall 
equal the aggregate amount of functional currency and the adjusted 
basis of each asset on the section 987 QBU's balance sheet on that day, 
less the aggregate amount of each

[[Page 88836]]

liability on the section 987 QBU's balance sheet on that day, in each 
case translated into the owner's functional currency as provided in 
paragraph (e)(2) of this section. Such amount shall be determined by:
    (i) Preparing a balance sheet for the relevant date from the 
section 987 QBU's books and records (within the meaning of Sec.  
1.989(a)-1(d)), as recorded in the section 987 QBU's functional 
currency and showing all assets and liabilities reflected on such books 
and records as provided in Sec.  1.987-2(b);
    (ii) Making adjustments necessary to conform the items reflected on 
the balance sheet described in paragraph (e)(1)(i) of this section to 
United States tax accounting principles; and
    (iii) Translating the asset and liability amounts on the adjusted 
balance sheet described in paragraph (e)(1)(ii) of this section into 
the functional currency of the owner in accordance with paragraph 
(e)(2) of this section.
    (2) Translation of balance sheet items into the owner's functional 
currency. The amount of the section 987 QBU's functional currency, the 
basis of an asset, or the amount of a liability shall be translated as 
follows:
    (i) Marked item. A marked item (as defined in Sec.  1.987-1(d)) 
shall be translated into the owner's functional currency at the spot 
rate (as defined in Sec.  1.987-1(c)(1)) applicable to the last day of 
the relevant taxable year.
    (ii) Historic item. A historic item (as defined in Sec.  1.987-
1(e)) shall be translated into the owner's functional currency at the 
historic rate (as defined in Sec.  1.987-1(c)(3)).
    (f) [Reserved].
    (g) Examples. The following examples illustrate the provisions of 
this section. For purposes of the examples, U.S. Corp is a domestic 
corporation that uses the calendar year as its taxable year and has the 
dollar as its functional currency. Except as otherwise indicated, U.S. 
Corp elects under Sec.  1.987-3(c)(2)(iv)(B) to use the historic 
inventory method with respect to all of its section 987 QBUs but does 
not make other elections under section 987. Exchange rate and tax 
accounting (for example, depreciation rate) assumptions used in these 
examples are selected for the purpose of illustrating the principles of 
this section, and no inference is intended by their use. Additionally, 
the examples are not intended to demonstrate when activities constitute 
a trade or business within the meaning of Sec.  1.989(a)-1(b)(2)(ii)(A) 
and Sec.  1.989(a)-1(c) and therefore whether a section 987 QBU is 
onsidered to exist.

    Example 1. (i) On July 1, 2021, U.S. Corp establishes Japan 
Branch, a section 987 QBU of U.S. Corp that has the yen as its 
functional currency, and transfers to Japan Branch $1,000 and raw 
land with a basis of $500. Japan Branch immediately exchanges the 
$1,000 for [yen]100,000. On the same day, Japan Branch borrows 
[yen]10,000. For the taxable year 2021, Japan Branch earns 
[yen]2,000 per month (total of [yen]12,000 for the six-month period 
from July 1, 2021, through December 31, 2021) for providing services 
and incurs [yen]333.33 per month (total of [yen]2,000 when rounded 
for the six-month period from July 1, 2021, through December 31, 
2021) of related expenses. Assume that the spot rate on July 1, 
2021, is $1 = [yen]100; the spot rate on December 31, 2021, is $1 = 
[yen]120; and the average rate for the period of July 1, 2021, to 
December 31, 2021, is $1 = [yen]110. Thus, the [yen]12,000 of 
services revenue when properly translated under Sec.  1.987-3(c)(1) 
at the yearly average exchange rate equals $109.09 ([yen]12,000 x 
($1/[yen]110)) = $109.09). The [yen]2,000 of expenses translated at 
the same yearly average exchange rate equals $18.18 ([yen]2,000 x 
($1/[yen]110) = $18.18). Thus, Japan Branch's net income translated 
into dollars equals $90.91 ($109.09 - $18.18 = $90.91).
    (ii) Under paragraph (a) of this section, U.S. Corp must compute 
the net unrecognized section 987 gain or loss of Japan Branch for 
2021. Because this is Japan Branch's first taxable year, the net 
unrecognized section 987 gain or loss (as defined under paragraph 
(b) of this section) is the branch's unrecognized section 987 gain 
or loss for 2021 as determined in paragraph (d) of this section. The 
calculation under paragraph (d) of this section is made as follows:
    (iii) Step 1. Under paragraph (d)(1) of this section, U.S. Corp 
must determine the change in the owner functional currency net value 
(OFCNV) of Japan Branch for 2021 in dollars. The change in the OFCNV 
of Japan Branch for 2021 is equal to the OFCNV of Japan Branch 
determined in dollars on the last day of 2021, less the OFCNV of 
Japan Branch determined in dollars on the last day of the preceding 
taxable year.
    (A) The OFCNV of Japan Branch determined in dollars on the last 
day of the current taxable year is determined under paragraph (e) of 
this section as the sum of the basis of each asset on Japan Branch's 
balance sheet on December 31, 2021, less the sum of each liability 
on Japan Branch's balance sheet on that date, translated into 
dollars as provided in paragraph (e)(2) of this section.
    (B) For this purpose, Japan Branch will show the following 
assets and liabilities on its balance sheet for December 31, 2021:
    (1) [yen]120,000;
    (2) Raw land with a basis of [yen]55,000 ($500 translated under 
Sec.  1.987-2(d)(2) at the historic rate of $1 = [yen]110); and
    (3) Liabilities of [yen]10,000.
    (C) Under paragraph (e)(2) of this section, U.S. Corp will 
translate these items as follows. The [yen]120,000 is a marked asset 
and the [yen]10,000 liability is a marked liability (as each is 
defined in Sec.  1.987-1(d)). These items are translated into 
dollars on December 31, 2021, using the spot rate on December 31, 
2021, of $1 = [yen]120. The raw land is a historic asset (as defined 
in Sec.  1.987-1(e)) and is translated into dollars under paragraph 
(e)(2)(ii) of this section at the historic rate, which under Sec.  
1.987-1(c)(3)(1)(A) is the yearly average exchange rate of $1 = 
[yen]110 applicable to the year the land was transferred to the QBU. 
Thus, the OFCNV of Japan Branch on December 31, 2021, in dollars is 
$1,416.67 determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                         [yen]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Yen....................................         120,000  $1 = [yen]120 (spot rate--12/31/21)       $1,000.00
    Land...................................          55,000  1 = [yen]110 (yearly average rate--          500.00
                                                              2021).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................        1,500.00
Liabilities:
    Bank Loan..............................          10,000  1 = [yen]120 (spot rate--12/31/21).           83.33
                                            --------------------------------------------------------------------
        Total liabilities..................  ..............  ...................................           83.33
2021 ending OFCNV..........................  ..............  ...................................        1,416.67
----------------------------------------------------------------------------------------------------------------

    (D) Under paragraph (d)(1) of this section, the change in OFCNV 
of Japan Branch for 2021 is equal to the OFCNV of the branch 
determined in dollars on December 31, 2021, ($1,416.67) less the 
OFCNV of the branch determined in dollars on the last day of the 
preceding taxable year. Because this is the first taxable year of 
Japan Branch, the OFCNV of Japan Branch determined in dollars on the 
last day of the preceding taxable year is zero under paragraph 
(d)(1)(i)(B) of this section. Accordingly, the change in OFCNV of 
Japan Branch for 2021 is $1,416.67.
    (iv) Step 2. Under paragraph (d)(2) of this section, the 
aggregate amount determined in paragraph (d)(1) of this section 
(step 1) is increased by the total amount of assets described in 
paragraph (d)(2)(ii) of this section transferred from the section 
987 QBU to the owner during the taxable year translated into the 
owner's functional currency as provided in paragraph (d)(2)(ii) of 
this section. Because no such amounts

[[Page 88837]]

were transferred, there is no change in the $1,416.67 determined in 
step 1.
    (v) Step 3. Under paragraph (d)(3) of this section, the 
aggregate amount determined in paragraphs (d)(1) and (d)(2) of this 
section (steps 1 and 2) is decreased by the total amount of assets 
transferred from the owner to the section 987 QBU during the taxable 
year as determined in paragraph (d)(3)(ii) of this section in 
dollars. On July 1, 2021, U.S. Corp transferred to Japan Branch 
$1,000.00 (which Japan Branch immediately converted into 
[yen]100,000) and raw land with a basis of $500.00 (equal to 
[yen]55,000, translated under Sec.  1.987-2(d)(2) at the historic 
rate of $1 = [yen]110). Thus, the $1,416.67 determined under steps 1 
and 2 is reduced by $1,500.00, resulting in ($83.33).
    (vi) Steps 4 and 5. Because no liabilities were transferred by 
U.S. Corp to Japan Branch or by Japan Branch to U.S. Corp during the 
taxable year, the aggregate amount determined in paragraph (d)(3) of 
this section (Step 3) is not increased or decreased.
    (vii) Step 6. Under paragraph (d)(6) of this section, the 
aggregate amount determined after applying paragraphs (d)(1) through 
(5) of this section (steps 1 through 5) is decreased by the section 
987 taxable income of Japan Branch of $90.91 from ($83.33) to 
($174.24).
    (viii) Steps 7 and 8. Paragraphs (d)(7) and (d)(8) do not apply 
because Japan Branch does not have any tax-exempt or nondeductible 
items. Accordingly, the unrecognized section 987 loss of Japan 
Branch for 2021 is ($174.24), the amount determined after applying 
step 6.
    Example 2. (i) U.S. Corp operates in the United Kingdom through 
U.K. Branch, a section 987 QBU of U.S. Corp that has the pound as 
its functional currency. U.S. Corp properly elects under Sec.  
1.987-1(c)(1)(ii) for U.K. Branch to use a spot rate convention 
(when permitted). Under the chosen convention, the spot rate (the 
``convention rate'') for any transaction occurring during a month is 
the average of the pound spot rate and the 30-day forward rate for 
pounds on the next-to-last Thursday of the preceding month. The 
yearly average exchange rate was [pound]1 = $0.90 for 2020, [pound]1 
= $1.00 for 2021, and [pound]1 = $1.10 for 2022. The closing balance 
sheet of U.K. Branch in 2021 reflected the following assets:
    (A) [pound]100;
    (B) A sales office purchased in 2020 with an adjusted basis of 
[pound]1,000;
    (C) A delivery truck purchased in 2020 with an adjusted basis of 
[pound]200;
    (D) Inventory of 100 units purchased in 2021 with a basis of 
[pound]100; and
    (E) Stock in ABC Corporation purchased in 2021 with a basis of 
[pound]150, representing less than 10 percent of the total voting 
power and value of all classes of stock of ABC Corporation.
    The closing balance sheet of U.K. Branch for 2021 reflected one 
liability, [pound]50 of long-term debt entered into in 2020 with F 
Bank, an unrelated bank.
    The office, truck, stock, and inventory are historic assets (as 
defined in Sec.  1.987-1(e)). The [pound]100 and long-term debt are 
marked items (as defined in Sec.  1.987-1(d)). Assume that U.S. Corp 
translated U.K. Branch's 2021 closing balance sheet as follows:

----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [pound]               Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Pounds.................................          100.00  [pound]1 = $1.05 (convention rate--          105.00
                                                              Dec. 2021).
    Office.................................        1,000.00  [pound]1 = $0.90 (historic rate--            900.00
                                                              2020).
    Truck..................................          200.00  [pound]1 = $0.90 (historic rate--            180.00
                                                              2020).
    Stock..................................           50.00  [pound]1 = $1.00 (historic rate--            150.00
                                                              2021).
    Inventory..............................          100.00  [pound]1 = $1.00 (historic rate--            100.00
                                                              2021).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................        1,435.00
Liabilities:
    Bank Loan..............................           50.00  [pound]1 = $1.05 (convention rate--           52.50
                                                              Dec. 2021).
                                            --------------------------------------------------------------------
        Total liabilities..................  ..............  ...................................           52.50
2021 ending OFCNV..........................  ..............  ...................................        1,382.50
----------------------------------------------------------------------------------------------------------------

