[Code of Federal Regulations]
[Title 26, Volume 10]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.987-5]
[Page 571-576]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1_INCOME TAXES--Table of Contents
Sec. 1.987-5 Transition rules for certain qualified business units
using a profit and loss method of accounting for taxable years
beginning before January 1, 1987.
(a) Applicability--(1) In general. This section applies to qualified
business unit (QBU) branches of United States persons, whose functional
currency (as defined in section 985 of the Code and the regulations
thereunder) is other than the United States dollar (dollar) and that
used a profit and loss method of accounting for their last taxable year
beginning before January 1, 1987. Generally, a profit and loss method of
accounting is any method of accounting under which the taxpayer
calculates the profits of a QBU branch in its functional currency and
translates
[[Page 572]]
the net result into dollars. For all taxable years beginning after
December 31, 1986, such QBU branches must use the profit and loss method
of accounting as described in section 987, except to the extent
otherwise provided in regulations under section 985 or any other
provision of the Code. See Sec. 1.989(c)-1 regarding transition rules
for QBU branches of United States persons that have a nondollar
functional currency and that used a net worth method of accounting for
their last taxable year beginning before January 1, 1987.
(2) Insolvent QBU branches. A taxpayer may apply the principles of
this section to a QBU branch that used a profit and loss method of
accounting for its last taxable year beginning before January 1, 1987,
whose $E pool (as defined in paragraph (d)(3)(i) of this section) is
negative. For taxable years beginning on or after October 25, 1991, the
principles of this section shall apply to insolvent QBU branches.
(b) General rules. Generally, section 987 gain or loss occurs when a
QBU branch makes a remittance. A remittance is considered to be made
from one or more functional currency pools under rules provided in
paragraph (c) of this section. In general, the amount of section 987
gain or loss from a remittance equals the difference between the dollar
value of the functional currency adjusted basis of the property remitted
and the portion of the dollar basis in the applicable pool. Section 987
gain or loss is calculated under a 4-step procedure described in
paragraph (d) of this section. Section 987 gain or loss attributable to
a remittance is realized and must be recognized in the taxable year of
the remittance except to the extent otherwise provided in regulations.
(c) Determining the pool(s) from which a remittance is made--(1)
Remittances made during taxable years beginning after December 31, 1986,
and before October 25, 1991. A remittance made during taxable years
beginning after December 31, 1986 and before October 25, 1991, first
represents an amount of the QBU branch's post-86 profits pool (including
functional currency profits for the current taxable year determined
without regard to remittances made during the current year). To the
extent the functional currency amount of the remittance exceeds the
post-86 profits pool, it is considered to come out of the EQ pool.
Paragraph (d)(2) of this section describes the EQ pool and the post-86
profits pool.
(2) Remittances made in taxable years beginning on or after October
25, 1991. For remittances made in taxable years beginning on or after
October 25, 1991, the post-86 profits and EQ pools are combined into one
pool called the equity pool. Therefore, remittances made during those
taxable years will only come from the equity pool. The dollar basis of,
and section 987 gain or loss on, such remittances shall be calculated
utilizing the principles set forth in paragraphs (d)(4) and (5) of this
section.
(d) Calculation of section 987 gain or loss--(1) In general. This
paragraph (d) describes the 4-step procedure for calculating section 987
gain or loss.
(2) Step 1--Calculate the amount of the functional currency pools--
(i) EQ pool-- (A) Beginning pool. The beginning amount of the EQ pool is
equal to the functional currency adjusted bases of a QBU branch's assets
less the functional currency amount of the QBU branch's liabilities at
the end of the taxpayer's last taxable year beginning before January 1,
1987, as these amounts are determined under the rules of paragraphs (e)
and (f) of the section. The district director may allow for additional
adjustments to the beginning amount of the EQ pool to prevent the
recognition of section 987 gain or loss due to factors unrelated to the
movement of exchange rates.
(B) Adjusting the EQ pool. The EQ pool is increased by the
functional currency amount of any transfer (as determined under section
987) to the QBU branch made during the current taxable year or any prior
taxable year beginning after December 31, 1986. If the transfer is made
in a nonfunctional currency, this amount is translated into the QBU
branch's functional currency at the spot rate (determined under the
principles of section 988 and the regulations thereunder) on the date of
the transfer. The method for determining the rate must be applied
consistently each quarter. The EQ pool is decreased by the functional
currency amount of any remittance (as determined under section 987) made
during a
[[Page 573]]
prior taxable year beginning after December 31, 1986, that is considered
remitted from the EQ pool under paragraph (c) of this section. The EQ
pool must also be decreased by any transfer from the QBU branch that is
not a remittance.
