Internal Revenue Bulletin 2017-2 (PDF rendition): IRS Notices

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# INTERNAL REVENUE BULLETIN

IRS

Bulletin No. 2017-2
January 9, 2017

## HIGHLIGHTS OF THIS ISSUE

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

## INCOME TAX

### REG-128276-12, page 369.

The temporary and proposed regulations contain rules relating
to the recognition and deferral of foreign currency gain or loss
under section 987 with respect to a QBU in connection with
certain QBU terminations and certain other transactions involv-
ing partnerships. The temporary and proposed regulations also
provide for (i) an annual deemed termination election for a
section 987 QBU; (ii) an elective method, available to taxpayers
that make the annual deemed termination election, for trans-
lating all items of income or loss with respect to a section 987
QBU at the yearly average exchange rate; (iii) rules regarding
the treatment of section 988 transactions of a section 987
QBU; (iv) rules regarding QBUs with the U.S. dollar as their
functional currency; (v) rules regarding combinations and sep-
arations of section 987 QBUs; (vi) rules regarding the transla-
tion of income used to pay creditable foreign income taxes; (vii)
rules regarding the allocation of assets and liabilities of certain
partnerships for purposes of section 987; and (viii) rules under
section 988 requiring the deferral of certain section 988 loss
that arises with respect to related-party loans.

### Rev. Rul. 2017-02, page 364.

Federal rates; adjusted federal rates; adjusted federal long-
term rate and the long-term exempt rate. For purposes of
sections 382, 642, 1274, 1288, 7872, and other sections of
the Code, tables set forth the rates for January 2017.

### Notice 2017-03, page 368.

This notice provides the maximum vehicle values for use with
the special valuation rules under regulation section 1.61-21(d)
and (e) for 2017. These values are adjusted for inflation and
must be adjusted annually by reference to the Consumer Price
Index.

### T.D. 9794, page 273.

The final regulations provide guidance under section 987 re-
garding 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.

### T.D. 9795, page 326.

The temporary and proposed regulations contain rules relating
to the recognition and deferral of foreign currency gain or loss
under section 987 with respect to a QBU in connection with
certain QBU terminations and certain other transactions involv-
ing partnerships. The temporary and proposed regulations also
provide for an annual deemed termination election for a section
987 QBU; an elective method, available to taxpayers that make
the annual deemed termination election, for translating all
items of income or loss with respect to a section 987 QBU at
the yearly average exchange rate; rules regarding the treat-
ment of section 988 transactions of a section 987 QBU; rules
regarding QBUs with the U.S. dollar as their functional cur-
rency; rules regarding combinations and separations of sec-
tion 987 QBUs; rules regarding the translation of income used
to pay creditable foreign income taxes; rules regarding the
allocation of assets and liabilities of certain partnerships for
purposes of section 987; and rules under section 988 requir-
ing the deferral of certain section 988 loss that arises with
respect to related-party loans.

### T.D. 9801, page 355.

The final regulations provide a revised definition of issue price for
purposes of the arbitrage restrictions under section 148 that
apply to tax-exempt bonds under section 103, tax credit bonds
under section 54A, and direct pay bonds under section 6431.

(Continued on the next page)

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## EMPLOYEE PLANS

Notice 2017-01, page 367.

This notice provides guidance on section 7528(b)(2) of the
Code, relating to an exemption from the requirement to pay a
user fee for certain requests to the IRS for determination
letters with respect to the qualified status of pension, profit-
sharing, stock bonus, annuity, and employee stock ownership
plans maintained by small employers. This notice is being
issued as a result of changes made to the determination letter
program and remedial amendment period rules set forth in
Rev. Proc. 2016-37, 2016-29 I.R.B. 136.

## EXCISE TAX

### REG-134438-15, page 373.

These proposed regulations would modify the current definition
of "net premiums written" for purposes of the fee imposed by
section 9010 of the Affordable Care Act.

## ADMINISTRATIVE

REG-133353-16, page 372.

This document contains proposed regulations that authorize
the disclosure of certain items of return information to the
Bureau of the Census in conformance with section 6103(j)(1) of
the Internal Revenue Code.

### Notice 2017-03, page 368.

This notice provides the maximum vehicle values for use with
the special valuation rules under regulation section 1.61-21(d)
and (e) for 2017. These values are adjusted for inflation and
must be adjusted annually by reference to the Consumer Price
Index.

### T.D. 9802, page 361.

This document contains temporary regulations that authorize
the disclosure of certain items of return information to the
Bureau of the Census in conformance with section 6103(j)(1) of
the Internal Revenue Code.

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## The IRS Mission

Provide America's taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.

## Introduction

The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of internal
management are not published; however, statements of inter-
nal practices and procedures that affect the rights and duties
of taxpayers are published.

Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings to
taxpayers or technical advice to Service field offices, identify-
ing details and information of a confidential nature are deleted
to prevent unwarranted invasions of privacy and to comply with
statutory requirements.

Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

### Part I .- 1986 Code.

This part includes rulings and decisions based on provisions of
the Internal Revenue Code of 1986.

### Part II .- Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A, Tax
Conventions and Other Related Items, and Subpart B, Legisla-
tion and Related Committee Reports.

Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury's Office of the Assistant Sec-
retary (Enforcement).

### Part IV .- Items of General Interest.

This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative index for
the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

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## Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

T.D. 9794
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602

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

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Final Regulations.

SUMMARY: This document contains fi-
nal regulations that provide guidance un-
der 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 corpora-
tions and individuals that own QBUs sub-
ject to section 987. In addition, published
elsewhere in this issue of the Bulletin,
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 applica-
bility, see § 1.987-11.

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

SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

The collection of information con-
tained 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 col-
lection of information are mandatory.

The collection of information in these
final regulations is in §§ 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 spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books and records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial 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 regula-
tions 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 reg-
ulations under section 987 (the 2006 pro-
posed regulations) and withdrew proposed
regulations under section 987 published
on September 25, 1991 (INTL-965-86,
56 FR 48457) (the 1991 proposed regula-
tions). The Treasury Department and the

IRS received many written comments in
response to the 2006 proposed regula-
tions. After consideration of all the com-
ments, the 2006 proposed regulations, as
revised by this Treasury decision, are ad-
opted as final regulations. Temporary reg-
ulations (TD 9795) and proposed regula-
tions (REG-128276-12) under section
987 are being published contemporane-
ously 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. Sec-
tion 987 further requires the taxpayer to
make "proper adjustments" (as prescribed
by the Secretary) for transfers of property
between QBUs having different func-
tional 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 ordi-
nary income or loss and sourcing such
gain or loss by reference to the source of
the income giving rise to post-1986 accu-
mulated earnings.1 Section 989(b)(4) pro-
vides that, "[e]xcept as provided in regu-
lations," 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) di-
rects the Secretary to "prescribe such reg-
ulations as may be necessary or appropri-
ate to carry out the purposes of [subpart J],
including regulations . . . providing for the
appropriate treatment of related party
transactions (including transactions be-

1The legislative history of section 987 is discussed extensively in the preamble to the 2006 proposed regulations. See 71 FR 52876.

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tween qualified business units of the same
taxpayer) . ... "

#### A. 1991 proposed regulations

The 1991 proposed regulations gener-
ally 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 trans-
lated into the functional currency of the
taxpayer using the weighted average ex-
change 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 ac-
cording to the following formula:

Amount remitted in the
QBU's functional currency
Equity pool in the QBU's
functional currency

x

Basis pool in the taxpayer's
functional currency

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 asso-
ciated with the remittance.

One important consequence of the eq-
uity pool paradigm was that all branch
equity gave rise to exchange gain or loss,
regardless of whether the equity was in-
vested in assets that actually exposed the
QBU's owner to currency fluctuations.
For example, both cash denominated in
the QBU's functional currency and mo-
bile equipment equally gave rise to ex-
change gain or loss. As a result, under the
1991 proposed regulations, exchange rate
changes that, at most, had only an uncer-
tain 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 re-
mittances or causing a termination of the
QBU. Given these distortions, the Trea-
sury Department and the IRS withdrew
the 1991 proposed regulations and pro-
posed new regulations on September 6,
2006.

### B. 2006 proposed regulations

The 2006 proposed regulations ad-
opted 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 refer-
ence to the items of income, gain, deduc-
tion, 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 trans-
lated, 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. How-
ever, the basis of certain "historic assets"
and the deductions for depreciation, de-
pletion, 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 pre-
vents the imputation of foreign currency
gains or losses to such assets. Addition-
ally, the 2006 proposed regulations re-
quired the adjusted basis and amount re-
alized 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 reg-
ulations, 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 de-
ferred until a remittance is made. A
marked item generally is defined under
the 2006 proposed regulations as an asset
(marked asset) or liability (marked liabil-
ity) 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 func-
tional currency of the owner and items for
which exchange rate changes have no ef-
fect 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 sec-
tion 987 QBU makes a remittance, a por-
tion 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 pro-
portion 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 cur-
rency, without reduction for the remit-
tance.

### II. Summary of Comments and Changes

Many comments were received in re-
sponse to the 2006 proposed regulations.
This Part II discusses those comments and
the changes made in response to them.

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Certain comments received in response to
the 2006 proposed regulations are ad-
dressed in the temporary regulations and
are discussed in the preamble to the tem-
porary regulations rather than in this pre-
amble.

### A. General comments regarding the FEEP method, including regarding administrability

A number of comments suggested that
the FEEP method, in particular §§ 1.987-
3 and -4 of the 2006 proposed regula-
tions, would be difficult to administer.
Some of those comments expressed a
preference to more closely align regula-
tions under section 987 with the financial
accounting rules under Accounting Stan-
dards Codification, Foreign Currency
Matters, section 830 (ASC 830).2

ASC 830 adopts a functional currency
paradigm in which assets, liabilities, and
operations of a foreign entity are mea-
sured using the entity's functional cur-
rency3 and then translated into the report-
ing 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 en-
tity 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 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 8309 explains the rationale
for accounting for translation gain or loss
in equity and not income:

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 real-
ized upon sale or liquidation, but
that effect is related to the net in-
vestment and not to the operations
of the investee. Prior to sale or liq-
uidation, that effect is so uncertain
and remote as to require that trans-
lation adjustments arising 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 de-
nominated in a currency other than the
entity's functional currency. Changes in
exchange rates between the functional
currency of the foreign entity and the cur-
rency in which such transactions are de-
nominated give rise to changes in expected
cash flows in the functional currency, re-
sulting 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 cate-
gory of foreign currency transactions that
give rise to transaction gains and losses
under generally accepted accounting prin-
ciples overlaps considerably with the def-
inition of a section 988 transaction for tax
purposes.