    (ii) U.K. Branch uses the first-in, first-out (FIFO) method of 
accounting for inventory. In 2022, U.K. Branch sold 100 units of 
inventory for a total of [pound]300 and purchased another 100 units 
of inventory for [pound]100. There is depreciation of [pound]33 with 
respect to the office and [pound]40 with respect to the truck, and 
U.K. Branch incurred [pound]30 of business expenses during 2022. 
Neither the depreciation nor the business expenses are inventoriable 
costs. All items of income earned and expenses incurred during 2022 
are received and paid, respectively, in pounds. Under Sec.  1.987-3, 
U.K. Branch's section 987 taxable income or loss is determined as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                Amount in
                    Item                         [pound]               Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
Gross receipts.............................          300.00  [pound]1 = $1.10 (yearly average             330.00
                                                              rate--2022).
Less:
    COGS...................................        (100.00)  [pound]1 = $1.00 (historic rate--          (100.00)
                                                              2021).
                                            --------------------------------------------------------------------
        Gross income.......................  ..............  ...................................          230.00
Dep:
    Office.................................         (33.00)  [pound]1 = $0.90 (historic rate--           (29.70)
                                                              2020).
    Truck..................................         (40.00)  [pound]1 = $0.90 (historic rate--           (36.00)
                                                              2020).
Other expenses.............................         (30.00)  [pound]1 = $1.10 (yearly average            (33.00)
                                                              rate--2022).
                                            --------------------------------------------------------------------
        Total expenses.....................  ..............  ...................................         (98.70)
Section 987 taxable income.................  ..............  ...................................          131.30
----------------------------------------------------------------------------------------------------------------

    Accordingly, U.K. Branch has $131.30 of section 987 taxable 
income in 2022.
    (iii) In December 2022, U.K. Branch transferred [pound]30 to 
U.S. Corp, and U.S. Corp transferred a computer with a basis of $10 
to U.K. Branch. U.S. Corp's net accumulated unrecognized section 987 
gain or loss for all prior taxable years as determined in paragraph 
(c) of this section is $30.
    (iv) The unrecognized section 987 gain or loss of U.K. Branch 
for 2022 is determined as follows:
    (A) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of U.K. Branch determined under paragraph (e) of 
this section on the last day of 2022, less the OFCNV of U.K. Branch 
determined on the last day of 2021. The OFCNV of U.K. Branch on 
December 31, 2022, and the change in OFCNV for 2022, are determined 
as follows:

[[Page 88838]]



----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [pound]               Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Pounds.................................          240.00  [pound]1 = $1.15 (convention rate--          276.00
                                                              Dec. 2022).
    Office.................................          967.00  1 = $0.90 (historic rate--2020)....          870.30
    Truck..................................          160.00  [pound]1 = $0.90 (historic rate--            144.00
                                                              2020).
    Inventory..............................          100.00  [pound]1 = $1.10 (historic rate--            110.00
                                                              2022).
    Computer...............................            9.09  [pound]1 = $1.10 (historic rate--             10.00
                                                              2022).
    Stock..................................          150.00  [pound]1 = $1.00 (historic rate--            150.00
                                                              2021).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................        1,560.30
Liabilities:
    Bank Loan..............................           50.00  [pound]1 = $1.15 (convention rate--           57.50
                                                              Dec. 2022).
                                            --------------------------------------------------------------------
        Total liabilities..................  ..............  ...................................           57.50
2022 ending OFCNV..........................  ..............  ...................................        1,502.80
Less:
    2021 ending OFCNV......................  ..............  ...................................      (1,382.50)
                                            --------------------------------------------------------------------
        Change in OFCNV....................  ..............  ...................................          120.30
----------------------------------------------------------------------------------------------------------------

    (B) Step 2. Under paragraph (d)(2) of this section, the 
aggregate amount determined in step 1 must be increased by the total 
amount of assets described in paragraph (d)(2)(ii) of this section 
transferred from U.K. Branch to U.S. Corp during the taxable year, 
translated into U.S. Corp's functional currency as provided in 
paragraph (d)(2)(ii) of this section. The amount of assets 
transferred from U.K. Branch to U.S. Corp during 2022 is determined 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Asset                         [pound]               Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
[pound]30..................................           30.00  [pound]1 = $1.15 (convention rate--           34.50
                                                              Dec. 2022).
----------------------------------------------------------------------------------------------------------------

    (C) Step 3: Decrease the aggregate amount described in steps 1 
and 2 by the owner's transfers to the section 987 QBU. Under 
paragraph (d)(3) of this section, the aggregate amount determined in 
steps 1 and 2 must be decreased by the total amount of all assets 
transferred from U.S. Corp to U.K. Branch during the taxable year as 
determined in paragraph (d)(3)(ii) of this section. The amount of 
assets transferred from U.S. Corp to U.K. Branch during 2022 is 
determined as follows:

----------------------------------------------------------------------------------------------------------------
                   Asset                                                                            Amount in $
----------------------------------------------------------------------------------------------------------------
Computer...................................  ..............  ...................................           10.00
----------------------------------------------------------------------------------------------------------------

    (D) Step 4. Under paragraph (d)(4) of this section, the 
aggregate amount determined in steps 1 through 3 must be decreased 
by the aggregate amount of liabilities transferred by U.K. Branch to 
U.S. Corp. Under these facts, such amount is $0.
    (E) Step 5. Under paragraph (d)(5) of this section, the 
aggregate amount determined in steps 1 through 4 must be increased 
by the aggregate amount of liabilities transferred by U.S. Corp to 
U.K. Branch. Under these facts, such amount is $0.
    (F) Step 6. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 is decreased or 
increased, respectively, by any section 987 taxable income or loss 
of U.K. Branch computed under Sec.  1.987-3 for the taxable year. 
The amount of U.K. Branch's taxable income, as determined above, is 
$131.30.
    (H) Steps 7 and 8: Paragraphs (d)(7) and (d)(8) do not apply 
because U.K. Branch does not have any tax-exempt income or 
nondeductible expense.
    (v) Summary. Taking steps 1 through 8 into account, the amount 
of U.S. Corp's unrecognized section 987 gain or loss with respect to 
U.K. Branch in 2022 is computed as follows:

------------------------------------------------------------------------
                  Step                      Amount in $       Balance
------------------------------------------------------------------------
1.......................................        + 120.30         $120.30
2.......................................         + 34.50          154.80
3.......................................         - 10.00          144.80
4.......................................             - 0          144.80
5.......................................             + 0          144.80
6.......................................        - 131.30           13.50
7.......................................             + 0           13.50
8.......................................             - 0           13.50
------------------------------------------------------------------------

    Thus, U.S. Corp's unrecognized section 987 gain for 2022 with 
respect to U.K. Branch is $13.50. As of the end of 2022, before 
taking into account the recognition of any section 987 gain or loss 
under Sec.  1.987-5, U.S. Corp's net unrecognized section 987 gain 
is $43.50 (that is, $30.00 accumulated from prior years, plus $13.50 
in 2022).
    Example 3. (i) Background. U.S. Corp is the owner of Business A, 
a section 987 QBU that has the euro as its functional currency. 
Business A uses the FIFO method to account for inventory and uses 
the simplified inventory method described in Sec.  1.987-
3(c)(2)(iv)(A). On the last day of 2020, U.S. Corp begins Business A 
by contributing to Business A a building with a basis of $780, a 
machine with a basis of $300, and $100. On January 1, 2021, Business 
A converts the $100 into [euro]100. The tax basis of the building 
and machine is translated into euros using the historic rate, which 
is the yearly average exchange rate for 2020, the year of the 
transfer. Accordingly, the building and the machine have a tax basis 
of [euro]780 and [euro]300, respectively, on December 31, 2020. The

[[Page 88839]]

building and machine have annual depreciation of [euro]20 and 
[euro]30, respectively. Business A determines that 50 percent of the 
building depreciation should be allocated to the cost of goods 
manufactured (that is, treated as an inventoriable cost) and 50 
percent should be allocated to selling, general and administrative 
(SG&A) expenses. The machine is used exclusively to manufacture 
inventory. Relevant exchange rates for purposes of this example are 
as follows:

------------------------------------------------------------------------
                                          Yearly average    December 31
                  Year                     exchange rate     spot rate
------------------------------------------------------------------------
2020....................................       [euro]1 =       [euro]1 =
                                                   $1.00           $1.00
2021....................................       [euro]1 =       [euro]1 =
                                                   $1.50           $2.00
2022....................................       [euro]1 =       [euro]1 =
                                                   $2.50           $3.00
------------------------------------------------------------------------

    (ii) Operations in 2021. During 2021, Business A recognizes 
[euro]140 of revenue from sales of finished goods. The related COGS 
is [euro]70. Business A pays [euro]10 in salaries allocable to SG&A. 
Inventoriable costs in 2021 include [euro]10 of depreciation on the 
building and [euro]30 of depreciation on the machine. Business A's 
balance sheet on December 31, 2021, shows no liabilities and the 
following assets: currency of [euro]160, the building with an 
adjusted basis of [euro]760, the machine with an adjusted basis of 
[euro]270, and ending inventory with a FIFO cost basis of [euro]40, 
comprising raw materials and finished goods.
    (A) Determination of income. Under the simplified inventory 
method, Business A's income for 2021 is computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                     Item                           [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Sales revenue.................................             140  [euro]1 = $1.50 (yearly avg.                 210
                                                                 rate--2021).
COGS before adjustments.......................              70  [euro]1 = $1.50 (yearly avg.                 105
                                                                 rate--2021).
    Adjustment for cost recovery deductions     ..............  ................................            (20)
     (see calculation below).
    Adjustment for beginning inventory (none).  ..............  ................................               0
                                               -----------------------------------------------------------------
        Adjusted COGS.........................  ..............  ................................              85
SG&A:
    Depreciation on building (50%)............              10  [euro]1 = $1.00 (historic rate--              10
                                                                 2020).
    Salaries..................................              10  [euro]1 = $1.50 (yearly avg.                  15
                                                                 rate--2021).
                                               -----------------------------------------------------------------
        Total SG&A............................  ..............  ................................              25
Section 987 net income (revenue less COGS and   ..............  ................................             100
 SG&A).
----------------------------------------------------------------------------------------------------------------

    COGS Adjustments.
    Adjustment for cost recovery deductions included in 
inventoriable costs.

----------------------------------------------------------------------------------------------------------------
                                                                                                    Adjustment
                                                                    2021 yearly    Difference in   (depreciation
               Depreciation amount                 Historic rate     avg. rate      translation     x change in
                                                                                       rates          rates)
----------------------------------------------------------------------------------------------------------------
[euro]10 (building).............................            1.00            1.50          (0.50)            ($5)
[euro]30 (machine)..............................            1.00            1.50          (0.50)            (15)
                                                 ---------------------------------------------------------------
    Total adjustment for cost recovery            ..............  ..............  ..............            (20)
     deductions.................................
----------------------------------------------------------------------------------------------------------------

    (B) Determination of OFCNV for 2020 and 2021.
    Under the simplified inventory method, the OFCNV of Business A 
for 2020 and 2021 is determined under paragraph (e) of this section 
as follows:

                                               OFCNV--End of 2021
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Euros..................................             160  [euro]1 = $2.00 (year-end spot                  320
                                                              rate--2021).
    Building...............................             760  [euro]1 = $1.00 (historic rate--                760
                                                              2020).
    Machine................................             270  [euro]1 = $1.00 (historic rate--                270
                                                              2020).
    Inventory..............................              40  [euro]1 = $1.50 (yearly average                  60
                                                              rate--2021).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................           1,410
Liabilities:
        Total liabilities..................  ..............  ...................................               0
2021 ending OFCNV..........................  ..............  ...................................           1,410
----------------------------------------------------------------------------------------------------------------


[[Page 88840]]


                                               OFCNV--End of 2020
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Euros..................................             100  [euro]1 = $1.00 (year-end spot                  100
                                                              rate--2020).
    Building...............................             780  [euro]1 = $1.00 (historic rate--                780
                                                              2020).
    Machine................................             300  [euro]1 = $1.00 (historic rate--                300
                                                              2020).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................           1,180
Liabilities:
        Total liabilities..................  ..............  ...................................               0
2020 ending OFCNV..........................  ..............  ...................................           1,180
----------------------------------------------------------------------------------------------------------------

    (C) Determination of net unrecognized section 987 gain or loss. 
The net unrecognized section 987 gain or loss of Business A is 
determined under paragraph (d) of this section as follows (relevant 
steps only):
    (1) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of Business A determined under paragraph (e) of 
this section on the last day of 2021, less the OFCNV of Business A 
determined on the last day of 2020.

