On June 13, 2018, the U.S. Department of the Treasury (Treasury) and IRS issued Notice 2018-57, deferring the effective date of the 2016 final and temporary Section 987 regulations, in general, to taxable years beginning in 2020.
§987 is designed in part to capture certain currency gains and losses from a foreign branch or similar foreign flow-through entity—a qualified business unit (QBU). §987 requires recognition of currency gains and losses caused by fluctuations in exchange rates between the time a U.S. owner recognizes the foreign QBU income in its U.S. taxable income and when the foreign branch or flow-through entity later remits the previously taxed income to the U.S. owner. §987 similarly captures currency gains and losses in the earnings and profits of a controlled foreign corporation (CFC) when it owns a QBU with a different functional currency than the CFC.
The 2016 final and temporary §987 regulations require U.S. owners to compute foreign currency gain or loss under a balance sheet method. Under this method, the tax basis of financial QBU assets and liabilities is translated to U.S. dollars at an end-of-year spot exchange rate, but the tax basis of nonfinancial QBU assets and liabilities, such as fixed assets, intangible assets and long-term liabilities, is translated to U.S. dollars at historical exchange rates. U.S. owners also must translate depreciation and amortization deductions from a QBU to U.S. dollars at historical exchange rates. A CFC applies the same rules in translating QBU balance sheet items to the CFC’s functional currency.
Commenters have expressed concerns that the method of computing currency gain or loss under the 2016 §987 regulations is unduly complex and costly to comply with. They also noted the transition method of the regulations imposes an undue financial burden on taxpayers because it permanently disregards unrealized currency losses generated in years prior to the transition.
The deferral of the regulations’ effective date is intended to give Treasury and the IRS sufficient time to consider changes to the final regulations as part of a review required by presidential executive order. Potential changes to the regulations may allow taxpayers to elect alternative rules for transitioning to the final regulations and alternative rules for determining §987 currency gain or loss.
Taxpayers with foreign branches, foreign disregarded entities or foreign partnerships should consider the effects of the regulation method and transition to the regulations. Taxpayers with unrealized currency losses attributable to foreign branches or flow-through entities may want to consider triggering some or all of the loss in the intervening period before the regulations—or their successors—are issued and effective.
Contact Chris or your trusted BKD advisor if you have questions.