(ii) Post-86 profits pool. The amount of a QBU branch's post-86
profits pool is calculated at the end of each taxable year beginning
after December 31, 1986. The opening balance of the post-86 profits pool
at the beginning of the first taxable year beginning after December 31,
1986, is zero. The post-86 profits pool is increased by the functional
currency amount of the QBU branch's profits (determined under section
987) for the taxable year. The post-86 profits pool is decreased by the
functional currency amount of the QBU branch's losses (determined under
section 987) for the taxable year and the amount of any remittances by
the QBU branch during the taxable year from the post-86 profits pool as
provided under paragraph (c) of this section.
(iii) Adjustments to the equity pool. For remittances made in
taxable years beginning on or after October 25, 1991 under paragraph
(c)(2) of this section, the post-86 profits and EQ pools are combined
into one pool called the equity pool. Additions to and subtractions from
the equity pool shall be made utilizing the principles of paragraphs
(d)(2)(i)(B) and (ii) of this section. For example, remittances shall
reduce the equity pool.
(3) Step 2--Calculate the dollar basis of the pools--(i) Dollar
basis of the EQ pool--(A) Beginning dollar basis. The beginning dollar
basis of the EQ pool (hereinafter referred to as the $E pool) equals:
(1) The dollar amount of all the QBU branch's profits reported on
the taxpayer's income tax returns for taxable years beginning before
January 1, 1987, plus the total dollar amount of all transfers to the
QBU branch during that period (properly reflected on the taxpayer's
books), less
(2) The dollar amount of all the QBU branch's losses reported on the
taxpayer's income tax returns for such years, and the total dollar basis
of all remittances and all transfers made by the QBU branch during that
period (properly reflected on the taxpayer's books).
A QBU branch's profits and losses shall be properly adjusted for foreign
taxes of the QBU branch.
(B) Adjusting the $E pool. The $E pool is increased by the dollar
amount of any transfers to the QBU branch made during the current
taxable year or any prior taxable year beginning after December 31,
1986. If a transfer is made in a currency other than the dollar, the
amount of the currency is translated into dollars at the spot rate
(determined under the principles of section 988 and the regulations
thereunder) on the date of the transfer. The $E pool is decreased by the
dollar basis of any remittance made during a prior taxable year
beginning after December 31, 1986, that is considered remitted from the
$E pool under paragraphs (c) and (d)(4) of these section. The $E pool is
also reduced by the amount of a transfer (other than a remittance) from
the QBU branch translated into dollars at the spot rate (determined
under the principles of section 988 and the regulations thereunder) on
the date of the transfer. The method for determining the spot rate must
be applied consistently to all transfers to and from a QBU branch.
(ii) Dollar basis of the post-86 profits pool. The amount of a QBU
branch's dollar basis in the post-86 profits pool (the $P pool) is
calculated at the end of each taxable year beginning after December 31,
1986. The opening balance of the $P pool at the beginning of the first
taxable year beginning after December 31, 1986, is zero. The $P pool is
increased by the functional currency amount of the QBU branch's profits
(determined under section 987) for the taxable year translated into
dollars at the weighted average exchange rate (as defined in Sec. 1.989
(b)-1) for the year. The $P pool is decreased by the functional currency
amount of the QBU branch's losses (determined under section 987) for the
taxable year translated into dollars at the weighted average exchange
rate for the year and by the dollar basis of any remittances made by the
QBU branch during the taxable year from the post-86 profits pool under
paragraph (c)(1) of this section.
[[Page 574]]
(iii) Combination of the $E and the $P pools. For taxable years
beginning on or after October 25, 1991 the $P and the $E pools are
combined into one pool called the basis pool. Additions to and
subtractions from the basis pool shall be made utilizing the principles
set forth in paragraphs (d)(3)(i) and (ii) of this section.
(4) Step 3--Calculation of the dollar basis of a remittance. For all
taxable years beginning after December 31, 1986, the dollar basis of a
remittance is calculated using the following formula:
[GRAPHIC] [TIFF OMITTED] TC09OC91.064
(5) Step 4--Calculation of the section 987 gain or loss on a
remittance. Section 987 gains or loss equals the difference between--
(i) The dollar amount of the remittance, and
(ii) The dollar basis of the remittance as calculated under
paragraph (d)(4) of this section.
(e) Functional currency adjusted basis of QBU branch assets acquired
in taxable years beginning before January 1, 1987--(1) Basis of asset.
For taxable years beginning after December 31, 1986, the functional
currency adjusted basis of a QBU branch asset acquired in a taxable year
beginning before January 1, 1987, is the functional currency basis of
the asset at the date of acquisition, as adjusted according to United
States tax principles. The functional currency adjusted basis of an
asset for which a functional currency basis was not determined at the
date of acquisition is the nonfunctional currency basis of the asset at
the date of acquisition multiplied by the spot exchange rate on the date
of acquisition, as adjusted according to United States tax principles.
(2) Adjustment to basis of asset. Any future adjustments to the
functional currency adjusted basis of such an asset are determined with
respect to the appropriate functional currency adjusted basis of the
asset as determined under this paragraph (e).