2021 ending OFCNV.......................................          $1,410
Less: 2020 ending OFCNV.................................         (1,180)
                                                         ---------------
    Change in OFCNV.....................................             230
 

    (2) Step 6. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 must be decreased 
by the section 987 taxable income of Business A. The amount of 
Business A's taxable income for 2021, as determined above, is $100.

Change in OFCNV.........................................            $230
Less: section 987 taxable income........................           (100)
                                                         ---------------
    Unrecognized section 987 gain.......................             130
Plus: Net accumulated unrecognized section 987 gain or                 0
 loss from prior years..................................
                                                         ---------------
    Net unrecognized section 987 gain...................             130
 

    (iii) Operations in 2022. During 2022, Business A recognizes 
[euro]180 of revenue from sales of finished goods. The related COGS 
is [euro]96. Business A pays [euro]10 in salaries allocable to SG&A. 
Inventoriable costs in 2022 include [euro]30 of depreciation on the 
machine and [euro]10 of depreciation on the building. Business A's 
balance sheet on December 31, 2022, shows no liabilities and the 
following assets: currency of [euro]260, the building with an 
adjusted basis of [euro]740, the machine with an adjusted basis of 
[euro]240, and ending inventory with a FIFO cost basis of [euro]54, 
comprising raw materials and finished goods.
    (A) Determination of income. Under the simplified inventory 
method, Business A's income for 2022 is computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                     Item                           [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Sales revenue.................................             180  [euro]1 = $2.50 (yearly avg.                 450
                                                                 rate--2022).
COGS before adjustments.......................              96  [euro]1 = $2.50 (yearly avg.                 240
                                                                 rate--2022).
    Adjustment for cost recovery deductions     ..............  ................................            (60)
     (see calculation below).
    Adjustment for beginning inventory (see     ..............  ................................            (40)
     calculation below).
                                               -----------------------------------------------------------------
        Adjusted COGS.........................  ..............  ................................             140
SG&A:
    Depreciation on building (50%)............              10  [euro]1 = $1.00 (historic rate--              10
                                                                 2020).
    Salaries..................................              10  [euro]1 = $2.50 (yearly avg.                  25
                                                                 rate--2022).
                                               -----------------------------------------------------------------
        Total SG&A............................  ..............  ................................              35
Section 987 net income (revenue less COGS and   ..............  ................................             275
 SG&A).
----------------------------------------------------------------------------------------------------------------

    COGS Adjustments.
    Adjustment for cost recovery deductions.

----------------------------------------------------------------------------------------------------------------
                                                                                                    Adjustment
                                                                    2022 yearly    Difference in   (depreciation
               Depreciation amount                 Historic rate     avg. rate      translation     x change in
                                                                                       rates          rates)
----------------------------------------------------------------------------------------------------------------
[euro]10 (building).............................            1.00            2.50          (1.50)           ($15)
[euro]30 (machine)..............................            1.00            2.50          (1.50)            (45)
                                                 ---------------------------------------------------------------
    Total adjustment for cost recovery            ..............  ..............  ..............            (60)
     deductions.................................
----------------------------------------------------------------------------------------------------------------

    Adjustment for beginning inventory.

[[Page 88841]]



----------------------------------------------------------------------------------------------------------------
                                                                                                    Adjustment
                                                    2021 yearly     2022 yearly    Difference in   (inventory x
           Prior year ending inventory               avg. rate       avg. rate      translation      change in
                                                                                       rates          rates)
----------------------------------------------------------------------------------------------------------------
[euro]40........................................            1.50            2.50          (1.00)           ($40)
                                                 ---------------------------------------------------------------
    Total adjustment for beginning inventory....  ..............  ..............  ..............            (40)
----------------------------------------------------------------------------------------------------------------

    (B) Determination of OFCNV. Under the simplified inventory 
method, the OFCNV of Business A for 2022 is determined under 
paragraph (e) of this section as follows:

                                               OFCNV--End of 2022
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
    Euros..................................             260  [euro]1 = $3.00 (year-end spot                  780
                                                              rate--2022).
    Building...............................             740  [euro]1 = $1.00 (historic rate--                740
                                                              2020).
    Machine................................             240  [euro]1 = $1.00 (historic rate--                240
                                                              2020).
    Inventory..............................              54  [euro]1 = $2.50 (yearly average                 135
                                                              rate--2022).
                                            --------------------------------------------------------------------
        Total assets.......................  ..............  ...................................           1,895
Liabilities:
        Total liabilities..................  ..............  ...................................               0
2022 ending OFCNV..........................  ..............  ...................................           1,895
----------------------------------------------------------------------------------------------------------------

    (C) Determination of net unrecognized section 987 gain or loss. 
The net unrecognized section 987 gain of Business A is determined 
under paragraph (d) of this section as follows (relevant steps 
only):
    (1) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of Business A determined under paragraph (e) of 
this section on the last day of 2022, less the OFCNV of Business A 
determined on the last day of 2021.

2022 ending OFCNV.......................................          $1,895
Less: 2021 ending OFCNV.................................         (1,410)
                                                         ---------------
    Change in OFCNV.....................................             485
 

    (2) Step 6. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 must be decreased 
by the section 987 taxable income of Business A. The amount of 
Business A's taxable income for 2022, as determined above, is $275.

Change in OFCNV.........................................            $485
Less: Section 987 taxable income........................           (275)
                                                         ---------------
    Unrecognized section 987 gain 2022..................             210
Plus: Net accumulated unrecognized section 987 gain from             130
 prior year.............................................
                                                         ---------------
    Net unrecognized section 987 gain...................             340
 

    Example 4.  (i) Background. The background facts about Business 
A are the same as in Example 3, except that Business A uses the 
dollar-value LIFO method to account for inventory.
    (ii) Operations in 2021. The facts about Business A's operations 
in 2021 are the same as in Example 3.
    (A) Determination of income. Under the simplified inventory 
method, Business A's income for 2021 is computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                     Item                           [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Sales revenue.................................             140  [euro]1 = $1.50 (yearly avg.                 210
                                                                 rate--2021).
COGS before adjustments.......................              70  [euro]1 = $1.50 (yearly avg.                 105
                                                                 rate--2021).
    Adjustment for cost recovery deductions     ..............  ................................            (20)
     (same as Example 1).
    Adjustment for LIFO liquidation (none)....  ..............  ................................               0
                                               -----------------------------------------------------------------
        Adjusted COGS.........................  ..............  ................................              85
SG&A:
    Depreciation on building (50%)............              10  [euro]1 = $1.00 (historic rate--              10
                                                                 2020).
    Salaries..................................              10  [euro]1 = $1.50 (yearly avg.                  15
                                                                 rate--2021).
                                               -----------------------------------------------------------------
        Total SG&A............................  ..............  ................................              25
Section 987 net income (revenue less COGS and   ..............  ................................             100
 SG&A).
----------------------------------------------------------------------------------------------------------------

    (B) Determination of OFCNV for 2020 and 2021. Under the 
simplified inventory method, the OFCNV of Business A for 2020 and 
2021 is determined under paragraph (e) of this section as follows:

                                               OFCNV--End of 2021
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
Euros......................................             160  [euro]1 = $2.00 (year-end spot                  320
                                                              rate--2021).
Building...................................             760  [euro]1 = $1.00 (historic rate--                760
                                                              2020).

[[Page 88842]]

 
Machine....................................             270  [euro]1 = $1.00 (historic rate--                270
                                                              2020).
Inventory..................................              40  [euro]1 = $1.50 (historic rate--                 60
                                                              2021).
                                            --------------------------------------------------------------------
    Total assets...........................  ..............  ...................................           1,410
Liabilities:
    Total liabilities......................  ..............  ...................................               0
2021 ending OFCNV..........................  ..............  ...................................           1,410
----------------------------------------------------------------------------------------------------------------


                                               OFCNV--End of 2020
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
Euros......................................             100  [euro]1 = $1.00 (year-end spot                  100
                                                              rate--2020).
Building...................................             780  [euro]1 = $1.00 (historic rate--                780
                                                              2020).
Machine....................................             300  [euro]1 = $1.00 (historic rate--                300
                                                              2020).
                                            --------------------------------------------------------------------
    Total assets...........................  ..............  ...................................           1,180
Liabilities:
    Total liabilities......................  ..............  ...................................               0
2020 ending OFCNV..........................  ..............  ...................................           1,180
----------------------------------------------------------------------------------------------------------------

    (C) Determination of net unrecognized section 987 gain or loss. 
The net unrecognized section 987 gain or loss of Business A for 2021 
is determined under paragraph (d) of this section as follows 
(relevant steps only):
    (1) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of Business A determined under paragraph (e) of 
this section on the last day of 2021, less the OFCNV of Business A 
determined on the last day of 2020.

2021 ending OFCNV.......................................          $1,410
Less: 2020 ending OFCNV.................................         (1,180)
                                                         ---------------
    Change in OFCNV.....................................           (230)
 

    (2) Step 6. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 must be decreased 
by the section 987 taxable income of Business A. The amount of 
Business A's taxable income for 2021, as determined above, is $100.

Change in OFCNV.........................................            $230
Less: section 987 taxable income........................           (100)
                                                         ---------------
    Unrecognized section 987 gain.......................             130
Plus: Net accumulated unrecognized section 987 gain or                 0
 loss from prior years..................................
                                                         ---------------
    Net unrecognized section 987 gain...................             130
 

    (iii) Operations in 2022. The facts about Business A's 
operations in 2022 are the same as in Example 3, except that due to 
Business A's dollar-value LIFO method of inventory accounting, 
Business A's balance sheet on December 31, 2022, reflects a 2021 
layer of inventory with a LIFO cost basis of [euro]40 and a 2022 
layer of inventory with a LIFO cost basis of [euro]10.80, and 
Business A's COGS is [euro]99.20.
    (A) Determination of income. Business A's income for 2022 is 
computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                     Item                           [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Sales revenue.................................             180  [euro]1 = $2.50 (yearly avg.                 450
                                                                 rate--2022).
COGS before adjustments.......................           99.20  [euro]1 = $2.50 (yearly avg.                 248
                                                                 rate--2022).
    Adjustment for cost recovery deductions     ..............  ................................            (60)
     (same as Example 3).
    Adjustment for LIFO liquidation (none)....  ..............  ................................               0
                                               -----------------------------------------------------------------
        Adjusted COGS.........................  ..............  ................................             188
SG&A:
    Depreciation on building (50%)............              10  [euro]1 = $1.00 (historic rate--              10
                                                                 2020).
    Salaries..................................              10  [euro]1 = $2.50 (yearly avg.                  25
                                                                 rate--2022).
                                               -----------------------------------------------------------------
        Total SG&A............................  ..............  ................................              35
Section 987 net income (revenue less COGS and   ..............  ................................             227
 SG&A).
----------------------------------------------------------------------------------------------------------------


                                               OFCNV--End of 2022
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
Euros......................................          260.00  [euro]1 = $3.00 (year-end spot                  780
                                                              rate--2022).
Building...................................          740.00  [euro]1 = $1.00 (historic rate--                740
                                                              2020).
Machine....................................          240.00  [euro]1 = $1.00 (historic rate--                240
                                                              2020).
Inventory..................................           10.80  [euro]1 = $2.50 (historic rate--                 27
                                                              2022).
                                                      40.00  [euro]1 = $1.50 (historic rate--                 60
                                                              2021).
                                            --------------------------------------------------------------------
    Total assets...........................  ..............  ...................................           1,847

[[Page 88843]]

 
Liabilities:
    Total liabilities......................  ..............  ...................................               0
2022 ending OFCNV..........................  ..............  ...................................           1,847
----------------------------------------------------------------------------------------------------------------

    (B) Determination of net unrecognized section 987 gain or loss. 
The net unrecognized section 987 gain of Business A for 2022 is 
determined under paragraph (d) of this section as follows (relevant 
steps only):
    (1) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of Business A determined under paragraph (e) of 
this section on the last day of 2022, less the OFCNV of Business A 
determined on the last day of 2021.

2022 ending OFCNV.......................................          $1,847
Less: 2021 ending OFCNV.................................         (1,410)
                                                         ---------------
    Change in OFCNV.....................................             437
 

    (2) Step 6--Decrease the aggregate amount determined in steps 1 
through 5 by the section 987 taxable income of the section 987 QBU 
for the taxable year. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 must be decreased 
by the section 987 taxable income of Business A. The amount of 
Business A's taxable income for 2022, as determined above, is $227.