Some comments suggested that, in en-
acting section 987, Congress intended to
substantially adopt the financial account-

ing rules for foreign currency translation
for tax purposes. The Treasury Depart-
ment 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 discon-
tinuities between section 987 and the fi-
nancial accounting rules, particularly re-
garding the recognition of foreign currency
gains and losses. Under Financial Ac-
counting Standard No. 52 (FAS 52), trans-
lation gain or loss is deferred in an equity
account until a sale or liquidation of the
foreign entity, at which point the eco-
nomic effects of the aggregate translation
gain or loss can be measured against a real
economic event. The "equity pool" para-
digm 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 re-
mittance as required by the section 987
statute, making the consequences of im-
puting foreign currency gain or loss to all
assets and liabilities substantially greater.

As expressed in the preamble to the
2006 proposed regulations, the adminis-
trative convenience achieved by generally
adopting the FAS 52 computational meth-
odology in the 1991 proposed regulations
gave rise to many cases in which the sec-
tion 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 im-
puted 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

2ASC 830 codifies Financial Accounting Standard No. 52.

3The functional currency of a foreign entity is defined in ASC 830 as the currency of the primary economic environment in which the entity operates.

4ASC 830-30-45-3.

5 ASC 830-10-55-10-11,830-30-45-3.

6ASC 830-30-45-3.

7ASC 830-30-45-12.

8 ASC 830-30-40-1.

9ASC 830-230-45-1.

10ASC 830-20-35-1.

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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 signif-
icant 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 pur-
poses. Similarly, the Treasury Department
and the IRS have determined that an ap-
proach based on consistency with FAS 52
computations modified to address abuses,
as suggested in some comments, is inap-
propriate 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 remit-
tances without regard to the owner's ac-
tual 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 con-
siderations unique to section 987, will
carry out the purposes of section 987 most
appropriately.

Other comments recommended a hy-
brid approach that would combine the
methodology of the 1991 proposed regu-
lations for computing a section 987
QBU's net income with the methodology
of the 2006 proposed regulations for com-
puting section 987 gain or loss. Under the
proposed hybrid approach, section 987
gain or loss generally would be deter-
mined under the method of the 2006 pro-
posed 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 re-
spect to historic assets in determining tax-
able income or loss than would be used to

translate such basis to determine section
987 gain or loss. These comments gener-
ally favored the FEEP method for deter-
mining 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 regula-
tions, but asserted that determining tax-
able income or loss in the functional cur-
rency 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 leg-
islative 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 "ex-
change gain or loss inherent in accumu-
lated earnings or branch capital," as
contemplated by Congress, and inappro-
priately 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 simplifi-
cation would cause basis recovery deduc-
tions with respect to depreciable and am-
ortizable assets that are included in
section 987 taxable income or loss to re-
flect exchange rate fluctuations with re-
spect 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 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 § 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. Accord-
ingly, 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 situa-
tion 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 €100
on the last day of year 1, when the historic
exchange rate is €1 = $1, and takes into
account €10 of depreciation with respect
to the equipment in year 2, when the
yearly average exchange rate is €1 =
$1.50, the €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 depre-
ciation were translated at the €1 = $1
historic rate under the 2006 proposed reg-
ulations. 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 trans-
lating the adjusted basis of historic assets
using the historic exchange rate for each
asset. For euro QBU, solely with refer-
ence to the depreciable equipment, year 2
depreciation causes a $10 reduction in
OFCNV, because in computing the
change in OFCNV, the €10 change in
equipment basis during year 2 is trans-
lated at the €1 = $1 historic rate (year 2
closing balance sheet of $90 adjusted ba-
sis, 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, sec-
tion 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 in-
crease section 987 gain reflected in the
FEEP by $5 (negative $10 change in OF-
CNV, less $15 depreciation deduction).

Considering all of these effects to-
gether, under the hybrid approach, the ap-
preciation of the euro decreases section
987 taxable income by $5 and increases

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section 987 gain reflected in the FEEP by
$5. In other words, the FEEP reflects cur-
rency 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 par-
ticular, section 1092 reflects a policy con-
cern regarding inconsistent timing of
recognition of gains and losses from off-
setting positions. Under the hybrid ap-
proach, the exchange rate effect with re-
spect 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, offset-
ting effects arising from a single asset
would be taken into account at different
times. Accordingly, the Treasury Depart-
ment and the IRS have determined that it
would be inappropriate for regulations un-
der 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 recog-
nized only upon voluntary remittances
from the QBU. Rather, consistent with the
discussion in the preamble to the 2006
proposed regulations, the Treasury De-
partment and the IRS have determined
that, in order to carry out the purposes of
section 987(3) as indicated by the legisla-
tive 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 ba-
sis 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 de-
scribed 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 un-
derlie the recommendation of the hybrid
approach. The concerns about offsetting
amounts recognized at different times un-
der the hybrid approach would not arise
for taxpayers that make the deemed an-
nual termination election set forth in
§ 1.987-8T(d) of the temporary regula-
tions. Accordingly, as described in the
preamble to the temporary regulations, a
taxpayer that makes the deemed annual
termination election may also elect under
§ 1.987-3T(d) to apply the hybrid ap-
proach. Additionally, the Treasury De-
partment and the IRS have made several
changes in these final regulations in re-
sponse to comments expressing concern
about the complexity and administrability
of the 2006 proposed regulations.

In addition to the comments recom-
mending a hybrid approach under which
taxable income would be translated at a
single exchange rate without any adjust-
ments, other comments expressed more
particular concerns regarding the com-
plexity and administrability of the FEEP
paradigm specifically with respect to in-
ventory 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 adminis-
tration and compliance while introducing
little distortion into the FEEP calculation.
The Treasury Department and the IRS do
not agree with these specific recommen-
dations to expand the scope of marked
assets, because even assets that turn over
quickly or have low-value individually
could inappropriately give rise to signifi-
cant amounts of section 987 gain or loss in
the aggregate over time. The Treasury De-
partment and the IRS do, however, ac-
knowledge the general points about com-
plexity and administrability reflected in
these suggestions, which are similar to the
concerns expressed in the comments rec-
ommending the hybrid approach.

In order to reduce complexity and im-
prove administrability, the final regula-

tions modify the 2006 proposed regula-
tions 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 in-
come attributable to such items is trans-
lated at the average exchange rate, and
simplifying the adjustments that are re-
quired to translate basis recovery for his-
toric items at the historic rate. These
changes balance the administrability ben-
efits 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 cur-
rency 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 ad-
vance payments of unearned income as
section 987 marked items, (c) apply a
simplified method with respect to inven-
tory, and (d) translate both basis recovery
and amount realized with respect to
marked assets at the yearly average ex-
change 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 §§ 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 dur-
ing a single taxable year, the 2006 pro-
posed regulations required taxpayers to
track multiple historic spot rates. A com-
ment 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 ex-

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change rate in lieu of a spot rate in trans-
lating historic items.

The Treasury Department and the IRS
agree that using the yearly average ex-
change rate rather than a spot rate to trans-
late historic items would reduce complex-
ity and improve administrability without
introducing significant distortions into the
determination of section 987 taxable in-
come or loss or section 987 gain or loss.
Accordingly, § 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 § 1.987-1(c)(1)(iii). A taxpayer that
makes this election is deemed to also
make the historic inventory election under
§ 1.987-3(c)(2)(iv)(B) that is described in
Part II.A.3 of this preamble.

In addition, to further improve admin-
istrability, § 1.987-1(c)(3)(iii) permits a
section 987 QBU that acquires deprecia-
ble 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 ex-
penses and liabilities for advance pay-
ments of unearned income should be
treated as section 987 marked items be-
cause 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 sig-
nificant distortions in the determination of
section 987 gain or loss. Accordingly, the
definition of marked item under § 1.987-
1(d) includes prepaid expenses and liabil-
ities 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 tax-
able income or loss with respect to a sec-
tion 987 QBU under proposed § 1.987-3,
cost of goods sold (COGS) had to be
translated at a historic spot rate that cor-
responded to the date the liquidated inven-
tory was acquired or manufactured. A his-
toric spot rate also had to be used to
determine the OFCNV of the QBU under
proposed § 1.987-4 with respect to inven-
tory that was reflected on the section 987
QBU's year-end balance sheet. For these
purposes, the cost basis of inventory pur-
chased for resale generally would have
been translated into the owner's func-
tional 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 compo-
nents of COGS at the appropriate historic
spot rate for each cost component, result-
ing in an effective historic rate for manu-
factured inventory that was a blend of the
historic rates applicable to such compo-
nents. 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 depre-
ciation, 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 sim-
plified method be provided to deal with
the administrative difficulties in applying
the 2006 proposed regulations to inven-
tory.

In response to comments, these final
regulations simplify the translation of
COGS and ending inventory in two
significant ways. First, the use under
§ 1.987-1(c)(3) of the yearly average ex-
change rate rather than a spot rate as the
historic rate will significantly simplify the
translation of COGS and ending inven-
tory. 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, § 1.987-3(c)(2)
(iv)(A) prescribes a simplified inventory
method under which (i) COGS is trans-
lated into the functional currency of the
section 987 QBU's owner at the yearly
average exchange rate for the current tax-
able year with a requirement to make only
two discrete adjustments to the translated
COGS amount, and (ii) a simplified his-
toric rate is used for purposes of determin-
ing the OFCNV under Reg. § 1.987-4 for
inventory to which the simplified inven-
tory method applies. A taxpayer that pre-
fers the inventory method under the 2006
proposed regulations can elect under
§ 1.987-3(c)(2)(iv)(B) to translate inven-
toriable costs that are included in COGS
or ending inventory at the historic rate for
each such cost and, if they wish, can fur-
ther elect under § 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 trans-
lating each inventoriable cost at the appro-
priate historic rate. Taxpayers applying
the simplified inventory method must
make two adjustments to COGS described
in § 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 regula-
tions. In particular, the adjustments gen-
erally 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 in-
come or loss that would have resulted if
inventoriable costs were translated at his-
toric rates.