(f) Functional currency amount of QBU branch liabilities acquired in
taxable years beginning before January 1, 1987. For the first taxable
year beginning after December 31, 1986, the amount of a QBU branch
liability incurred in a taxable year beginning before January 1, 1987,
is the functional currency amount of the liability at the date incurred,
as adjusted according to United States tax principles. The functional
currency amount of a liability for which a functional currency amount
was not determined at the date incurred is the nonfunctional currency
amount of the liability at the date incurred multiplied by the spot
exchange rate on the date incurred, as adjusted according to the United
States tax principles.
(g) Examples. The provisions of this section are illustrated by the
following examples.
Example 1: (i) Facts. U.S. is a domestic corporation. B, a QBU
branch of U.S., operates in country X and was established in 1985. B's
functional currency is the FC. U.S. is on a calendar taxable year and,
prior to January 1, 1987, accounted for the operations of B by the
profit and loss method of accounting as set forth in Rev. Rul. 75-107,
1975-1 C.B. 32. B's books and records were kept according to United
States tax principles. B received a transfer of $2,000 in 1985, and had
profits of $3,000 in 1985 and $5,000 in 1986. B made a remittance in
1986, the dollar basis of which was $1,000. As of December 31, 1986, the
adjusted basis of B's functional currency assets exceeded the functional
currency amount of its liabilities by 15,000 FC (the beginning pool of
EQ). Under section 987, B has profits of 8,000 FC in 1987, which are
worth $1,000 when translated at the weighted average exchange rate for
1987 as required by sections 987(2) and 989(b)(4). B has no profits or
loss in 1988. There are no transfers to B in 1987 and 1988. B remits
18,000 FC in 1988. Under section 987, the appropriate exchange rate for
the 1988 remittance is 10 FC/$1.
[[Page 575]]
(ii) Calculation of section 987 loss on remittance--(A) Post-86
profits. Under paragraph (c)(i) of this section, the 18,000 FC
remittance comes first out of the post-86 profits pool (8,000 FC) and
second out of EQ (10,000 FC). The loss on the 1988 remittance out of the
post-86 profits pool equals:
Dollar value of post-86 profits remitted - Dollar basis of post-86
profits remitted=
(8,000 FC x 10 FC/$1) - $1,000 = $800 - $1,000 = <=$200 loss.
(B) EQ. Under paragraph (d) of this section, U.S. calculates 987
gain or loss on the 10,000 FC remittance of EQ from B as follows:
Step 1. The total EQ pool equals 15,000 FC (the functional currency
adjusted bases of its assets less the functional currency amount of its
liabilities as of December 31, 1986). There are no adjustments necessary
under paragraph (d)(2)(i)(B) of this section.
Step 2. The $E pool is $9,000 (the $2,000 transfer in 1985 plus
profits of $3,000 in 1985 and $5,000 in 1986 and less than $1,000 basis
of the 1986 remittance). There are no adjustments necessary under
paragraph (d)(3)(i)(B) of this section.
Step 3. The entire 10,000 FC remittance is deemed to come out of EQ.
Step 4. The dollar basis of the EQ remitted equals: N x $E
determined under paragraph (d)(3)(i)=
[GRAPHIC] [TIFF OMITTED] TC09OC91.065
Where:
[GRAPHIC] [TIFF OMITTED] TC09OC91.066
Step 5. Section 987 loss of U.S. on remittance equals:
Dollar value of the EQ remitted - Dollar basis of the EQ remitted =
(10,000 FC x 10 FC/$1) - $6,000 = $1,000 - $6,000 = <=$5,000
loss.
(C) Total loss on remittance. The total combined loss on the
remittance is '$5,200. The total of amounts determined in
paragraphs (ii)(A) and (B) of this Example 1.
Example 2: (i) Facts. D is a domestic corporation. B, a QBU branch
of D, operates in country X. B's functional currency is the FC. At the
end of B's last taxable year beginning before October 25, 1991, B's EQ
pool equals 15,000 FC and B's post-86 profits pool equals 8,000 FC. B's
$E amount equals $9,000, and the $P pool equals $1,000. In B's first
taxable year beginning on or after October 25, 1991, B remits 18,000 FC.
Under section 987, the appropriate exchange rate for this remittance is
10FC:$1.
(ii) Computation of the equity pool.
15,000 FC (EQ pool) + 8,000 FC (post-86 profits pool) = 23,000 FC
(equity pool)
(iii) Computation of the basis pool.
[GRAPHIC] [TIFF OMITTED] TC09OC91.067
(iv) Dollar basis in remittance.
[GRAPHIC] [TIFF OMITTED] TC09OC91.068
(v) Computation of section 987 loss by U.S. on remittance.
[GRAPHIC] [TIFF OMITTED] TC09OC91.069
[[Page 576]]
(h) Character and source of section 987 gain or loss. Section 987
gain or loss is sourced and characterized as provided by section 987 and
regulations issued under that section.
[T.D. 8367, 56 FR 48434, Sept. 25, 1991; 56 FR 65684, Dec. 18, 1991]