Change in OFCNV.........................................            $437
Less: section 987 taxable income........................           (227)
                                                         ---------------
    Unrecognized section 987 gain 2022..................             210
Plus: net accumulated unrecognized section 987 gain from             130
 prior years............................................
                                                         ---------------
    Net unrecognized section 987 gain...................             340
 

    (iv) Operations in 2023. During 2023, Business A recognizes 
revenue of [euro]252 from sales of finished goods. The related COGS 
is [euro]140.80, reflecting a full liquidation of the 2022 inventory 
layer with a LIFO cost basis of $10.80 and a partial liquidation of 
inventory from the 2021 layer with a LIFO cost basis of $10.00. 
Business A pays [euro]10 in salaries allocable to SG&A. 
Inventoriable costs in 2023 include [euro]10 of depreciation on the 
building and [euro]30 of depreciation on the machine. Business A's 
balance sheet on December 31, 2023, shows no liabilities and the 
following assets: currency of [euro]422, the building with an 
adjusted basis of [euro]720, the machine with an adjusted basis of 
[euro]210, and a 2021 layer of ending inventory with a LIFO cost 
basis of [euro]30, comprising raw materials and finished goods. The 
yearly average exchange rate for 2023 is [euro]1 = $3.50, and the 
spot rate on December 31, 2023 is [euro]1 = $4.00.
    (A) Determination of income. Business A's income for 2023 is 
computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                     Item                           [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Sales revenue.................................             252  [euro]1 = $3.50 (yearly avg.                 882
                                                                 rate--2023).
COGS before adjustments.......................          140.80  [euro]1 = $3.50 (yearly avg.              492.80
                                                                 rate--2023).
    Adjustment for cost recovery deductions     ..............  ................................        (100.00)
     (see calculation below).
    Adjustment for LIFO liquidation (see        ..............  ................................         (30.80)
     calculation below).
                                               -----------------------------------------------------------------
        Adjusted COGS.........................  ..............  ................................          362.00
SG&A:
    Depreciation on building (50%)............              10  [euro]1 = $1.00 (historic rate--              10
                                                                 2020).
    Salaries..................................              10  [euro]1 = $3.50 (yearly avg.                  35
                                                                 rate--2023).
                                               -----------------------------------------------------------------
        Total SG&A............................  ..............  ................................              45
Section 987 net income........................  ..............  ................................             475
----------------------------------------------------------------------------------------------------------------

    COGS Adjustments.
    Adjustment for cost recovery deductions.

----------------------------------------------------------------------------------------------------------------
                                                                                                    Adjustment
                                                      Historic     2023  yearly    Difference in   (depreciation
              Depreciation  amount                     rate          avg. rate      translation    x change  in
                                                                                       rates          rates)
----------------------------------------------------------------------------------------------------------------
[euro]10 (building).............................            1.00            3.50          (2.50)           ($25)
[euro]30 (machine)..............................            1.00            3.50          (2.50)            (75)
                                                 ---------------------------------------------------------------
    Total adjustment for cost recovery            ..............  ..............  ..............           (100)
     deductions.................................
----------------------------------------------------------------------------------------------------------------

    Adjustment for LIFO liquidation.

----------------------------------------------------------------------------------------------------------------
                                                                                                    Adjustment
                                                                                   Difference in    (liquidated
            LIFO  liquidation  layer              Historic  rate   2023  yearly     translation       layer x
                                                                     avg. rate         rates         change in
                                                                                                      rates)
----------------------------------------------------------------------------------------------------------------
[euro]10.80 (2022)..............................            2.50            3.50          (1.00)        ($10.80)
[euro]10 (2021).................................            1.50            3.50          (2.00)         (20.00)
                                                 ---------------------------------------------------------------

[[Page 88844]]

 
    Total adjustment for liquidation of LIFO      ..............  ..............  ..............         (30.80)
     layers.....................................
----------------------------------------------------------------------------------------------------------------

    (B) Determination of OFCNV. The OFCNV of Business A for 2023 is 
determined under paragraph (e) of this section as follows:

                                               OFCNV--End of 2023
----------------------------------------------------------------------------------------------------------------
                                                Amount in
                   Assets                        [euro]                Translation rate             Amount in $
----------------------------------------------------------------------------------------------------------------
Euros......................................             422  [euro]1 = $4.00 (year-end spot                1,688
                                                              rate--2023).
Building...................................             720  [euro]1 = $1.00 (historic rate--                720
                                                              2020).
Machine....................................             210  [euro]1 = $1.00 (historic rate--                210
                                                              2020).
Inventory..................................              30  [euro]1 = $1.50 (historic rate--                 45
                                                              2021).
                                            --------------------------------------------------------------------
    Total assets...........................  ..............  ...................................           2,663
Liabilities:
    Total liabilities......................  ..............  ...................................               0
2023 ending OFCNV..........................  ..............  ...................................           2,663
----------------------------------------------------------------------------------------------------------------

    (C) Determination of net unrecognized section 987 gain or loss. 
The net unrecognized section 987 gain of Business A is determined 
under paragraph (d) of this section as follows (relevant steps 
only):
    (1) Step 1. Under paragraph (d)(1) of this section, the change 
in OFCNV for the taxable year must be determined. This amount is 
equal to the OFCNV of Business A determined under paragraph (e) of 
this section on the last day of 2023, less the OFCNV of Business A 
determined on the last day of 2022.

2023 ending OFCNV.......................................          $2,663
Less: 2022 ending OFCNV.................................         (1,847)
                                                         ---------------
Change in OFCNV.........................................             816
 

    (2) Step 6--Decrease the aggregate amount determined in steps 1 
through 5 by the section 987 taxable income of the section 987 QBU 
for the taxable year. Under paragraph (d)(6) of this section, the 
aggregate amount determined in steps 1 through 5 must be decreased 
by the section 987 taxable income of Business A. The amount of 
Business A's taxable income for 2023, as determined above, is $475.

Change in OFCNV.........................................            $816
Less: section 987 taxable income........................           (475)
                                                         ---------------
    Unrecognized section 987 gain 2023..................             341
Plus: net accumulated unrecognized section 987 gain from             340
 prior years............................................
                                                         ---------------
    Net unrecognized section 987 gain...................             681
 

Sec.  1.987-5   Recognition of section 987 gain or loss.

    (a) Recognition of section 987 gain or loss by the owner of a 
section 987 QBU. The taxable income of an owner of a section 987 QBU 
shall include the owner's section 987 gain or loss recognized with 
respect to the section 987 QBU for the taxable year. Except as 
otherwise provided, for any taxable year the owner's section 987 gain 
or loss recognized with respect to a section 987 QBU shall equal:
    (1) The owner's net unrecognized section 987 gain or loss with 
respect to the section 987 QBU determined under Sec.  1.987-4 on the 
last day of such taxable year (or, if earlier, on the day the section 
987 QBU is terminated under Sec.  1.987-8); multiplied by
    (2) The owner's remittance proportion for the taxable year, as 
determined under paragraph (b) of this section.
    (b) Remittance proportion. The owner's remittance proportion with 
respect to a section 987 QBU for a taxable year shall equal:
    (1) The remittance, as determined under paragraph (c) of this 
section, to the owner from the section 987 QBU for such taxable year; 
divided by
    (2) The sum of
    (A) The aggregate adjusted basis of the gross assets of the section 
987 QBU as of the end of the taxable year that are reflected on its 
year-end balance sheet translated into the owner's functional currency 
as provided in Sec.  1.987-4(e)(2) and
    (B) The amount of the remittance as determined under paragraph (c) 
of this section.
    (c) Remittance--(1) Definition. A remittance shall be determined in 
the owner's functional currency and shall equal the excess, if any, of:
    (i) The aggregate of all amounts transferred from the section 987 
QBU to the owner during the taxable year, as determined in paragraph 
(d) of this section; over
    (ii) The aggregate of all amounts transferred from the owner to the 
section 987 QBU during the taxable year, as determined in paragraph (e) 
of this section.
    (2) Day when a remittance is determined. An owner's remittance from 
a section 987 QBU shall be determined on the last day of the owner's 
taxable year (or, if earlier, on the day the section 987 QBU is 
terminated under Sec.  1.987-8).
    (3) Termination. A termination of a section 987 QBU as determined 
under Sec.  1.987-8 is treated as a remittance of all the gross assets 
of the section 987 QBU to the owner on the date of such termination. 
See Sec.  1.987-8(e). Accordingly, the remittance proportion in the 
case of a termination is 1.
    (d) Aggregate of all amounts transferred from the section 987 QBU 
to the owner for the taxable year. For purposes of paragraph (c)(1)(i) 
of this section, the aggregate amount transferred from the section 987 
QBU to the owner for the taxable year shall be the aggregate amount of 
functional currency and the aggregate adjusted basis of the assets 
transferred, as determined in the owner's functional currency under 
Sec.  1.987-4(d)(2). Solely for this purpose, the amount of liabilities 
transferred from the owner to the section 987 QBU, as determined in the 
owner's functional currency under Sec.  1.987-4(d)(5), shall be treated 
as a transfer of assets from the section 987 QBU to the owner in an 
amount equal to the amount of such liabilities.

[[Page 88845]]

    (e) Aggregate of all amounts transferred from the owner to the 
section 987 QBU for the taxable year. For purposes of paragraph 
(c)(1)(ii) of this section, the aggregate of all amounts transferred 
from the owner to the section 987 QBU for the taxable year shall be the 
aggregate amount of functional currency and the aggregate adjusted 
basis of the assets transferred, as determined in the owner's 
functional currency under Sec.  1.987-4(d)(3). Solely for this purpose, 
the amount of liabilities transferred from the section 987 QBU to the 
owner determined under Sec.  1.987-4(d)(4) shall be treated as a 
transfer of assets from the owner to the section 987 QBU in an amount 
equal to the amount of such liabilities.
    (f) Determination of owner's adjusted basis in transferred assets--
(1) In general. The owner's adjusted basis in an asset received in a 
transfer from a section 987 QBU (whether or not such transfer is made 
in connection with a remittance, as defined in paragraph (c) of this 
section) shall be determined in the owner's functional currency under 
the rules prescribed in paragraphs (f)(2) and (f)(3) of this section.
    (2) Marked asset. The basis of a marked asset shall be the amount 
determined by translating the section 987 QBU's functional currency 
basis of the asset, after taking into account Sec.  1.988-1(a)(10), 
into the owner's functional currency at the spot rate (as defined in 
Sec.  1.987-1(c)(1)) applicable to the date of transfer.
    (3) Historic asset. The basis of a historic asset shall be the 
amount determined by translating the section 987 QBU's functional 
currency basis of the asset, after taking into account Sec.  1.988-
1(a)(10), into the owner's functional currency at the historic rate for 
the asset (as defined in Sec.  1.987-1(c)(3)).
    (g) Example. The following example illustrates the calculation of 
section 987 gain or loss under this section:

    Example. (i) U.S. Corp, a domestic corporation with the dollar 
as its functional currency, operates in the United Kingdom through 
Business A, a section 987 QBU with the pound as its functional 
currency. During 2021, the following transfers took place between 
U.S. Corp and Business A. On January 5, 2021, U.S. Corp transferred 
to Business A $300, which Business A used during the year to 
purchase services. On March 5, 2021, Business A transferred a 
machine to U.S. Corp. The pound adjusted basis of the machine when 
properly translated into dollars as described under Sec.  1.987-
4(d)(2)(ii)(B) and paragraph (d) of this section is $500. On 
November 1, 2021, Business A transferred pounds to U.S. Corp. The 
dollar amount of the pounds when properly translated as described 
under Sec.  1.987-4(d)(2)(ii)(A) and paragraph (d) of this section 
is $2,300. On December 7, 2021, U.S. Corp transferred a truck to 
Business A with an adjusted basis of $2,000.
    (ii) At the end of 2021, Business A holds assets, properly 
translated into the owner's functional currency pursuant to Sec.  
1.987-4(e)(2), consisting of a computer with a pound adjusted basis 
equivalent to $500, a truck with a pound adjusted basis equivalent 
to $2,000, and pounds equivalent to $2,850. In addition, Business A 
has a pound liability entered into in 2020 with Bank A. All such 
assets and liabilities are reflected on the books and records of 
Business A. Assume that the net unrecognized section 987 gain for 
Business A as determined under Sec.  1.987-4 as of the last day of 
2021 is $80.
    (iii) U.S. Corp's section 987 gain with respect to Business A is 
determined as follows:
    (A) Computation of amount of remittance. Under paragraphs (c)(1) 
and (c)(2) of this section, U.S. Corp must determine the amount of 
the remittance for 2021 in the owner's functional currency (dollars) 
on the last day of 2021. The amount of the remittance for 2021 is 
$500, determined as follows:
    Transfers from Business A to U.S. Corp in dollars:

Machine.................................................            $500
Pounds..................................................           2,300
                                                         ---------------
    Aggregate transfers from Business A to U.S. Corp....           2,800
 

    Transfers from U.S. Corp to Business A in dollars:

U.S. dollars............................................            $300
Truck...................................................           2,000
                                                         ---------------
    Aggregate transfers from U.S. Corp to Business A....           2,300
 

    Computation of amount of remittance:

Aggregate transfers from Business A to U.S. Corp........          $2,800
Less: aggregate transfers from U.S. Corp to Business A..         (2,300)
                                                         ---------------
    Total remittance....................................             500
 

    (B) Computation of section 987 QBU gross assets plus remittance. 
Under paragraph (b)(2) of this section, Business A must determine 
the aggregate basis of its gross assets that are reflected on its 
year-end balance sheet translated into the owner's functional 
currency and must increase this amount by the amount of the 
remittance.