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The first adjustment requires the trans-
lated COGS amount to be adjusted to re-
verse 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 de-
duction, this adjustment is calculated as
the portion of the deduction treated as an
inventoriable cost, computed in the func-
tional 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 pe-
riod in which the functional currency of a
section 987 QBU has strengthened against
its owner's functional currency, the ad-
justment would reduce the amount of
COGS determined in the owner's func-
tional currency to correspond to the
amount that would have been determined
if cost recovery deductions that are inven-
toriable costs had been translated at the
historic rate, as other cost recovery deduc-
tions are translated. To enhance adminis-
trability and respond to comments re-
ceived, this adjustment is taken into
account in determining COGS in full in
the taxable year in which the inventoriable
cost recovery deductions are allowed, re-
gardless 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 ac-
counting methods. For both non-LIFO
and LIFO inventory, the adjustment gen-
erally 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 inventori-
able costs were translated at their respec-
tive historic rates rather than at the yearly
average exchange rate. For non-LIFO in-
ventory, the adjustment is made on an
annual basis with respect to beginning in-
ventory. For LIFO inventory, the adjust-
ment is made only when a LIFO layer is
liquidated or partially liquidated.

i. adjustment for non-LIFO inventory

For non-LIFO inventory, the second ad-
justment required under the simplified in-
ventory method is an adjustment with
respect to beginning inventory. The adjust-
ment, which must be made annually, cor-
rects the distortion that arises from translat-
ing beginning inventory at the current yearly
average exchange rate as part of translating
COGS, after the same inventory was trans-
lated in the immediately preceding year
(when the inventory represented ending in-
ventory 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, com-
puted 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 adjust-
ment would reduce the amount of COGS
determined in the owner's functional cur-
rency by the difference between beginning
inventory translated at the current yearly
average exchange rate and at the yearly av-
erage 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 sec-
tion 987 taxable income or loss as would
have occurred under the 2006 proposed reg-
ulations if the yearly average exchange rate
had been used as the historic rate. Addition-
ally, because this adjustment is reflected in
section 987 taxable income or loss, which is
a component of the § 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 in-
ventory on the year-end balance sheet from
giving rise to section 987 gain or loss, not-
withstanding 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 adjust-
ment required under the simplified inven-

tory 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 ex-
change 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 liqui-
dated during the year multiplied by the
amount (whether positive or negative) that
is determined by subtracting the yearly
average exchange rate for the current tax-
able year from the yearly average ex-
change 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 § 1.987-4 with
respect to inventory that is reflected on the
section 987 QBU's year-end balance
sheet, § 1.987-1(c)(3)(i)(B) provides a
simplified historic rate for inventory to
which the simplified inventory method ap-
plies. Under § 1.987-1(c)(3)(i)(B), the
simplified historic rate for inventory dif-
fers 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 av-
erage exchange rate for the taxable year in
which the relevant LIFO layer arose. If the
inventory is accounted for under a non-
LIFO method, the historic rate is the av-
erage 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 re-
flected on a section 987 QBU's year-end
balance sheet, the inventory is translated
at the average exchange rate for that tax-
able year. Thus, although non-LIFO in-
ventory subject to the simplified method is
nominally a historic asset, it is translated

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at a current exchange rate each year sim-
ilar 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 pro-
vided special rules for translating the ad-
justed 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 cur-
rency net value of the section 987 QBU
for the preceding taxable year under
§ 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 ac-
quired. In response to general comments
on the complexity of administering the
2006 proposed regulations, and consider-
ing 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 pro-
vided that banks, insurance companies,
and similar financial entities would not be
subject to the regulations. In addition, the
2006 proposed regulations identified leas-
ing companies, finance coordination cen-
ters, regulated investment companies, and
real estate investment trusts as "similar
financial entities." A comment requested
that the final regulations clarify the mean-
ing of "similar financial entities." Com-
ments also suggested excluding entities

from the scope of "similar financial en-
tity" (and therefore making such entities
subject to the final regulations) if they
primarily engage in transactions with re-
lated parties that are not themselves finan-
cial entities. A comment noted that it
would be anomalous to apply the final
regulations with respect to all of the op-
erating 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 finan-
cial entities" in the 2006 proposed regu-
lations is unclear and agree that entities
primarily engaged in transactions with re-
lated persons that are not themselves fi-
nancial entities should be subject to the
final regulations. Accordingly, § 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 iden-
tified as "similar financial entities." Addi-
tionally, the exception from the applica-
tion 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
§ 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 pro-
posed regulations. The Treasury Depart-
ment and the IRS are still considering how
section 987 should apply to excluded en-
tities and request additional comments re-
garding 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 ap-
plying section 987 with respect to such
excluded entities are effective, the ex-
cluded 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 provid-
ing such an election more generally with-
out regard to the relative amount of
marked items held by an eligible QBU.
The Treasury Department and the IRS
have determined that the proposed elec-
tion would create substantial administra-
tive difficulties for the IRS, particularly
given that an electing QBU would main-
tain books and records in its functional
currency but would determine tax conse-
quences 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 § 1.987-2(b)(2) of the 2006 pro-
posed regulations, stock other than port-
folio 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 recommenda-
tion, which is reflected in § 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 at-
tributing assets and liabilities, and items
of income or expense, to an eligible QBU
and that those rules should apply for pur-
poses of sections 985, 987, and 989 to
avoid inconsistencies across subpart J.
Accordingly, § 1.989(a)-1(d)(3) is revised

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to provide that the principles of § 1.987-
2(b) apply in determining whether an as-
set, 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 § 1.987-
1(b)(3) is revised to cross-reference the
QBU definition under § 1.989-1(a). The
1991 proposed regulations generally would
have applied to a QBU within the meaning
of § 1.989(a)-1 that has a functional
currency different than the functional cur-
rency of its owner. The 2006 proposed
regulations, in contrast, did not refer di-
rectly to the § 1.989-1(a) QBU definition.
Rather, the 2006 regulations generally de-
fined an eligible QBU as activities that
constitute a trade or business as defined in
§ 1.989(a)-1(c) for which a separate set of
books and records are maintained. By re-
lying on the definition of a QBU in
§ 1.989(a)-1, as the 1991 proposed regu-
lations did, the final regulations avoid in-
advertently introducing inconsistencies
across subpart J in the definition of a
QBU.

### F. Offsetting positions

Under § 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 re-
cording (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 tax-
payer 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 func-
tional 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 sec-
tion 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 param-
eters of the "offsetting position" factor, par-
ticularly in the context of banks.

As discussed in Part II.B of this pre-
amble, 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 fi-
nancial entity context, the Treasury De-
partment and the IRS have determined
that the "offsetting position" factor in
§ 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 sec-
tion 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 oc-
casions 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 va-
riety of transactions between a section 987
QBU and its home office. More signifi-
cantly, 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 appro-
priately determining section 987 gain or

loss under § 1.987-4 because all transfers
affect the OFCNV of the section 987
QBU. Furthermore, the Treasury Depart-
ment and the IRS have determined that the
annual netting convention of § 1.987-5,
which simplifies the calculation of a re-
mittance 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 remit-
tance. Accordingly, the recommendation
to include an ordinary-course exception to
the definition of transfer has not been ad-
opted.

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 sec-
tion 7701. Accordingly, the recommenda-
tion 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 func-
tional currency as a single QBU for pur-
poses 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 De-
partment 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 consol-
idated group and how this election should
be technically effectuated.

Several comments recommended ex-
tending 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 com-
ments received, the Treasury Department

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and the IRS have been unable to reconcile
in a satisfactory manner the timing of sec-
tion 987 gain or loss and section 987
taxable income or loss under the final reg-
ulations with the principles of § 1.1502-
13, including separate entity accounting
for consolidated group members. As a re-
sult, this recommendation has not been
adopted in the final regulations. The Trea-
sury Department and the IRS continue to
welcome comments with specific recom-
mendations 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 ag-
gregate partnerships. The Treasury De-
partment and the IRS have determined
that allowing grouping of directly and in-
directly 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 pur-
poses. 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 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 subchap-
ter 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 func-
tional 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 func-
tional 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 con-
sistency requirement for all section 987
QBUs with the same functional currency
could inappropriately facilitate the recog-

nition of section 987 losses coupled with
the deferral of section 987 gains. Accord-
ingly, 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 distor-
tions 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, § 1.987-4(d) reflects addi-
tional steps in the calculation of unrecog-
nized 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 trans-
lated at the same rate at which such taxes
were translated under section 986(a).

##### J. Clarification that the rules of §§ 1.987-3 and -4 apply for determining the E&P of a corporation

Comments indicated that the 2006 pro-
posed regulations did not clearly specify
whether the rules provided for determin-
ing section 987 taxable income or loss
applied for purposes of determining the
earnings and profits of a foreign corpora-
tion. Accordingly, § 1.987-3(a) clarifies
that a foreign corporation that owns a sec-
tion 987 QBU must apply § 1.987-3 in
determining earnings and profits with re-
spect to the section 987 QBU.

### K. FEEP annual calculation requirement

Section 1.987-4(a) of the 2006 pro-
posed regulations required the determina-
tion of the net unrecognized section 987
gain or loss of a section 987 QBU by the
owner annually. In addition, § 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 com-
ment requested elimination of these an-
nual calculations and recordkeeping re-
quirements. The Treasury Department and
the IRS remain of the view that the annual
calculation and recordkeeping require-
ments are necessary for IRS examiners to
verify taxpayer compliance with the final
regulations. Based on its experience ex-
amining taxpayer positions that relate to
events in prior years, the IRS has deter-
mined that contemporaneous recordkeep-
ing and calculation requirements provide
a significantly more reliable basis for ver-
ifying compliance than calculations per-
formed years after the relevant events,
which in many cases would be performed
by individuals without direct access to the
individuals most familiar with the under-
lying facts or responsible for producing
and maintaining the records. Accordingly,
the annual requirements have been re-
tained.

#### L. Character and source of section 987 gain or loss

Consistent with the 1991 proposed reg-
ulations, 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 partic-
ular, § 1.987-6(b)(2) of the 2006 pro-
posed regulations required the owner to
use the asset method under § 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 excep-
tion that would allow a taxpayer to elect to
trace identified amounts of section 987
gain or loss to particular assets or liabili-
ties 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 sec-
tion 987 gain and loss for all assets and

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liabilities and for all years prior to a re-
mittance. Accordingly, the Treasury De-
partment and the IRS decline to adopt this
comment.

A comment questioned whether sec-
tion 987(3), which refers to sourcing sec-
tion 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 com-
ment acknowledged the Treasury Depart-
ment'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
§ 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 refer-
ence to post-1986 accumulated earnings.

The Treasury Department and the IRS
have determined that sourcing and char-
acterizing section 987 gain or loss with
direct reference to post-1986 accumulated
earnings would give rise to substantial
complexity and compliance burdens, in-
cluding 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 con-
tinue to believe that, as noted in the pre-
amble to the 2006 proposed regulations,
the average tax book value of assets is a
reasonable proxy for post-1986 accumu-
lated earnings in the context of section
987. For these reasons, the Treasury De-
partment 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 § 1.861-9T(g) to char-
acterize and source 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 Trea-
sury Department and the IRS have deter-
mined 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 appropri-
ate 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 attribut-
able to section 988 transactions not di-
rectly related to the business needs of the
controlled foreign corporation (CFC).
This policy, which has been adopted in
§ 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 sub-
part 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 § 1.861-9T(g) to char-
acterize 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 determina-
tion 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 Trea-
sury Department and the IRS proposed the
aggregate approach because it appropri-
ately determines section 987 gain or loss
with respect to partnership assets and lia-
bilities by reference to the functional cur-
rencies of the partners that ultimately bear
the economic exposure to fluctuations in
the exchange rate between their own func-
tional currency and the functional cur-
rency of the activities of the partnership.
Accordingly, under §§ 1.989(a)-1(b)(2)(i)
of the 2006 proposed regulations, a part-
nership itself was not treated as a section
987 QBU, but certain activities of a part-
nership that constituted a trade or business
could qualify as a QBU that is an eligible
QBU of a partner. Thus, a partner gener-
ally 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 regula-
tions instead treat a partnership as a sep-
arate entity with its own functional cur-
rency. The comments generally were
premised on the concern that the aggre-
gate 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 aggre-
gate approach. One comment acknowl-
edged the economic rationale for the ag-
gregate 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 Depart-
ment and the IRS have determined that it
is feasible to administer the aggregate ap-

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proach with respect to a partnership that is
wholly owned by related persons. More-
over, 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 with-
out meaningfully altering the group's eco-
nomic position. Accordingly, the final
section 987 regulations retain the aggre-
gate approach of the 2006 proposed reg-
ulations only for so-called "section 987
aggregate partnerships," which are de-
fined in § 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
§ 1.989(a)-1(b)(2)(i)(C), which now pro-
vides that a partnership, other than a sec-
tion 987 aggregate partnership, is a QBU.

The 2006 proposed regulations pro-
vided a rule for determining a partner's
share of the assets and liabilities of an
eligible QBU owned indirectly through a
partnership. Specifically, § 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 de-
termined in a manner consistent with how
the partners have agreed to share the eco-
nomic 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 liabili-
ties 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 re-
gard. Accordingly, as discussed in the pre-
amble to the temporary regulations, the
temporary regulations provide more spe-
cific 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 Trea-
sury 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 tax-
able 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 tax-
able 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 aggre-
gate approach is appropriate for applying
section 987 to section 987 aggregate part-
nerships, the Treasury Department and the
IRS anticipate that regulations for apply-
ing section 987 to other partnerships (non-
aggregate partnerships) will be developed
under a separate project and may adopt a
different approach. Accordingly, the Trea-
sury Department and the IRS request
comments describing how an entity ap-
proach might apply to non-aggregate part-
nerships, including comments on (1)
whether and how section 987 should ap-
ply 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 ap-
plies with respect to partnerships in which
significant U.S. partners and CFCs to-
gether own more than 50 percent of the
capital and profits interests in the partner-
ship, 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 ac-
tivities 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 reorga-
nizations described in section 381(a). The
preamble to the 2006 proposed regula-
tions 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 com-
ments supported a rule under which a sec-
tion 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 transac-
tion.

The Treasury Department and the IRS
remain of the view that a transfer of sub-
stantially all of a section 987 QBU's assets
and liabilities under section 351 should re-
sult in a termination under § 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 Trea-
sury Department and the IRS agree that it
is appropriate in certain circumstances to
defer section 987 gain or loss that other-
wise would be recognized as a result of
certain transactions, including termina-
tions, that result in deemed transfers from
a section 987 QBU where some or all of
the assets of the section 987 QBU con-
tinue to be reflected on the books and
records of a section 987 QBU in the same
controlled group. Additionally, the Trea-
sury Department and the IRS have deter-
mined 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 regula-
tions, the temporary regulations provide
rules under which certain section 987 gain
or loss that otherwise would be recog-
nized upon a combination, separation, ter-
mination, or other event with respect to a
section 987 QBU is deferred and recog-
nized upon a subsequent event to the ex-
tent assets of the section 987 QBU con-
tinue to be reflected on the books and
records of a section 987 QBU in the same
controlled group. Under these rules, a sec-
tion 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 con-
tinue to be reflected on the books and
records of a section 987 QBU.

Comments recommended eliminating
the rule in the 2006 proposed regulations

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under which a section 987 QBU termi-
nates 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 recom-
mended that the final regulations elimi-
nate the rule under which a section 987
QBU terminates when it is acquired by a
non-CFC from a CFC owner in a reorga-
nization 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 per-
sons within the meaning of section 267(b).
Accordingly, consistent with section
989(c)(5), a section 987 QBU will termi-
nate under § 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 § 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
§ 301.7701-3, the section 987 QBU ter-
minates 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, § 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 sec-
tion 987 QBU immediately after the ex-
change (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 de-
termining the amount of the remittance from
the section 987 QBU under § 1.987-5.

Under the 2006 proposed regulations, a
section 987 QBU terminates when its ac-
tivities cease, such that it no longer meets
the definition of an eligible QBU under
§ 1.987-1(b)(3). For administrative con-
venience, § 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 transi-
tioning 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 new sec-
tion 987 QBU were determined with ref-
erence 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 lia-
bilities deemed transferred to the new sec-
tion 987 QBU were determined with ref-
erence to the historic spot rates for such
assets and liabilities without adjustment.
Accordingly, section 987 gain or loss de-
termined under the owner's prior method
was not taken into account. Except to the
extent of any previously recognized sec-
tion 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 recommend-
ing changes to the transition rules under
§ 1.987-10 of the 2006 proposed regula-
tions. One comment recommended that
the deferral transition method be elimi-
nated. The comment stated that the avail-
ability 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 lia-
bilities 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 unnec-
essary and detrimental to the fisc. By re-
quiring the translation of assets and liabil-
ities 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 sub-
stantial overall section 987 losses deter-

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mined under their prior method, which
may not correspond to economic losses, to
preserve those losses while taxpayers with
substantial overall section 987 gains de-
termined under their prior method could
avoid taking some of those gains into ac-
count by using the fresh start method.
Such an election effectively would oper-
ate as a one-time election for certain tax-
payers to reduce Federal income tax
liability. Additionally, the Treasury De-
partment and the IRS have determined
that there would be considerable adminis-
trative 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 regula-
tions 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 fi-
nal regulations provide further guidance
on the application of the fresh start
method where a taxpayer cannot trace his-
toric spot exchange rates. In response to
this comment, § 1.987-10(b)(3) provides
that, if a taxpayer cannot reliably deter-
mine the historic rate for a particular asset
or liability, the historic rate must be de-
termined based on reasonable assump-
tions consistently applied. In addition, the
general rules of § 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 taxpay-
ers 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 con-
temporaneous recordkeeping, the Trea-
sury Department and the IRS have deter-
mined that retroactive application of the
final regulations would present significant

administrative and compliance difficul-
ties, 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 veri-
fiable in hindsight. Accordingly, this rec-
ommendation has not been adopted.

A comment asserted that taxpayers that
recognized section 987 gain or loss under
the principles of the 1991 proposed regu-
lations may be treated unfairly relative to
taxpayers that did not follow those pro-
posed regulations. To address this per-
ceived unfairness, the comment recom-
mended that taxpayers be permitted to
elect to include a section 481(a) adjust-
ment to account for the difference be-
tween 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 Trea-
sury 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 permit-
ted to apply section 987 using any reason-
able method. Regardless of any perceived
inequity, however, as discussed earlier in
this Part II.O of the preamble, the Trea-
sury Department and the IRS have deter-
mined that the fresh start transition
method is the appropriate method for tran-
sitioning section 987 QBUs to the final
regulations. Under the fresh start transi-
tion method, unrecognized section 987
gain or loss determined under a prior sec-
tion 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 § 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 liabil-
ities reflected on a section 987 QBU's
transition date balance sheet. Addition-
ally, it is unclear how a section 481(a)
adjustment could apply with respect to
section 987 gain or loss arising from as-
sets and liabilities that are no longer on
the balance sheet on the transition date,

absent a requirement to redetermine sec-
tion 987 gain or loss as if the final regu-
lations 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 inad-
ministrable. 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 deferral method, effectively would op-
erate as a one-time election to reduce Fed-
eral income tax liability. Accordingly, for
the foregoing reasons, this recommenda-
tion has not been adopted.

The Treasury Department and the IRS
recognize that certain taxpayers have ad-
opted a section 987 method based on a
reasonable application of the 2006 pro-
posed regulations (2006 method). Tax-
payers that adopted the 2006 method gen-
erally already transitioned to that method
in accordance with the principles § 1.987-10
of the 2006 proposed regulations. Because
the final regulations adopt the 2006 pro-
posed 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, § 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 gen-
eral rule that the historic rate is the yearly
average exchange rate, § 1.987-10(c)(3)
permits taxpayers to use historic rates de-
termined 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 asso-
ciated with complying with these regula-
tions. 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

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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 signifi-
cantly changed circumstances or other cir-
cumstances that demonstrate a substantial
non-tax business reason for revoking the
election.