Computer................................................            $500
Pounds..................................................           2,850
Truck...................................................           2,000
                                                         ---------------
    Aggregate gross assets..............................           5,350
    Remittance..........................................             500
    Aggregate basis of Business A's gross assets at end            5,850
     of 2021, increased by amount of remittance.........
 

    (C) Computation of remittance proportion. Under paragraph (b) of 
this section, Business A must compute the remittance proportion by 
dividing the $500 remittance amount by the $5,850 sum of the 
aggregate basis of Business A's gross assets and the amount of the 
remittance. The resulting remittance proportion is 0.085.
    (D) Computation of section 987 gain or loss. The amount of U.S. 
Corp's section 987 gain or loss that must be recognized with respect 
to Business A is determined under paragraph (a) of this section by 
multiplying the 0.085 remittance proportion by the $80 of net 
unrecognized section 987 gain. U.S. Corp's resulting recognized 
section 987 gain for 2021 is $6.80.

0
Par. 5. Sections 1.987-6 through 1.987-11 are added to read as follows:
* * * * *
Sec.
1.987-6 Character and source of section 987 gain or loss.
1.987-7 Section 987 aggregate partnerships.
1.987-8 Termination of a section 987 QBU.
1.987-9 Recordkeeping requirements.
1.987-10 Transition rules.
1.987-11 Effective/applicability date.
* * * * *


Sec.  1.987-6  Character and source of section 987 gain or loss.

    (a) Ordinary income or loss. Section 987 gain or loss is ordinary 
income or loss for Federal income tax purposes.
    (b) Character and source of section 987 gain or loss--(1) In 
general. With respect to each section 987 QBU, the owner must determine 
the character and source of section 987 gain or loss in the year of a 
remittance under the rules of this paragraph (b) for all purposes of 
the Internal Revenue Code, including sections 904(d), 907, and 954.
    (2) Method required to characterize and source section 987 gain or 
loss. The owner must use the asset method set forth in Sec.  1.861-
9T(g) to characterize and source section 987 gain or loss. In applying 
the asset method, the owner must take into account only the assets of 
the section 987 QBU and must consistently determine the value of the 
assets on the basis of either the tax book value or the fair market 
value of the assets. The modified gross income method described in 
Sec.  1.861-9T(j) cannot be used.
    (3) Coordination with section 954. Solely for purposes of 
determining the excess of foreign currency gains over foreign currency 
losses characterized as foreign personal holding company income under 
section 954(c)(1)(D), section 987 gain or loss that is characterized 
pursuant to paragraph (b)(2) of this section by reference to assets 
that give rise to subpart F income shall be treated as foreign currency 
gain or foreign currency loss attributable to section 988 transactions 
not directly related to the business needs of the controlled foreign 
corporation.

[[Page 88846]]

    (c) Examples. The following examples illustrate the application of 
this section.

    Example 1.  CFC is a controlled foreign corporation as defined 
in section 957 with the Swiss franc (Sf) as its functional currency. 
CFC is the owner of Business A, a section 987 QBU that has the euro 
as its functional currency. For the year 2021, CFC recognizes 
section 987 gain of Sf10,000 under Sec.  1.987-5. Applying the rules 
of this section, Business A has average total assets of Sf1,000,000, 
which generate income as follows: Sf750,000 of assets that generate 
foreign source general limitation income under section 904(d)(1)(A), 
none of which is subpart F income under section 952; and Sf250,000 
of assets that generate foreign source passive income under section 
904(d)(1)(B), all of which is subpart F income. Under paragraph (b) 
of this section, Sf7,500 (Sf750,000/Sf1,000,000 x Sf10,000) of the 
section 987 gain will be characterized as foreign source general 
limitation income that is not subpart F income under section 952, 
and Sf2,500 (Sf250,000/Sf1,000,000 x Sf10,000) will be characterized 
as foreign source passive income that is characterized as foreign 
personal holding company income under section 954(c)(1)(D). All of 
the section 987 gain is treated as ordinary income.
    Example 2.  The facts are the same as in Example 1 except that: 
(a) CFC recognizes section 987 loss of Sf40,000, Sf10,000 of which 
is characterized under paragraph (b) of this section by reference to 
assets that give rise to subpart F income; and (b) CFC otherwise has 
Sf12,000 of net foreign currency gain determined under Sec.  1.954-
2(g) that is taken into account in determining the excess of foreign 
currency gain over foreign currency losses characterized as foreign 
personal holding company income under section 954(c)(1)(D). Under 
paragraph (b)(3) of this section, the Sf10,000 section 987 loss 
characterized by reference to assets that give rise to subpart F 
income is treated as foreign currency loss attributable to section 
988 transactions not directly related to the business needs of the 
controlled foreign corporation for purposes of determining the 
excess of foreign currency gains over foreign currency losses 
characterized as foreign personal holding company income under 
section 954(c)(1)(D). Accordingly, CFC will aggregate the Sf10,000 
section 987 loss with the Sf12,000 net foreign currency gain and 
will have Sf2,000 of net foreign currency gain characterized as 
foreign personal holding company income under section 954(c)(1)(D).


Sec.  1.987-7  Section 987 aggregate partnerships.

    (a) In general. This section provides rules for determining an 
owner's share of the assets and liabilities of an eligible QBU that is 
owned indirectly, as described in Sec.  1.987-1(b)(4)(ii), through a 
section 987 aggregate partnership.
    (b) [Reserved].
    (c) Coordination with subchapter K. [Reserved].


Sec.  1.987-8   Termination of a section 987 QBU.

    (a) Scope. This section provides rules regarding the termination of 
a section 987 QBU. Paragraph (b) of this section provides general rules 
for determining when a termination occurs. Paragraph (c) of this 
section provides exceptions to the general termination rules for 
certain transactions described in section 381(a). Paragraph (e) of this 
section describes certain effects of terminations. Paragraph (f) of 
this section contains examples that illustrate the principles of this 
section.
    (b) In general. Except as provided in paragraph (c) of this 
section, a section 987 QBU terminates if the conditions described in 
one of paragraphs (b)(1) through (4) is satisfied.
    (1) Trade or business ceases. A section 987 QBU ceases its trade or 
business. When a section 987 QBU ceases its trade or business is 
determined based on all the facts and circumstances, provided that an 
owner may continue to treat a section 987 QBU as a section 987 QBU for 
a reasonable period during the winding up of such trade or business, 
which period may in no event exceed two years from the date on which 
such QBU ceases its activities carried on for profit.
    (2) Substantially all assets transferred. The section 987 QBU 
transfers substantially all (within the meaning of section 
368(a)(1)(C)) of its assets to its owner. For purposes of this 
paragraph (b)(2), the amount of assets transferred from the section 987 
QBU to its owner as a result of a transaction shall be reduced by the 
amount of assets transferred from the owner to the section 987 QBU 
pursuant to the same transaction. See Examples 2, 5, and 6 in paragraph 
(f) of this section.
    (3) Owner no longer a CFC. A foreign corporation that is a 
controlled foreign corporation (as defined in section 957) that is the 
owner of a section 987 QBU ceases to be a controlled foreign 
corporation as a result of a transaction or series of transactions 
after which persons that were related to the corporation within the 
meaning of section 267(b) immediately before the transaction or series 
of transactions collectively own sufficient interests in the 
corporation such that the corporation would continue to be considered a 
controlled foreign corporation if such persons were United States 
shareholders within the meaning of section 951(b).
    (4) Owner ceases to exist. The owner of the section 987 QBU ceases 
to exist (including in connection with a transaction described in 
section 381(a)).
    (c) Transactions described in section 381(a)--(1) Liquidations. 
Notwithstanding paragraph (b) of this section, a termination does not 
occur when the owner of a section 987 QBU ceases to exist in a 
liquidation described in section 332, except in the following cases:
    (i) The distributor is a domestic corporation and the distributee 
is a foreign corporation.
    (ii) The distributor is a foreign corporation and the distributee 
is a domestic corporation.
    (iii) The distributor and the distributee are both foreign 
corporations and the functional currency of the distributee is the same 
as the functional currency of the distributor's section 987 QBU.
    (2) Reorganizations. Notwithstanding paragraph (b) of this section, 
a termination does not occur when the owner of the section 987 QBU 
ceases to exist in a reorganization described in section 381(a)(2), 
except in the following cases:
    (i) The transferor is a domestic corporation and the acquiring 
corporation is a foreign corporation.
    (ii) The transferor is a foreign corporation and the acquiring 
corporation is a domestic corporation.
    (iii) The transferor is a controlled foreign corporation 
immediately before the transfer, the acquiring corporation is a foreign 
corporation that is not a controlled foreign corporation immediately 
after the transfer, and the acquiring corporation was related to the 
transferor within the meaning of section 267(b) immediately before the 
transfer.
    (iv) The transferor and the acquiring corporation are foreign 
corporations and the functional currency of the acquiring corporation 
is the same as the functional currency of the transferor's section 987 
QBU.
    (d) [Reserved].
    (e) Effect of terminations. A termination of a section 987 QBU as 
determined in this section is treated as a remittance of all the gross 
assets of the section 987 QBU to its owner immediately before the 
section 987 QBU terminates. Thus, except as otherwise provided in these 
regulations under section 987, a termination results in the recognition 
of any net unrecognized section 987 gain or loss of the section 987 
QBU. See Sec.  1.987-5(c)(3).
    (f) Examples. The following examples illustrate the principles of 
this section. Except as otherwise provided, U.S. Corp is a domestic 
corporation that has the U.S. dollar as its functional currency, and 
Business A is a section 987 QBU.