A comment recommended that the fi-
nal 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 Trea-
sury Department and the IRS have deter-
mined that requiring Commissioner con-
sent 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. Accord-
ingly, this recommendation has not been
adopted.

With one exception, the elections un-
der the final regulations are made on a
QBU-by-QBU basis. As provided under
the 2006 proposed regulations and de-
scribed in Part II.H of this preamble, an
owner must make the grouping election
described in § 1.987-1(b)(2)(ii) with re-
spect to all of its section 987 QBUs that
have the same functional currency.

The 2006 proposed regulations de-
scribed elections made under section 987
as methods of accounting but provided
procedures for making and revoking such
elections that were inconsistent with treat-
ing the elections as methods of account-
ing. 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 § 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 § 1.987-1(f) of the 2006 pro-
posed 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 time-
liness 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 addi-
tional time was needed to make a deter-
mination. If the Director did not respond
to the taxpayer within 120 days of filing,
the owner was deemed to have demon-
strated that such failure to timely file was
due to reasonable cause.

The Treasury Department and the IRS
have determined, in part based on the ex-
perience of the IRS in administering other
regulations, that the procedures described
in the 2006 proposed regulations may in-
appropriately 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
§ 301.9100-1 for requesting an extension
of time to make an election.

### Q. Other changes

The final regulations reflect other mod-
ifications 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 supple-
mented and reaffirmed by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. It is hereby certified
that these regulations will not have a sig-
nificant economic impact on a substantial
number of small entities within the mean-
ing of section 601(6) of the Regulatory

Flexibility Act (5 U.S.C. chapter 6). Ac-
cordingly, a regulatory flexibility analysis
is not required. This certification is based
on the fact that these regulations will pri-
marily 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 com-
ment on its impact on small business.

## Drafting Information

The principal authors of these final reg-
ulations are Mark E. Erwin, Steven D.
Jensen and Sheila Ramaswamy of the Of-
fice of Associate Chief Counsel (Interna-
tional). However, other personnel from
the IRS and the Treasury Department par-
ticipated in their development.
* * * * *

## Amendment to the Regulations

Accordingly, 26 CFR part 1 is amended
as follows:

PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 987, 989(c), and
7805 * * *

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

§ 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 § 1.987-
1(b)(2)), the tax book value shall be de-
termined by applying the rules of para-
graphs (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

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amount of assets computed under § 1.987-
4(d)(1)(i)(B) and (e) on the last day of the
preceding taxable year. The end-of-year
functional currency amount of assets shall
be determined by reference to the func-
tional currency amount of assets com-
puted under § 1.987-4(d)(1)(i)(A) and (e)
on the last day of the current taxable year.
The beginning-of-year and end-of-year
functional currency amount of assets, as
so determined within each grouping, must
then be averaged as provided in paragraph
(g)(2)(i) of this section.

* * * * *

(vi) Effective/applicability date. Gener-
ally, paragraph (g)(2)(ii)(A)(1) of this sec-
tion 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 § 1.987-11(b) a
taxpayer applies §§ 1.987-1 through
1.987-11 beginning in a taxable year prior
to the earliest taxable year described in
§ 1.987-11(a), then paragraph (g)(2)(ii)
(A)(1) of this section shall apply to tax-
able years beginning on or after the first
day of such prior taxable year.

* * * * *

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

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

(a) In general. This section applies in
the case of a taxpayer or qualified busi-
ness unit (QBU) (including a section 987
QBU (as defined in § 1.987-1(b)(2))
changing from one functional currency
(old functional currency) to another func-
tional 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 sec-
tion, the adjustments shall be made on the
last day of the last taxable year ending
before the year of change (as defined in
§ 1.481-1(a)(1)). Gain or loss required to
be recognized under paragraphs (b),
(d)(2), (e)(2), and (e)(4)(iii) of this section
is not subject to section 481 and, there-
fore, 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 ex-
change 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 ex-
change gain or loss attributable to a sec-
tion 988 transaction (as defined in section
988(c)(1)(A) through (C)) that, after ap-
plying 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 func-
tional currency basis of property and the
new functional currency amount of liabil-
ities 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 rele-
vant 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 cur-
rency 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 §§ 1.987-1
through 1.987-11 pursuant to § 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 sec-
tion shall be taken into account.

(A) Determining new historic rates.
The historic rate (as defined in § 1.987-
1(c)(3)) for the year of change and subse-
quent taxable years with respect to a his-
toric item (as defined in § 1.987-1(e))
reflected on the balance sheet of the sec-
tion 987 QBU immediately prior to the
year of change shall be equal to the his-
toric 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 § 1.987-
1(c)(1)) for translating an amount denom-
inated in the section 987 QBU's old func-
tional 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) func-
tional currency owns a section 987 QBU
that changes from a British pound (GBP)
functional currency to a euro (EUR) func-
tional currency, the historic rate for trans-
lating a specific historic item of this sec-
tion 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 his-
toric 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 § 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 § 1.987-4(d)(1)(i)(B) and
§ 1.987-4(e), the section 987 QBU's
marked items (as defined in § 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 func-
tional currency as a taxpayer changes its
functional currency to a new functional
currency that is different than the func-
tional currency of the taxpayer, and as a
result the taxpayer becomes an owner of a
section 987 QBU (see § 1.987-1), the

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taxpayer and section 987 QBU will be-
come subject to section 987 for the year of
change and subsequent years.

(2) QBU changing to the owner's func-
tional currency. If a section 987 QBU
changes its functional currency to the
functional currency of its owner, the sec-
tion 987 QBU shall be treated as if it
terminated on the last day of the last tax-
able year ending before the year of
change. See §§ 1.987-5 and 1.987-8 for
the effect of a termination of a section 987
QBU that is subject to §§ 1.987-1 through
1.987-11.

(e) Step 3B-Additional adjustments
that are necessary when a taxpayer/owner
changes functional currency-(1) Corpo-
rations. The amount of a corporation's
new functional currency earnings and
profits and the amount of its new func-
tional 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 main-
tained 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 corpora-
tion changing to the United States dollar
as its functional currency. A United States
shareholder (within the meaning of sec-
tion 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 cur-
rency to the dollar shall recognize foreign
currency gain or loss computed under sec-
tion 986(c) as if all previously taxed earn-
ings 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 corpora-
tions. [Reserved].

(4) Adjustments to a section 987
QBU's balance sheet and net accumu-
lated unrecognized section 987 gain or
loss when an owner changes functional
currency-(i) Owner changing to a func-
tional currency other than the section 987
QBU's functional currency. If an owner of
a section 987 QBU, subject to §§ 1.987-1
through 1.987-11 pursuant to § 1.987-
1(b)(1), changes to a functional currency
other than the functional currency of the
section 987 QBU, the adjustments de-
scribed 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 § 1.987-
1(c)(3)) for the year of change and subse-
quent taxable years with respect to a his-
toric item (as defined in § 1.987-1(e))
reflected on the balance sheet of the sec-
tion 987 QBU immediately prior to the
year of change shall be equal to the his-
toric rate prior to the year of change (that
is, a rate that translates the section 987
QBU's functional currency into the own-
er's old functional currency) divided by
the spot rate for translating an amount
denominated in the owner's new func-
tional currency into the owner's old func-
tional 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 sec-
tion 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 his-
toric 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
§ 1.987-4(d)(1)(i)(B). For purposes of de-
termining the change in the owner func-

tional currency net value of the section
987 QBU on the last day of the last tax-
able year preceding the year of change
under §§ 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 un-
recognized section 987 gain or loss. Any
net accumulated unrecognized section 987
gain or loss determined under § 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 differ-
ent 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 § 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 func-
tional 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 §§ 1.987-5 and
1.987-8 for the consequences of a termi-
nation of a section 987 QBU that is sub-
ject to §§ 1.987-1 through 1.987-11.

(f) Example. The provisions of this sec-
tion are illustrated by the following exam-
ple:

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 €1:£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 Decem-
ber 31, 2019.

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GBP

EUR

Assets:

Cash on hand

£40,000

€80,000

Accounts Receivable

£10,000

€20,000

Inventory

£100,000

€200,000

€100,000 Euro Bond (£100,000 historical basis)

£50,000

€100,000

Fixed assets:

Property

£200,000

€400,000

Plant

£500,000

€1,000,000

Accumulated Depreciation

(£200,000)

(€400,000)

Equipment

£1,000,000

€2,000,000

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 Equity

£1,300,000

€2,600,000

(iii) Exchange gain or loss on section 988 trans-
actions. Under paragraph (b) of this section, FC will
recognize a £50,000 loss (£50,000 current value mi-
nus £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
£50,000 loss on the Euro Bond.

(g) Effective/applicability date. Gener-
ally, this regulation shall apply to taxable
years beginning on or after one year after
the first day of the first taxable year fol-
lowing December 7, 2016. If pursuant to
§ 1.987-11(b) a taxpayer applies §§ 1.987-
1 through 1.987-11 beginning in a taxable
year prior to the earliest taxable year de-
scribed in § 1.987-11(a), then this section
shall apply to taxable years of the tax-
payer beginning on or after the first day of
such prior taxable year.

Par. 4. Section 1.987-0 is added and
§§ 1.987-1 through 1.987-5 are revised to
read as follows:

** * * *

### Sec.

1.987-0 Section 987; Table of contents.
1.987-1 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 tax-
able income or loss of an owner of a
section 987 QBU.

1.987-4 Determination of net unrecog-
nized section 987 gain or loss of a section
987 QBU.

1.987-5 Recognition of section 987 gain
or loss.

** * * *

### § 1.987-0 Section 987; table of contents.

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

§ 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.

§ 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, in-
terests in partnerships, and certain acqui-
sition indebtedness.

(3) Adjustments to items reflected on the
books and records.