    Example 1. Cessation of operations. (i) Facts. U.S. Corp is the 
owner of Business A,

[[Page 88847]]

a sales office of U.S. Corp in Country X. Business A ceases sales 
activities on December 31, 2021. During 2022, Business A sells all 
of the assets used in its sales activities and winds up its 
business, settling outstanding accounts.
    (ii) Analysis. Business A's trade or business ceases on December 
31, 2021. The cessation of Business A's trade or business causes a 
termination of the Business A section 987 QBU under paragraph (b)(1) 
of this section on December 31, 2021, unless U.S. Corp chooses to 
continue to treat Business A as a section 987 QBU until completion 
of the wind-up activities in 2022. If U.S. Corp chooses to continue 
to treat Business A as a section 987 QBU during the wind-up of 
Business A, Business A section 987 QBU would terminate under 
paragraph (b)(1) of this section upon completion of the wind-up in 
2022.
    Example 2. Transfer of a section 987 QBU to a member of a 
consolidated group. (i) Facts. U.S. Corp, the owner of Business A, 
transfers all the assets and liabilities of Business A to DS, a 
domestic corporation all of the stock of which is owned by U.S. 
Corp, in a transaction qualifying under section 351. U.S. Corp and 
DS are members of the same consolidated group.
    (ii) Analysis. Pursuant to Sec.  1.987-2(c)(2)(i) and (ii), as a 
result of the deemed exchange of the assets and liabilities of 
Business A for DS stock in a section 351 transaction, Business A is 
treated as transferring its assets and liabilities to U.S. Corp 
immediately before the transfer by U.S. Corp of the assets and 
liabilities to DS. Because a section 351 transaction is not a 
transaction described in section 381(a), the transfer of all of the 
assets of Business A to U.S. Corp causes a termination of the 
Business A section 987 QBU under paragraph (b)(2) of this section.
    Example 3. Cessation of controlled foreign corporation status. 
(i) Facts. Foreign parent (FP) is a foreign corporation that owns 
all the stock of U.S. Corp, a domestic corporation. U.S. Corp owns 
all of the stock of FC, a controlled foreign corporation as defined 
in section 957. FC is the owner of Business A. FP contributes cash 
to FC in exchange for FC stock representing 60 percent of the voting 
power and value of all FC stock. FC no longer constitutes a 
controlled foreign corporation after the capital contribution.
    (ii) Analysis. Because FC ceases to qualify as a controlled 
foreign corporation as a result of a transaction after which persons 
that were related to FC within the meaning of section 267(b) 
immediately before the transaction collectively own sufficient 
interests in FC such that the FC would continue to be considered a 
controlled foreign corporation if such persons were United States 
shareholders within the meaning of section 951(b), the Business A 
section 987 QBU terminates pursuant to paragraph (b)(3) of this 
section.
    Example 4. Section 332 liquidation. (i) Facts. U.S. Corp owns 
all of the stock of FC, a foreign corporation. FC is the owner of 
Business A. Pursuant to a liquidation described in section 332, FC 
transfers all of its assets and liabilities to U.S. Corp.
    (ii) Analysis. FC's liquidation causes a termination of the 
Business A section 987 QBU as provided in paragraph (b)(4) of this 
section because FC ceases to exist as a result of the liquidation. 
The exception for certain section 332 liquidations provided under 
paragraph (c)(1) of this section does not apply because U.S. Corp is 
a domestic corporation and FC is a foreign corporation. See 
paragraph (c)(1)(ii) of this section.
    Example 5. Transfers to and from a section 987 QBU pursuant to 
the same transaction. (i) Facts. U.S. Corp owns 100 percent of DC1 
and DC2, each a domestic corporation. DC1 owns Entity A, a DE that 
conducts a business (Business A) in Country X that constitutes a 
section 987 QBU of DC1. DC2 subsequently contributes property to 
Entity A in exchange for a 95 percent interest in Entity A. The 
property DC2 contributes to Entity A is used in the business 
conducted by Business A and is reflected on its books and records as 
provided under Sec.  1.987-2(b).
    (ii) Analysis. (A) For general Federal income tax purposes, 
Entity A is converted to a partnership when DC2 contributes property 
to Entity A in exchange for a 95 percent interest in Entity A. DC2's 
contribution is treated as a contribution to a partnership in 
exchange for an ownership interest in the partnership. DC1 is 
treated as contributing all of Business A to the partnership in 
exchange for a partnership interest. See Rev. Rul. 99-5 (situation 
2), (1999-1 CB 434) and Sec.  601.601(d)(2) of this chapter. For 
purposes of this section, these deemed transactions are not taken 
into account. See Sec.  1.987-2(c) and Sec.  1.987-2(c)(10), Example 
9.
    (B) Under Sec.  1.987-1(b)(5)(i), Entity A is converted to a 
section 987 aggregate partnership when DC2 contributes property to 
Entity A in exchange for a 95 percent interest in Entity A because 
DC1 and DC2 own all the interests in partnership capital and 
profits, DC1 and DC2 are related within the meaning of section 
267(b), and the requirements of Sec.  1.987-1(b)(5)(i)(B) are 
satisfied. Because DC2 is a partner in a section 987 aggregate 
partnership that owns Business A and because DC2 and Business A have 
different functional currencies, DC2's portion of the Business A 
assets constitutes a section 987 QBU of DC2.
    (C) As a result of the conversion of Entity A to a partnership, 
DC2 acquires an allocable share of 95 percent of the assets of 
Business A, as determined under Sec.  1.987-7. Accordingly, under 
Sec.  1.987-2(c)(5), DC2 is treated as contributing 95 percent of 
its contributed property to its Business A section 987 QBU. In 
addition, DC2 is treated as transferring 5 percent of the 
contributed property to DC1, and DC1 is subsequently treated as 
transferring that property to DC1's Business A section 987 QBU. In 
addition, 95 percent of the original (pre-conversion) assets of 
Business A cease being reflected on the books and records of DC1's 
section 987 QBU. Under Sec.  1.987-2(b)(5), these amounts are 
treated as if they are transferred from DC1's section 987 QBU to 
DC1, and DC1 is treated as transferring these assets to DC2. DC2 is 
subsequently treated as transferring these assets to DC2's Business 
A section 987 QBU. The other 5 percent of the original (pre-
conversion) assets are treated as remaining on the books and records 
of DC1's section 987 QBU and are not deemed to be transferred.
    (D) For purposes of determining whether substantially all the 
assets of Business A were transferred from DC1's section 987 QBU as 
provided under paragraph (b)(2) of this section, the amount of 
assets transferred from Business A to DC1 under Sec.  1.987-2(c) (95 
percent of the assets held by Business A before the contribution by 
DC2) must be reduced by the 5 percent of the assets contributed by 
DC2, which were treated as transferred from DC2 to DC1 and 
subsequently transferred from DC1 to its Business A section 987 QBU, 
as a result of the formation of the section 987 aggregate 
partnership. Accordingly, the amount of assets transferred from 
DC1's section 987 QBU for purposes of paragraph (b)(2) of this 
section is equal to 95 percent of the original (pre-conversion) 
assets minus 5 percent of DC2's contributed assets.
    Example 6. Deemed transfers to a CFC upon a check-the-box 
election. (i) Facts. In 2021, U.S. Corp forms an entity in a foreign 
country, Entity A. Entity A owns Business A, which has the pound as 
its functional currency. Entity A forms Entity B in another foreign 
country. Entity B owns Business B, a section 987 QBU that has the 
euro as its functional currency. At the time of formation, Entity A 
and Entity B elect to be DEs. In 2026, Entity A files an election on 
Form 8832 to be classified as a corporation under Sec.  301.7701-
3(g)(1)(iv) and becomes a CFC (FC) owned directly by U.S. Corp. FC 
has the pound as its functional currency.
    (ii) Analysis. (A) Under Sec.  1.987-1(b)(4)(i), U.S. Corp is 
the owner of Business A and Business B. In 2026, when Entity A 
elects to be classified as a corporation, U.S. Corp is deemed to 
contribute the assets and liabilities of Business A and Business B 
to FC under section 351 in exchange for FC stock. Pursuant to Sec.  
1.987-2(c)(2)(i) and (ii), as a result of the deemed exchange of the 
assets and liabilities of Business A and Business B for FC stock in 
a section 351 transaction, Business A and Business B are each 
treated as transferring their assets and liabilities to U.S. Corp 
immediately before U.S. Corp's transfer of such assets and 
liabilities to FC. The transfer of assets from Business A and 
Business B to U.S. Corp causes terminations of those section 987 
QBUs under paragraph (b)(2) of this section. The assets and 
liabilities of Business A and Business B are now owned by FC, but 
because FC and Business A have the same functional currency, only 
Business B qualifies as a section 987 QBU to which section 987 
applies.
    (B) Terminations also would have occurred in 2026 if U.S. Corp 
had contributed Entity A and Entity B to an existing foreign 
corporation owned by U.S. Corp or to a newly created foreign 
corporation owned by U.S. Corp pursuant to a section 351 exchange 
because the transfer of all of the assets of Business A and Business 
B would cause terminations of those section 987 QBUs under paragraph 
(b)(2) of this section.
    Example 7. Sale of a section 987 QBU to a member of a 
consolidated group. (i) Facts. U.S. Corp, the owner of Business A, 
sells all of the assets and liabilities of Business A to DS, a 
domestic corporation, in exchange for cash. U.S. Corp and DS are 
members of the

[[Page 88848]]

same consolidated group. The cash received on the sale is recorded 
on the books of U.S. Corp.
    (ii) Analysis. Pursuant to Sec.  1.987-2(c)(2)(i) and (ii), 
Business A is treated as transferring all of its assets and 
liabilities to U.S. Corp immediately before the sale by U.S. Corp to 
DS. As a result of this deemed transfer from Business A to U.S. 
Corp, the Business A section 987 QBU terminates under paragraph 
(b)(2) of this section.


Sec.  1.987-9  Recordkeeping requirements.

    (a) In general. A taxpayer that is an owner of a section 987 QBU 
shall keep a copy of each election made by the taxpayer in accordance 
with the rules of Sec.  1.987-1(g)(3) (if not required to be made on a 
form published by the Commissioner regarding section 987) and such 
reasonable records as are sufficient to establish the section 987 QBU's 
taxable income or loss and section 987 gain or loss.
    (b) Supplemental information. An owner's obligation to maintain 
records under section 6001 and paragraph (a) of this section is not 
satisfied unless the following information is maintained in such 
records with respect to each section 987 QBU:
    (1) The amount of the items of income, gain, deduction, or loss 
attributed to the section 987 QBU in the functional currency of the 
section 987 QBU.
    (2) The amount of assets and liabilities attributed to the section 
987 QBU in the functional currency of the section 987 QBU.
    (3) The exchange rates used to translate items of income, gain, 
deduction, or loss of the section 987 QBU into the owner's functional 
currency and, if a spot rate convention is used, the manner in which 
such convention is determined.
    (4) The exchange rates used to translate the assets and liabilities 
of the section 987 QBU into the owner's functional currency and, if a 
spot rate convention is used, the manner in which such convention is 
determined.
    (5) The amount of the items of income, gain, deduction, or loss 
attributed to the section 987 QBU translated into the functional 
currency of the owner.
    (6) The amount of assets and liabilities attributed to the section 
987 QBU translated into the functional currency of the owner.
    (7) The amount of assets and liabilities transferred by the owner 
to the section 987 QBU determined in the functional currency of the 
owner.
    (8) The amount of assets and liabilities transferred by the section 
987 QBU to the owner determined in the functional currency of the 
owner.
    (9) The amount of the unrecognized section 987 gain or loss for the 
taxable year.
    (10) The amount of the net accumulated unrecognized section 987 
gain or loss at the close of the taxable year.
    (11) If a remittance is made, the computations determined under 
Sec.  1.861-9T(g) for purposes of sourcing and characterizing the 
remittance under Sec.  1.987-5.
    (12) The transition information required to be determined under 
Sec.  1.987-10(e).
    (c) Retention of records. The records required by this section, or 
records that support the information required on a form published by 
the Commissioner regarding section 987, must be maintained and kept at 
all times available for inspection by the Internal Revenue Service for 
so long as the contents thereof may become relevant in the 
administration of the Internal Revenue Code.
    (d) Information on a dedicated section 987 form. The requirements 
of paragraph (b) of this section shall be satisfied if the taxpayer 
provides the specific information required on a form published by the 
Commissioner for this purpose.


Sec.  1.987-10  Transition rules.

    (a) Scope. These transition rules shall apply to any taxpayer that 
is an owner of a section 987 QBU pursuant to Sec.  1.987-1(b)(4) on the 
transition date (as defined in Sec.  1.987-11(c)). Except as provided 
in paragraph (c) of this section, a taxpayer to which this section 
applies must transition from the method previously used to comply with 
section 987 (the ``prior section 987 method'') to the method prescribed 
by these regulations pursuant to the fresh start transition method set 
forth in paragraph (b) of this section.
    (b) Fresh start transition method--(1) In general. Pursuant to the 
fresh start transition method, and solely for purposes of this section, 
all section 987 QBUs of a taxpayer, other than section 987 QBUs subject 
to paragraph (c) of this section, are deemed to terminate on the day 
before the transition date. No section 987 gain or loss is determined 
or recognized as a result of the deemed termination. The owner of a 
section 987 QBU that is deemed to terminate under this section is 
treated as having transferred all of the assets and liabilities 
attributable to such QBU to a new section 987 QBU on the transition 
date. This deemed transfer of assets and liabilities is taken into 
account only for purposes of transitioning to these regulations under 
section 987 and shall not be taken into account in determining the 
amounts transferred from the owner to the section 987 QBU during the 
taxable year for purposes of Sec.  1.987-5(c)(1)(ii).
    (2) Application of Sec.  1.987-4. For purposes of applying Sec.  
1.987-4 with respect to a section 987 QBU described in paragraph (b)(1) 
of this section for the taxable year beginning on the transition date, 
the amount of assets and liabilities deemed transferred from the owner 
to the section 987 QBU on the transition date pursuant to paragraph 
(b)(1) of this section shall be determined by translating such assets 
and liabilities (without regard to whether the asset or liability is a 
marked item or a historic item) at the historic rate as determined 
under paragraph (b)(3) of this section.
    (3) Determination of historic rate. For purposes of applying these 
regulations with respect to a section 987 QBU described in paragraph 
(b)(1) of this section for taxable years beginning on or after the 
transition date, the historic rate (as defined in Sec.  1.987-1(c)(3)) 
for an asset or liability deemed transferred under paragraph (b)(1) of 
this section from an owner to the section 987 QBU on the transition 
date shall be the historic rate under Sec.  1.987-1(c)(3) determined by 
reference to the date the assets were acquired or liabilities entered 
into or assumed by the section 987 QBU deemed terminated (that is, 
without regard to the deemed termination or transfer described in 
paragraph (b)(1) of this section). However, if the owner is not able to 
determine reliably the historic rate for a particular asset or 
liability, then the historic rate must be determined based on 
reasonable assumptions (for example, assumptions about turnover and 
aging of accounts receivable), consistently applied.
    (4) Example. The provisions of this paragraph (b) are illustrated 
by the following example. Exchange rate assumptions used in the example 
are selected for the purpose of illustrating the principles of this 
section, and no inference is intended by their use. Additionally, the 
effect of depreciation is not taken into account for purposes of this 
example.

    Example. (i) U.S. Corp is a domestic corporation with the dollar 
as its functional currency. U.S. Corp owns Business A, a U.K. branch 
with the pound as its functional currency. Business A was formed on 
January 1, year 1. U.S. Corp uses the method prescribed in the 1991 
proposed section 987 regulations to determine the section 987 gain 
or loss of Business A. U.S. Corp contributed [pound]6,000 to 
Business A on January 1, year 1. On the same day, Business A bought 
a truck for [pound]4,000 and a computer for [pound]1,000.

[[Page 88849]]

Business A had profits determined under Sec.  1.987-1(b)(1)(i) 
through (iii) of the 1991 proposed section 987 regulations of 
[pound]250 in each of year 1, year 2, and year 3, and the yearly 
average exchange rate was used in each of those years to translate 
Business A's profits under the 1991 proposed section 987 
regulations. The yearly average exchange rate was [pound]1 = $1.10 
in year 1, [pound]1 = $1.20 in year 2, and [pound]1 = $1.30 in year 
3. Business A incurred a [pound]50 loss in each of year 4 and year 
5. Business A made no remittances to U.S. Corp in any year.
    (ii) On January 1, year 5, Business A transitions to the method 
provided in these regulations pursuant to the fresh start transition 
method described in paragraph (b) of this section. Pursuant to 
paragraph (b)(1) of this section, Business A is deemed to terminate 
on December 31, year 4. However, no section 987 gain or loss is 
determined or recognized as a result of the deemed termination. 
Pursuant to paragraph (b)(2) of this section, for purposes of 
applying Sec.  1.987-4 with respect to Business A for year 5, the 
amount of assets and liabilities transferred from U.S. Corp to 
Business A on the transition date shall be determined by translating 
all of Business A's assets at the historic rates for those assets as 
determined under Sec.  1.987-1(c)(3) and paragraph (b)(3) of this 
section. Because U.S. Corp is not able to determine reliably the 
historic rate for the pound currency it is deemed to transfer to 
Business A, U.S. Corp determines the historic rate for these pounds 
based on a last-in, first-out cash flow assumption. Thus, it is 
assumed that the [pound]50 loss in each of year 4 and year 5 first 
reduces the [pound]250 earned in year 3. Accordingly, for purposes 
of determining the amount of assets and liabilities deemed 
transferred from U.S. Corp to Business A on January 1, year 5, U.S. 
Corp translates Business A's assets and liabilities as follows:

----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                    Assets                          [pound]             Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Pounds........................................           1,000  [pound]1 = $1.10 (yearly average           1,100
                                                                 rate--year 1).
Pounds........................................             250  [pound]1 = $1.10 (yearly average             275
                                                                 rate--year 1).
Pounds........................................             250  [pound]1 = $1.20 (yearly average             300
                                                                 rate--year 2).
Pounds........................................             150  [pound]1 = $1.30 (yearly average             195
                                                                 rate--year 3).
Truck.........................................           4,000  [pound]1 = $1.10 (yearly average           4,400
                                                                 rate--year 1).
Computer......................................           1,000  [pound]1 = $1.10 (yearly average           1,100
                                                                 rate--year 1).
                                               -----------------------------------------------------------------
    Total assets..............................  ..............  ................................           7,370
Liabilities:
    Total liabilities.........................  ..............  ................................               0
----------------------------------------------------------------------------------------------------------------


    (c) Transition of section 987 QBUs that applied the method set 
forth in the 2006 proposed section 987 regulations.--(1) In general. 
If, with respect to a particular section 987 QBU, a taxpayer's prior 
section 987 method was based on a reasonable application of the method 
described in the 2006 proposed section 987 regulations (REG-208270-86, 
71 FR 52876), then the taxpayer shall apply these regulations under 
section 987 with respect to such section 987 QBU without regard to 
paragraph (b) of this section.
    (2) Application of Sec.  1.987-4. For purposes of applying Sec.  
1.987-4 with respect to a section 987 QBU described in paragraph (c)(1) 
for the taxable year beginning on the transition date, the owner 
functional currency net value of the section 987 QBU on the last day of 
the preceding taxable year under Sec.  1.987-4(d)(1)(B) shall be the 
amount that was determined under Sec.  1.987-4(d)(1)(A) of the 2006 
proposed section 987 regulations for the preceding taxable year. 
Additionally, for purposes of applying Sec.  1.987-4 with respect to a 
section 987 QBU described in paragraph (c)(1) for all taxable years 
that end after the transition date, the section 987 QBU's net 
unrecognized section 987 gain or loss for all prior taxable years under 
Sec.  1.987-4(c) shall take into account the aggregate of the amounts 
determined under Sec.  1.987-4(d) of the 2006 proposed section 987 
regulations for taxable years for which the taxpayer applied the 2006 
proposed section 987 regulations, reduced by the amounts taken into 
account under Sec.  1.987-5 of the 2006 proposed section 987 
regulations upon a remittance for all such prior taxable years.
    (3) Use of prior historic rate. For purposes of applying these 
regulations under section 987 with respect to historic items (as 
defined in Sec.  1.987-1(e)), other than inventory, that are reflected 
on the balance sheet of the section 987 QBU on the transition date, a 
taxpayer may use the same historic exchange rates as were used under 
the taxpayer's application of the 2006 proposed section 987 regulations 
in place of the historic rates that otherwise would be determined under 
Sec.  1.987-1(c)(3), provided that, for all taxable years that end 
after the transition date, the taxpayer does so with respect to all 
historic items (other than inventory) that are reflected on the balance 
sheet of the section 987 QBU on the transition date.
    (4) Example. The provisions of this paragraph (c) are illustrated 
by the following example. Exchange rate assumptions used in the example 
are selected for the purpose of illustrating the principles of this 
section, and no inference is intended by their use. Additionally, the 
effect of depreciation is not taken into account for purposes of this 
example.

    Example. (i) U.S. Corp is a domestic corporation with the dollar 
as its functional currency. U.S. Corp owns Business A, a U.K. branch 
with the pound as its functional currency. Business A was formed on 
January 1, year 1. U.S. Corp uses a reasonable application of the 
method described in the 2006 proposed section 987 regulations to 
determine the section 987 gain or loss of Business A. On January 1, 
year 5, Business A transitions to the method provided in these 
regulations pursuant to the method described in this paragraph (c). 
Business A's opening balance sheet on January 1, year 5, includes 
pounds, a truck acquired in year 2, inventory accounted for under 
the FIFO method, and no liabilities. These assets remain on the 
balance sheet on December 31, year 5.
    (ii) Pursuant to paragraph (c)(3) of this section, U.S. Corp 
chooses to use the same historic exchange rates as were used under 
its application of the 2006 proposed regulations in place of the 
historic rates prescribed under Sec.  1.987-1(c)(3) for purposes of 
applying these regulations with respect to historic items (other 
than inventory) held on the transition date.
    (iii) The pounds are marked items under Sec.  1.987-1(d). 
Because the pounds are marked items, for purposes of determining the 
owner functional currency net value of Business A on the last day of 
year 5 pursuant to Sec.  1.987-4(e), the pounds are translated into 
dollars using the spot rate (as defined in Sec.  1.987-1(c)(1)) 
applicable to the last day of year 5.
    (iv) The truck held on Business A's balance sheet on January 1, 
year 5, is a historic item under Sec.  1.987-1(e). For purposes of 
determining the owner functional currency net value of Business A on 
the last day of year 5 pursuant to Sec.  1.987-4(e), the basis of 
the truck is translated into dollars using the spot rate on the day 
the truck was acquired in year 2, as determined under Sec.  1.987-
1(c)(3) of the 2006 proposed section 987 regulations. If U.S. Corp 
had not chosen pursuant to paragraph (c)(3) of this section to use 
the same historic exchange rates as were used under its application 
of the 2006 proposed regulations, the basis of the truck would have 
been translated into dollars using the historic rate described in 
Sec.  1.987-1(c)(3), which is the yearly average exchange rate for 
year 5.

[[Page 88850]]

    (v) The inventory held on Business A's balance sheet on January 
1, year 5, is a historic item under Sec.  1.987-1(e). For purposes 
of determining the owner functional currency net value of Business A 
on the last day of year 5 pursuant to Sec.  1.987-4(e), the FIFO 
cost basis of the inventory is translated into dollars using the 
historic rate, which pursuant to Sec.  1.987-1(c)(3)(i)(B) is the 
yearly average exchange rate for year 5.
    (vi) Pursuant to paragraph (c)(3) of this section, for purposes 
of applying Sec.  1.987-4 with respect to Business A for year 5, the 
owner functional currency net value of Business A on the last day of 
year 4 under Sec.  1.987-4(d)(1)(B) is the amount that was 
determined under Sec.  1.987-4(d)(1)(A) of the 2006 proposed section 
987 regulations for year 4. Additionally, Business A's net 
unrecognized section 987 gain or loss for all prior years under 
Sec.  1.987-4(c) shall take into account the aggregate of the 
amounts determined under Sec.  1.987-4(d) of the 2006 proposed 
section 987 regulations for year 1 through year 4, reduced by the 
amounts taken into account under Sec.  1.987-5 of the 2006 proposed 
section 987 regulations upon a remittance for all such prior taxable 
years.

    (d) Adjustments to avoid double counting. If a difference between 
the treatment of any item under these regulations and the treatment of 
the item under the taxpayer's prior section 987 method would result in 
income, gain, deduction or loss being taken into account more than 
once, then the net unrecognized section 987 gain or loss of the section 
987 QBU, as determined under Sec.  1.987-4(b) for the first taxable 
year for which these regulations apply, shall be adjusted to account 
for the difference.
    (e) Reporting--(1) In general. Except as otherwise provided in this 
paragraph (e), the taxpayer must attach a statement titled ``Section 
987 Transition Information'' to its timely filed return for the first 
taxable year to which these regulations under section 987 apply 
providing the following information:
    (i) A description of each section 987 QBU to which these rules 
apply, the section 987 QBU's owner, the section 987 QBU's principal 
place of business, and a description of the prior section 987 method 
used by the taxpayer to determine section 987 gain or loss with respect 
to the section 987 QBU.
    (ii) Any assumptions used by the taxpayer for determining the 
exchange rates used to translate the amount of assets and liabilities 
transferred to the section 987 QBU on the transition date, as provided 
in paragraph (b)(3) of this section.
    (iii) With respect to each section 987 QBU subject to paragraph (c) 
of this section, a statement regarding whether historic items (as 
defined in Sec.  1.987-1(c)(3)) are translated pursuant to paragraph 
(c)(2) of this section at the same historic rates as were used under 
the taxpayer's application of the 2006 proposed regulations or at the 
historic rates determined under Sec.  1.987-1(c)(3).
    (iv) With respect to each section 987 QBU with respect to which an 
adjustment is made pursuant to paragraph (d) of this section, a 
description of the adjustment and the basis for the computation of such 
adjustments.
    (2) Attachments not required where information is reported on a 
form. Paragraph (e) of this section shall not apply to the extent the 
information described in such paragraph is required to be reported on a 
form published by the Commissioner.