(4) Assets and liabilities of a section 987

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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 inter-
ests in DEs and section 987 aggregate
partnerships.

(6) Changes in form of ownership.

(7) Application of general tax law princi-
ples.

(8) Interaction with § 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.

§ 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.

§ 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 sec-
tion 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 deter-
mined in step 1 by the amount of assets
transferred from the section 987 QBU to
the owner.

(3) Step 3: Decrease the amount deter-
mined 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 deter-
mined 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 deter-
mined 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 section 987 taxable income or loss,
respectively, of the section 987 QBU for
the taxable year.

(7) Step 7: Increase the amount deter-
mined in steps 1 through 6 by any ex-
penses that are not deductible in comput-
ing the section 987 taxable income or loss
of the section 987 QBU for the taxable
year.

(8) Step 8: Decrease the amount deter-
mined 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.

§ 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 ba-
sis in transferred assets.

(1) In general.

(2) Marked asset.

(3) Historic asset.

(g) Example.

§ 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.

§ 1.987-7 Section 987 aggregate
partnerships.

(a) In general.

(b) [Reserved].

(c) Coordination with subchapter K.

§ 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.

§ 1.987-9 Recordkeeping requirements.

(a) In general.

(b) Supplemental information.

(c) Retention of records.

(d) Information on a dedicated section 987
form.

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§ 1.987-10 Transition rules.

(a) Scope.

(b) Fresh start transition method.

(1) In general.

(2) Application of § 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 § 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 infor-
mation is reported on a form.

§ 1.987-11 Effective/applicability date.

(a) In general.

(b) Application of these regulations to tax-
able years beginning after December 7,
2016.

(c) Transition date.

### § 1.987-1 Scope, definitions, and special rules.

(a) In general. These regulations under
section 987 (§§ 1.987-1 through 1.987-
11) provide rules for determining the tax-
able income or loss of a taxpayer with
respect to a section 987 QBU (as defined
in paragraph (b)(2) of this section). Fur-
ther, these regulations provide rules for
determining the timing, amount, charac-
ter, 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 def-
initions, 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. Sec-
tion 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 part-
nerships. Section 1.987-8 provides rules
regarding the termination of a section 987
QBU. Section 1.987-9 provides rules re-
garding the recordkeeping required under
section 987. Section 1.987-10 provides
transition rules. Section 1.987-11 pro-
vides the effective/applicability date of
these regulations.

(b) Scope of section 987 and defini-
tions-(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 para-
graph (b)(1)(iii) of this section, these reg-
ulations under section 987 do not apply to
specified entities described in this para-
graph (b)(1)(ii), other than specified enti-
ties 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 com-
panies, finance coordination centers, reg-
ulated investment companies, or real es-
tate 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 para-
graph (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 partner-
ship (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
§ 1.987-8(b). Except as provided in para-
graph (b)(2)(ii) of this section, the func-
tional currency of an eligible QBU shall
be determined under § 1.985-1.

(ii) Section 987 QBU grouping elec-
tion-(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.

(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 sin-
gle section 987 QBU. An owner may not
treat section 987 QBUs as a single section
987 QBU if such QBUs are owned indi-
rectly through different section 987 aggre-
gate partnerships. Additionally, an owner
may not treat section 987 QBUs that are
owned both directly and indirectly
through a section 987 aggregate partner-
ship as a single section 987 QBU.

(3) Definition of an eligible QBU-(i)
In general. Eligible QBU means a quali-
fied business unit, as defined in
§ 1.989(a)-1, that is not subject to the
Dollar Approximate Separate Transac-
tions Method rules of § 1.985-3.

(ii) Exclusion of certain entities. A cor-
poration, partnership, trust, estate, or en-
tity disregarded as an entity separate from
its owner for Federal income tax purposes
as described in § 301.7701-2(c)(2) (here-
after referred to as a "DE") is not an
eligible QBU (even though such an entity
may have activities that qualify as an eli-
gible QBU).

(4) Definition of owner. For purposes
of these regulations under section 987, an
owner is any person having direct or in-
direct ownership in an eligible QBU. Only

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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 eli-
gible QBU if the individual or corporation
is the owner for Federal income tax pur-
poses 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 § 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 partner-
ship-(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 partner-
ship 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 eli-
gible 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 un-
der the principles of § 1.987-7(b) are con-
sidered to be a section 987 QBU of such
partner if the partner has a functional cur-
rency different from that of the eligible
QBU.

(iii) Certain unrelated partners disre-
garded. In determining whether a partner-
ship is a section 987 aggregate partner-
ship, 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 exam-
ples 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 other-
wise provided, (i) Business A and Busi-
ness 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 lia-
bilities, 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 dif-
ferent 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 § 1.989(a)-1(c). Be-
cause the activities of DE1 do not constitute a trade
or business within the meaning of § 1.989(a)-1(c),
such activities are not an eligible QBU. In addition,
pursuant to paragraph (b)(3)(ii) of this section, DE1
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 DEI's
pound-denominated liability, see § 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 main-
tain 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, main-
tains 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 sec-
tion, DE1 is not the owner of the Business A, Busi-
ness 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 Busi-
ness B. For purposes of this example, assume Busi-
ness 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. More-
over, 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 of the Business AB
section 987 QBU that would include the activities of
both the Business A section 987 QBU and the Busi-
ness 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 cur-
rency. 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 partner-
ship capital and profits, Y and CFC are related within
the meaning of section 267(b), and the requirements
of § 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 § 1.987-7.

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(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 § 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
§ 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 § 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 Busi-
ness 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 eligi-
ble 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. Be-
cause each of the Business A, Business B, and Busi-
ness C eligible QBUs has a different functional cur-
rency 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 § 1.988-1(d)(1), (2), and
(4) on the relevant date.

(ii) Election to use a spot rate conven-
tion-(A) In general-spot rate conven-
tion. 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 deter-
mined 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 rea-
sonable 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 transac-
tions during a monthly period can be de-

termined 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 preced-
ing 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 deter-
mined 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 con-
vention used for financial accounting pur-
poses is presumed to reasonably approxi-
mate the rate in paragraph (c)(1)(i) of this
section. The Commissioner can rebut this
presumption if the Commissioner deter-
mines 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 tax-
payer 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 cer-
tain purposes. In particular, a taxpayer
that makes this election must use the spot
rate for purposes of determining the his-
toric rate, as provided in paragraph
(c)(3)(ii) of this section, and for purposes
of translating items of income, gain, de-
duction, or loss of a section 987 QBU into
the owner's functional currency, as de-
scribed in § 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 § 1.987-
3(c)(2)(iv)(B).

(2) Yearly average exchange rate. For
purposes of section 987, the yearly aver-
age 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 reason-
able 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 con-

vention that is consistent with the conven-
tion used for financial accounting pur-
poses is presumed to be a reasonable
method. The Commissioner can rebut this
presumption if the Commissioner deter-
mines that the use of the convention
would not have been expected to clearly
reflect income based on the facts and cir-
cumstances available at the time of the
election.

(3) Historic rate-(i) In general. Ex-
cept as otherwise provided in these regu-
lations, 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 in-
ventory method. In the case of inventory
with respect to which a taxpayer uses the
simplified inventory method described in
§ 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 appli-
cable 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 tax-
able year for which the determination of
the historic rate for such inventory is rel-
evant.

(C) Inventory under the historic inven-
tory method. In the case of inventory with
respect to which a taxpayer has elected
under § 1.987- 3(c)(2)(iv)(B) to use the
historic inventory method, each inventori-
able cost with respect to such inventory
may have a different historic rate. The
historic rate for each inventoriable cost is
the exchange rate at which such item
would be translated under § 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 as-
sumed.

(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

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has elected under paragraph (c)(1)(iii) of
this section to use spot rates in lieu of
yearly average exchange rates must deter-
mine historic rates under paragraphs
(c)(3)(i)(A) and (c)(3)(i)(D) of this section
using the spot rate (as defined in para-
graph (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 depre-
ciable 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 consis-
tently applied for all such property attrib-
utable 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 previ-
ously changed its functional currency,
§ 1.985-5(d)(1)(ii)(A) and § 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 § 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 in-
come, 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 § 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 sec-
tion 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 in-
come 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 fol-
lowing consistency and timeliness re-
quirements 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 bind-
ing on all section 987 QBUs that are eli-
gible 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 ac-
quired after the election is made and re-
gardless 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. Notwith-
standing paragraph (g)(1)(ii) of this sec-
tion, if a section 987 QBU is owned by a
foreign corporation, elections shall be
made in accordance with § 1.964-1(c) by
the foreign corporation's controlling domes-
tic shareholders, as defined under § 1.964-
1(c)(5)(i) (dealing with controlled foreign
corporations) and § 1.964-1(c)(5)(ii) (deal-
ing with noncontrolled section 902 corpora-
tions).

(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 § 1.987-
1(b)(2)(ii)" and provide the following in-
formation:

(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 conven-
tion. 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 § 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 sec-
tion 987 QBU for which the election is
being made.

(C) Election to use spot rates in lieu of
yearly average exchange rates. An elec-
tion under paragraph (c)(1)(iii) of this sec-
tion 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 § 1.987-1(c)(1)(iii)" and pro-
vide 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 inven-
tory method. An election under § 1.987-
3(c)(2)(iv)(B) to use the historic inventory
method shall be titled "Section 987 Elec-
tion to Use the Historic Inventory Method
Under § 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

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987, the form shall govern the manner in
which elections are made under section
987.

(4) No change in method of account-
ing. 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 revoked
without the consent of the Commissioner
or his delegate. The Commissioner or his
delegate will consider allowing a revoca-
tion of an election if the taxpayer can
demonstrate significantly changed cir-
cumstances or such other circumstances
that clearly demonstrate a substantial non-
tax business reason for revoking the elec-
tion.