Sec.  1.987-11  Effective/applicability date.

    (a) In general. Except as otherwise provided in this section, 
Sec. Sec.  1.987-1 through 1.987-10 shall apply to taxable years 
beginning on or after one year after the first day of the first taxable 
year following December 7, 2016.
    (b) Application of these regulations to taxable years beginning 
after December 7, 2016. A taxpayer may apply these regulations under 
section 987 to taxable years beginning after December 7, 2016, provided 
the taxpayer consistently applies these regulations to such taxable 
years with respect to all section 987 QBUs directly or indirectly owned 
by the taxpayer on the transition date (as defined in paragraph (b)(2) 
of this section) as well as all section 987 QBUs directly or indirectly 
owned on the transition date by members that file a consolidated return 
with the taxpayer or by any controlled foreign corporation, as defined 
in section 957, in which a member owns more than 50 percent of the 
voting power or stock value, as determined under section 958(a).
    (c) Transition date. The transition date is the first day of the 
first taxable year to which these regulations under section 987 are 
applicable with respect to a taxpayer under this section.

0
Par. 6. Section 1.988-0 is amended by adding an entry for Sec.  1.988-
1(a)(4).


Sec.  1.988-0  Taxation of gain or loss from a section 988 transaction; 
Table of Contents.

* * * * *


Sec.  1.988-1  Certain definitions and special rules.

    (a) * * *
    (4) Treatment of assets and liabilities of a section 987 aggregate 
partnership or DE that are not attributed to an eligible QBU.
* * * * *

0
Par. 7. Section 1.988-1 is amended by:
0
1. Adding paragraph (a)(4).
0
2. Revising paragraph (a)(10)(ii).
0
3. Adding two sentences to the end of paragraph (i).
    The additions and revision read as follows:


Sec.  1.988-1  Certain definitions and special rules.

    (a) * * *
    (4) Treatment of assets and liabilities of a section 987 aggregate 
partnership or DE that are not attributed to an eligible QBU--(i) 
Scope. This paragraph (a)(4) applies to assets and liabilities of a 
section 987 aggregate partnership as defined in Sec.  1.987-1(b)(5), or 
of an entity disregarded as an entity separate from its owner for 
Federal income tax purposes (DE), that are not attributable to an 
eligible QBU as defined in Sec.  1.987-1(b)(3).
    (ii) Section 987 Aggregate Partnerships. For purposes of applying 
section 988 and the applicable regulations to transactions involving 
assets and liabilities described in paragraph (a)(4)(i) of this section 
that are held by a section 987 aggregate partnership, the owners of the 
section 987 aggregate partnership (within the meaning of Sec.  1.987-
1(b)(4)) shall be treated as owning their share of such assets and 
liabilities. Section 1.987-7(b) shall apply for purposes of determining 
an owner's share of such assets or liabilities.
    (iii) Disregarded entities. For purposes of applying section 988 
and the applicable regulations to transactions involving assets and 
liabilities described in paragraph (a)(4)(i) of this section that are 
held by a DE, the owner of the DE (within the meaning of Sec.  1.987-
1(b)(4)) shall be treated as owning all such assets and liabilities.
    (iv) Example. The following example illustrates the application of 
paragraph (a)(4) of this section:

    Example. Liability held through a section 987 aggregate 
partnership. (i) Facts. P, a foreign partnership, has two equal 
partners, X and Y. X is a domestic corporation with the dollar as 
its functional currency. Y is a foreign corporation wholly owned by 
X that has the yen as its functional currency. P is a section 987 
aggregate partnership. On January 1, 2021, P borrowed yen and issued 
a note to the lender that obligated P to pay interest and repay 
principal to the lender in yen. Also on January 1, 2021, P used the 
yen it borrowed from the lender to acquire all of the stock of F, a 
foreign corporation, from an unrelated person. P also holds an 
eligible QBU (within the meaning of Sec.  1.987-1(b)(3)) that has 
the yen as its functional currency. P maintains one set of books and 
records. The assets and liabilities of the eligible QBU are 
reflected on the books and records of P as provided under Sec.  
1.987-2(b). The F stock held by P, and the yen liability incurred to 
acquire the F stock, are also recorded on the

[[Page 88851]]

books and records of P but, pursuant to Sec.  1.987-2(b)(2)(i), are 
not considered to be reflected on the books and records of the 
eligible QBU for purposes of section 987.
    (ii) Analysis. X's portion of the assets and liabilities of the 
eligible QBU owned by P is a section 987 QBU. Y's portion of the 
assets and liabilities of the eligible QBU owned by P is not a 
section 987 QBU because Y and the eligible QBU have the same 
functional currency. Because the F stock and yen-denominated 
liability incurred to acquire such stock are not considered 
reflected on the books and records of the eligible QBU, they are not 
subject to section 987. In addition, because the F stock and the 
yen-denominated liability incurred to acquire such stock are held by 
P (but not attributable to P's eligible QBU), X and Y are treated as 
owning their respective shares of such stock and liability pursuant 
to Sec.  1.988-1(a)(4)(ii) for purposes of applying section 988. As 
a result, P's becoming the obligor on the portion of the yen-
denominated note that is treated as an obligation of X is a section 
988 transaction pursuant to paragraphs (a)(1)(ii), (a)(2)(ii) and 
(a)(3) of this section. Similarly, the dispositions of yen to make 
payments of interest and principal on the liability, to the extent 
such yen are treated as owned by X under paragraph (a)(4)(ii) of 
this section, are section 988 transactions under paragraphs 
(a)(1)(i) and (a)(3) of this section. To the extent the yen are 
treated as owned by the eligible QBU, see Sec.  1.987-2(c) for the 
treatment of the payment of yen as a transfer from the eligible QBU 
to X. P's becoming the obligor on Y's portion of the yen-denominated 
note, and Y's portion of the yen disposed of in connection with 
payments on such note, are not section 988 transactions because Y 
has the yen as its functional currency.
* * * * *
    (10) * * *
    (ii) Certain intra-taxpayer transfers of section 988 transactions 
that result in the recognition of section 988 gain or loss--(A) In 
general. Exchange gain or loss with respect to nonfunctional currency 
or any item described in paragraph (a)(2) of this section entered into 
with another taxpayer shall be realized upon a transfer (as defined 
under Sec.  1.987-2(c)) of such currency or item from an owner to a 
section 987 QBU or from a section 987 QBU to an owner if as a result of 
such transfer--
    (1) The currency or item loses its character as nonfunctional 
currency or as an item described in paragraph (a)(2) of this section; 
or
    (2) The source of the exchange gain or loss could be altered absent 
the application of paragraph (a)(10)(ii)(B) of this section.
    (B) Computation of exchange gain or loss. Exchange gain or loss 
described in section (a)(10)(ii)(A) of this section shall be computed 
in accordance with Sec.  1.988-2 (without regard to Sec.  1.988-
2(b)(8)) as if the nonfunctional currency or item described in 
paragraph (a)(2) of this section had been sold or otherwise transferred 
at fair market value between unrelated taxpayers. For purposes of the 
preceding sentence, a taxpayer must use a translation rate that is 
consistent with the translation conventions of the section 987 QBU to 
or from which, as the case may be, the item is being transferred. In 
the case of a gain or loss incurred in a transaction described in this 
paragraph (a)(10)(ii) that does not have a significant business 
purpose, the Commissioner may defer such gain or loss.
* * * * *
    (i) * * * Generally, the revisions to paragraphs (a)(3), (a)(4), 
and (a)(10)(ii) of this section shall apply to taxable years beginning 
one year after the first day of the first taxable year following 
December 7, 2016. If pursuant to Sec.  1.987-11(b) a taxpayer applies 
Sec. Sec.  1.987-1 through 1.987-11 beginning in a taxable year prior 
to the earliest taxable year described in Sec.  1.987-11(a), then the 
revisions to paragraphs (a)(3), (a)(4), and (a)(10)(ii) of this section 
shall apply to taxable years of the taxpayer beginning on or after the 
first day of such prior taxable year.

0
Par. 8. Section 1.988-4 is amended by revising paragraph (b)(2) to read 
as follows:


Sec.  1.988-4  Source of gain or loss realized on a section 988 
transfer.

* * * * *
    (b) * * *
    (2) Proper reflection on the books of the taxpayer or qualified 
business unit--(i) In general. For purposes of paragraph (b)(1) of this 
section, the principles of Sec.  1.987-2(b) shall apply in determining 
whether an asset, liability, or item of income or expense is reflected 
on the books and records of a qualified business unit.
    (ii) Effective/applicability date. Generally, paragraph (b)(2)(i) 
of this section shall apply to taxable years beginning on or after one 
year after the first day of the first taxable year following December 
7, 2016. If pursuant to Sec.  1.987-11(b) a taxpayer applies Sec. Sec.  
1.987-1 through 1.987-11 beginning in a taxable year prior to the 
earliest taxable year described in Sec.  1.987-11(a), then paragraph 
(b)(2)(i) of this section shall apply to taxable years of the taxpayer 
beginning on or after the first day of such prior taxable year.
* * * * *

0
Par. 9. Section 1.989(a)-1 is amended by revising paragraph (b)(2)(i) 
and adding paragraphs (b)(4) and (d)(3) and (4) to read as follows:


Sec.  1.989(a)-1  Definition of a qualified business unit.

    (b) * * *
    (2) * * *
    (i) Persons--(A) Corporations. A corporation is a QBU.
    (B) Individuals. An individual is not a QBU.
    (C) Partnerships. A partnership, other than a section 987 aggregate 
partnership as defined in Sec.  1.987-1(b)(5), is a QBU.
    (D) Trusts and estates. A trust or estate is a QBU of a 
beneficiary.
* * * * *
    (4) Effective/applicability date. Generally, the revisions to 
paragraph (b)(2)(i) of this section shall apply to taxable years 
beginning on or after one year after the first day of the first taxable 
year following December 7, 2016. If pursuant to Sec.  1.987-11(b) a 
taxpayer applies Sec. Sec.  1.987-1 through 1.987-11 beginning in a 
taxable year prior to the earliest taxable year described in Sec.  
1.987-11(a), then the effective date of the revisions to paragraph 
(b)(2)(i) of this section with respect to the taxpayer shall apply to 
taxable years of the taxpayer beginning on or after the first day of 
such prior taxable year.
* * * * *
    (d) * * *
    (3) Proper reflection on the books of the taxpayer or qualified 
business unit. The principles of Sec.  1.987-2(b) shall apply in 
determining whether an asset, liability, or item of income or expense 
is reflected on the books of a qualified business unit (and therefore 
is attributable to such unit).
    (4) Effective/applicability date. Generally, the revisions to 
paragraph (d)(3) of this section shall apply to taxable years beginning 
on or after one year after the first day of the first taxable year 
following December 7, 2016. If pursuant to Sec.  1.987-11(b) a taxpayer 
applies Sec. Sec.  1.987-1 through 1.987-11 beginning in a taxable year 
prior to the earliest taxable year described in Sec.  1.987-11(a), then 
the revisions to paragraph (b)(2)(i) of this section shall apply with 
respect to taxable years of the taxpayer beginning on or after the 
first day of such prior taxable year.
* * * * *


Sec.  1.989(c)-1  [Removed]

0
Par. 10. Section 1.989(c)-1 is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 11. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


[[Page 88852]]



0
Par. 12. In Sec.  602.101, paragraph (b) is amended by adding an entry 
in numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       Control No.
------------------------------------------------------------------------
 
                                * * * * *
1.987-1.................................................       1545-2265
1.987-3.................................................       1545-2265
1.987-9.................................................       1545-2265
1.987-10................................................       1545-2265
 
                                * * * * *
------------------------------------------------------------------------


John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: November 14, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-28381 Filed 12-7-16; 8:45 am]
BILLING CODE 4830-01-P