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

(a) Scope and general principles. Para-
graph (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 pur-
poses of section 987. Items of income,
gain, deduction, and loss are attributed to
a section 987 QBU for purposes of com-
puting 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 pro-
vided in paragraphs (b)(2) and (3) of this
section, items are attributable to an eligi-
ble QBU to the extent they are reflected
on the separate set of books and records,
as defined in § 1.989(a)-1(d), of the eli-
gible 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 sec-
tion, the term "item" refers to any asset or
liability, and any item of income, gain,
deduction, or loss. Items that are attrib-

uted to an eligible QBU pursuant to this
section must be adjusted to conform to
Federal income tax principles. Except as
provided in § 1.989(a)-1(d)(3), these at-
tribution rules apply solely for purposes of
section 987. For example, the allocation
and apportionment of interest expense un-
der section 864(e) is independent of the
rules under section 987.

(2) Exceptions for non-portfolio stock,
interests in partnerships, and certain ac-
quisition 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 do-
mestic 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 de-
termining ownership, except that in apply-
ing 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 in-
curred 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 para-
graphs (b)(2)(i) through (iii) of this sec-
tion. For example, a section 951 inclusion
with respect to stock of a foreign corpo-
ration 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 avoid-
ance 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 (in-
cluding DEs), or other QBUs within the
meaning of § 1.989(a)-1(b) (including el-
igible 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 in-
come 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 fac-
tors 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 avoid-
ance. 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 eli-
gible 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 record-
ing) 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 transac-
tion;

(C) In accordance with generally ac-
cepted 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 con-
ditions 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 ac-
counting policies that is evidenced by
documentation contemporaneous with the
timely filing of a Federal income tax re-
turn 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 exam-
ple, 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 re-

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cords 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 tran-
sitory, 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 tax-
payer within the meaning of section
267(b) or section 707(b)) having offset-
ting positions with respect to the func-
tional 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
§ 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 currency treatment of such assets
or liabilities, see § 1.988-1(a)(4).

(c) Transfers to and from section 987
QBUs-(1) In general. The following
rules apply for purposes of determining
whether there is a transfer of an asset or a
liability from an owner to a section 987
QBU, or from a section 987 QBU to an
owner. These rules apply solely for pur-
poses of section 987.

(2) Disregarded transactions-(i) Gen-
eral 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
§ 1.987-1(b)(4)) if, as a result of a disre-
garded transaction (as defined in para-
graph (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 lia-
bility 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 trans-
action. For purposes of this section, a dis-
regarded transaction means a transaction
that is not regarded for Federal income tax
purposes (for example, any transaction be-
tween separate section 987 QBUs of the
same owner). For purposes of this para-
graph (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 § 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 in-
directly through the same entity (includ-
ing through a DE or a section 987 ag-
gregate 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 sec-
tion 351) for an asset or liability that is not
attributable to the section 987 QBU imme-
diately after the sale or exchange, the sold or
exchanged asset or liability that was attrib-
utable 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 (in-
cluding for purposes of recognizing section
987 gain or loss under § 1.987-5) and sub-
sequently 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 partner-
ship or in a DE, as described in paragraph
(c)(5) of this section.

(iii) Items derived from disregarded
transactions ignored. For purposes of sec-
tion 987, disregarded transactions shall
not give rise to items of income, gain,
deduction, or loss that are taken into ac-
count in determining section 987 taxable
income or loss under § 1.987-3.

(3) Transfers of assets to and from
section 987 QBUs owned through section
987 aggregate partnerships-(i) Contri-
butions to section 987 aggregate partner-
ships. Solely for purposes of section 987,
an asset shall be treated as transferred by
an indirect owner (as defined in § 1.987-
1(b)(4)(ii)) to a section 987 QBU of a
partner (as defined in § 1.987-1(b)(5)(ii))
to the extent the indirect owner contrib-
utes the asset to the section 987 aggregate
partnership that carries on the activities of
the section 987 QBU, provided that, im-
mediately 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 immedi-
ately 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 part-
ner of liabilities of a section 987 aggregate
partnership.

(ii) Distributions from section 987 ag-
gregate 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 re-
flected on the books and records of the
section 987 QBU immediately after such
distribution. For purposes of this para-
graph (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 as-
sumption by a section 987 aggregate part-
nership of liabilities of a partner.

(4) Transfers of liabilities to and from
section 987 QBUs owned through section
987 aggregate partnerships-(i) Assump-
tions of partner liabilities. Solely for pur-
poses of section 987, a liability of the
owner of a section 987 aggregate partner-
ship shall be treated as transferred to a
section 987 QBU of a partner if, and to the

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extent, the section 987 aggregate partner-
ship assumes such liability, provided that,
immediately prior to the transfer, the lia-
bility 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 im-
mediately following the transfer.

(ii) Assumptions of section 987 aggre-
gate 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 as-
sumes such liability of the section 987
aggregate partnership, provided that, im-
mediately prior to such assumption, the
liability is reflected on the books and re-
cords 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 in-
terests in DEs and section 987 aggregate
partnerships. Solely for purposes of sec-
tion 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 re-
cords 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 ex-
ample, 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 434), Rev. Rul.
99-6 (1999-1 CB 432), § 601.601(d)(2) of
this chapter, and section 708 and the appli-
cable 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 § 1.988-1(a)(10).
See § 1.988-1(a)(10) for rules regarding
the treatment of an intra-taxpayer transfer
of a section 988 transaction.

(9) [Reserved].

(10) Examples. The following exam-
ples illustrate the principles of this para-
graph (c). For purposes of the examples,
X and Y are domestic corporations, have
the U.S. dollar as their functional cur-
rency, and use the calendar year as their
taxable years. Furthermore, except as oth-
erwise 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 determin-
ing whether any of the transfers in these
examples result in remittances, see
§ 1.987-5.

Example 1. Transfer to a directly owned section
987 QBU. (i) Facts. X owns all of the interests in
DE1. DE1 owns Business A, which is a section 987
QBU of X. X owns €100 that are not reflected on the
books and records of Business A. Business A is in
need of additional capital and, as a result, X lends the
€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 dis-
regarded 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
€100 is reflected on the books and records of Busi-
ness A. Therefore, X is treated as transferring €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 § 1.987-5(c). See § 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 Busi-
ness 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 ca-
pacity 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 trans-
action 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 § 1.987-5(c).

Example 3. Intracompany sale of property be-
tween 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 equip-
ment 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 equip-
ment 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 inter-
branch 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 § 1.987-3. However, the yen and
equipment exchanged by DE1 and DE2 in connec-
tion 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 transfer-
ring the equipment to X, and X is subsequently

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treated as transferring such equipment to the Busi-
ness 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 subse-
quently 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 § 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 €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 con-
sidered 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 €30 and a €50 royalty,
respectively, to DE1.

(ii) Analysis. (A) Under § 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 § 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 § 1.987-7. Under § 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 sec-
tion 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 pay-
ments under the license are disregarded transactions.
Thus, pursuant to paragraph (c)(2)(iii) of this sec-
tion, DEI's receipt of the royalty pursuant to the
license agreement does not give rise to an item of

income, gain, deduction, or loss for purposes of
determining section 987 taxable income or loss un-
der § 1.987-3. However, the €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, €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 €50
royalty payment (€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 €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 § 1.987-5(c).

(C) The €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 disre-
garded 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
§ 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 § 1.987-3.

Example 6. Acquisition of an interest in a part-
nership. (i) Facts. (A) X owns all of the stock of Z,
a domestic corporation with the dollar as its func-
tional 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 § 1.987-1(b)(5)(i), Pis 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 § 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 § 1.987-7. Under § 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 § 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
§ 1.987-7. Under § 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 § 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 allo-
cable 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 liabil-
ities are consequently recorded on the books and
records of Z's Business A section 987 QBU. Ac-
cordingly, X and Y are treated as transferring those
assets and liabilities to Z, and Z is treated as con-
tributing those assets and liabilities to its new Busi-
ness A section 987 QBU.

Example 7. Acquisition of an interest in a part-
nership. (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 § 1.987-
1(b)(5)(i)(B) are satisfied. Z acquires a 20 percent
allocable share of the assets and liabilities of Busi-
ness A, as determined under § 1.987-7. Under
§ 1.987-1(b)(5)(ii), the assets and liabilities of Busi-
ness 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 cur-
rencies).

(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 allo-
cable portions of assets and liabilities from the Busi-
ness 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

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owns Business A. Y acquires 50 percent of the DE1
interests from X for cash.

(ii) Analysis. (A) DE1 is converted to a partner-
ship 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 Busi-
ness 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
§ 601.601(d)(2) of this chapter.

(B) For purposes of this paragraph (c), these
deemed transactions are disregarded transactions.
Under § 1.987-1(b)(5)(i), the newly formed partner-
ship 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 § 1.987-
1(b)(5)(i)(B) are satisfied. Because Y is a partner in
a section 987 aggregate partnership that owns Busi-
ness 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 § 1.987-7. Accordingly, 50 per-
cent of the assets and liabilities of Business A cease
being reflected on the books and records of X's
section 987 QBU. Under § 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. Accord-
ingly, the assets and liabilities of Business A allo-
cated 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 trans-
ferred 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 partner-
ship when Y contributes property to DE1 in ex-
change 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
§ 601.601(d)(2) of this chapter.

(B) For purposes of this paragraph (c), these
deemed transactions are disregarded transactions.
Under § 1.987-1(b)(5)(i), the newly formed partner-
ship 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 § 1.987-
1(b)(5)(i)(B) are satisfied. Because Y is a partner in
a section 987 aggregate partnership that owns Busi-
ness 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 § 1.987-7. Accordingly, under
§ 1.987-2(c)(5), Y is treated as contributing its al-
locable share of its contributed property to its Busi-
ness 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 § 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 corpo-
ration. (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 consoli-
dated 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 €100 to X. On January 2,
2022, X purports to transfer €50 to Business A. On
January 4, 2022, X purports to transfer another €50
to Business A. As of the end of 2021, X has an
unrecognized section 987 loss with respect to Busi-
ness 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 Inter-
nal Revenue Service (IRS) may disregard the pur-
ported 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
€100 to X. On January 4, 2021, X purports to trans-
fer €100 to Business B. The account in which Busi-
ness B deposited the €100 is used to pay the oper-
ating 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 remit-

tance, 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 €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 § 1.987-1(b)(2)(ii). On January 1,
2021, X borrows €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 €1,000 on the books and records of Busi-
ness 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 €1,000, X termi-
nates 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
€1,000 from a third party lender and records the
liability with respect to the borrowing on its books
and records. X contributes the €1,000 loan proceeds
to DE1 and the €1,000 are reflected on the books and
records of Business A. On December 31, 2022, when
Business A has $100 of net unrecognized section
987 loss resulting from the change in exchange rates
with respect to the €1,000 received from the borrow-
ing, 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 scruti-
nize the transaction under paragraph (b)(3) of this
section to determine whether a principal purpose of
recording the borrowed euros on the books and re-
cords of Business A, or not recording the corre-
sponding 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

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a consolidated return. On January 1, 2021, DE1
lends €1,000 to Y. X records the receivable with
respect to the loan on Business A's books and re-
cords. On December 31, 2022, when Business A has
$100 of net unrecognized section 987 gain resulting
from the loan, Y repays the €1,000 liability. The
repayment of the euro-denominated borrowing re-
sults 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 Busi-
ness 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 pur-
pose 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 €1,000
from a bank. On January 2, 2021, Business A dis-
tributes the €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 Busi-
ness 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 €1,000 from a bank. On July 1,
Business A pays €20 in interest on X's €1,000 ob-
ligation to the bank.

(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 €20 to X, and X is treated
as making a €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, trans-
ferred to a section 987 QBU shall be
translated into the section 987 QBU's
functional currency at the spot rate (as
defined in § 1.987-1(c)(1)) applicable to
the date of transfer. If the asset or liability
transferred is denominated in (or deter-

mined by reference to) the functional cur-
rency of the section 987 QBU (for exam-
ple, cash or a note denominated in the
functional currency of the section 987
QBU), no translation is required. See
§ 1.988-1(a)(10)(ii) for special rules re-
garding 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 sec-
tion 987 QBU's functional currency at the
rate provided in § 1.987-1(c)(3).

§ 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). Para-
graph (b) of this section provides rules for
determining items of income, gain, deduc-
tion, 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 applica-
tion of the rules of this section.

(b) Determination of each item of in-
come, gain, deduction, or loss in the sec-
tion 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, de-
duction, 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 denomi-
nated 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, deduc-
tion, or loss that is denominated in (or
determined by reference to) a nonfunc-
tional 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
§ 1.987-1(c)(1)) on the date such item is

properly taken into account, subject to the
limitation under § 1.987-1(c)(1)(ii)(B) re-
garding 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 sec-
tion 987 QBU owned through a section
987 aggregate partnership-(i) In gen-
eral. Except as otherwise provided in this
paragraph (b)(3), the taxable income or
loss of a section 987 aggregate partner-
ship, 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 In-
ternal Revenue Code.

(ii) Determination of each item of in-
come, gain, deduction, or loss in the eli-
gible QBU's functional currency. A sec-
tion 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 § 1.987-2(b) in the functional cur-
rency 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 deter-
mined under subchapter K of the Internal
Revenue Code.

(iv) Translation of items into the own-
er'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 func-
tional 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 curren-
cy-(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

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(as defined in § 1.987-1(c)(2)) for the
taxable year. However, an owner of a sec-
tion 987 QBU that has elected under
§ 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 § 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 ex-
change 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 § 1.987-1(e)) shall be the
historic rate as determined under § 1.987-
1(c)(3) for the property to which such re-
covery of basis is attributable.

(ii) [Reserved].

(iii) Gain or loss on the sale, ex-
change or other disposition of an inter-
est in a section 987 aggregate partner-
ship. [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 § 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 inven-
tory 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 inven-
toriable costs (including current-year in-
ventoriable costs and costs that were cap-
italized into inventory in prior years) that
are included in COGS at the historic rate
as determined under § 1.987-1(c)(3) for
each such cost. As described in § 1.987-
1(c)(1)(iii), a taxpayer that elects to use
spot rates in lieu of yearly average ex-
change 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 un-
der 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 adjust-
ment 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 method (as described in
section 472) and must make the adjustment
described in paragraph (c)(3)(iv) of this sec-
tion with respect to any inventory for which
the section 987 QBU uses the LIFO inven-
tory method. An owner of a section 987
QBU that uses the simplified inventory
method must make all of the applicable ad-
justments 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 de-
ductions included in inventoriable costs.
The translated COGS amount computed
under paragraph (c)(2)(iv)(A) of this sec-
tion must be increased or decreased (as
appropriate) to reflect the difference be-
tween the historic rates appropriate for
translating cost recovery deductions at-
tributable to other historic assets and the
exchange rate used to translate COGS un-
der paragraph (c)(2)(iv)(A) of this section,
to the extent any such cost recovery de-
ductions are included in inventoriable
costs for the taxable year. The adjustment
shall be included as an adjustment to
translated COGS computed under para-
graph (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, ex-
pressed 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 de-
scribed in paragraph (c)(2)(iv)(A) of this
section (that is, the yearly average ex-
change 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 trans-
lated COGS amount computed under
paragraph (c)(2)(iv)(A) of this section
must be increased or decreased (as appro-
priate) by the product of:

(A) The ending non-LIFO inventory
included on the closing balance sheet for
the preceding year, expressed in the func-
tional currency of the section 987 QBU;
and

(B) The exchange rate described in
§§ 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 av-
erage exchange rate for the preceding
year) less the exchange rate used to trans-
late 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 liqui-
dation. 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 trans-
lated COGS amount computed under
paragraph (c)(2)(iv)(A) of this section
must be increased or decreased (as ap-
propriate) by the product of:

(A) The amount of the LIFO layer liq-
uidated during the taxable year, expressed
in the functional currency of the section
987 QBU; and

(B) The exchange rate described in
§§ 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 tax-
able year).

(d) [Reserved].

(e) Examples. The following exam-
ples illustrate the application of this sec-
tion. 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 cur-
rency. 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

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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
§ 1.987-1(c)(1)(iii), U.S. Corp also
elects under § 1.987-1(c)(1)(ii) to use a
spot rate convention. Under this conven-
tion, 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 ex-
amples 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 § 1.987-4(g)
for an illustration of the simplified in-
ventory method described in paragraphs
(c)(2)(iv)(A) and (c)(3) of this section.

Example 1. Business A properly accrues £100 of
income from the provision of services. Under para-
graph (b)(2)(i) of this section, the £100 is translated
into €90 at the spot rate (as defined in § 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 €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 £100.
Under paragraph (b)(2)(i) of this section, the £100
amount realized is translated into €85 at the spot
rate (as defined in § 1.987-1(c)(1)) on the sale date

without the use of a spot rate convention. In de-
termining U.S. Corp's taxable income, the €85 is
translated into dollars at the rate provided in para-
graph (c)(1) of this section. The euro basis of the
property is translated into dollars at the rate pro-
vided in paragraph (c)(2)(i) of this section (that is,
the historic rate as determined under § 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 €3 per unit. Business A's gross sales are trans-
lated 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 €1 =
$1.02 for 2020 and €1 = $1.05 for 2021. Thus,
Business A's dollar gross sales will be computed
as follows:

Gross Sales (2021) Month # of units Amount in € €/$ yearly average rate Amount in $

Jan

100

€300

€1 = $1.05

$ 315.00

Feb

200

600

€1 = $1.05

630.00

March

0

0

€1 = $1.05

0

April

200

600

€1 = $1.05

630.00

May

100

300

€1 = $1.05

315.00

June

0

0

€1 = $1.05

0

July

100

300

€1 = $1.05

315.00

Aug

100

300

€1 = $1.05

315.00

Sept

0

0

€1 = $1.05

0

Oct

0

0

€1 = $1.05

0

Nov

100

300

€1 = $1.05

315.00

Dec

300

900

€1 = $1.05

945.00

1,200

$3,780.00

(ii) The purchase price for each inventory unit was €1.50. Under § 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)

Month

# of units

Amount in €

€/$ yearly average rate

Amount in $

Opening inventory (purchased in Dec. 2020)

100

€150

€1=$1.02

$153.00

Purchases in 2021

Jan

300

€450

€1=$1.05

$472.50

Feb

0

0

€1=$1.05

0

March

0

0

€1=$1.05

0

April

300

450

€1=$1.05

472.50

May

0

0

€1=$1.05

0

June

0

0

€1=$1.05

0

July

300

450

€1=$1.05

472.50

Aug

0

0

€1=$1.05

0

Sept

0

0

€1=$1.05

0

Oct

0

0

€1=$1.05

0

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Opening Inventory and Purchases (2021)

Month

# of units

Amount in €

€/$ yearly average rate

Amount in $

Nov

300

450

€1=$1.05

472.50

Dec

0

0

€1=$1.05

0

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 Janu-
ary 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 § 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 appropri-
ate. Thus, Business A's dollar gross sales will be
computed as follows:

Gross Sales (2021)

Sales

# of units

Amount in €

€/$ yearly average rate

Amount in $

Jan

100

€300

€1 = $1.00

$300

Feb

200

600

€1 = $1.05

630

March

0

0

€1 = $1.03

0

April

200

600

€1 = $1.02

612

May

100

300

€1 = $1.04

312

June

0

0

€1 = $1.05

0

July

100

300

€1 = $1.06

318

Aug

100

300

€1 = $1.05

315

Sept

0

0

€1 = $1.06

0

Oct

0

0

€1 = $1.07

0

Nov

100

300

€1 = $1.08

324

Dec

300

900

€1 = $1.08

972

1,200

$3,783

(ii) As in Example 3, the purchase price for each
inventory unit was €1.50. Under § 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)

Month

# of units

Amount in €

€/$ yearly average rate

Amount in $

Opening inventory (purchased in Dec. 2020)

100

€150

€1 = $1.00

$150

Purchases in 2021

Jan

300

€450

€1 = $1.00

$450

Feb

0

0

€1 = $1.05

0

March

0

0

€1 = $1.03

0

April

300

450

€1 = $1.02

459

May

0

0

€1 = $1.04

0

June

0

0

€1 = $1.05

0

July

300

450

€1 = $1.06

477

Aug

0

0

€1 = $1.05

0

Sept

0

0

€1 = $1.06

0

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Opening Inventory and Purchases (2021)

Month

# of units

Amount in €

€/$ yearly average rate

Amount in $

Oct 0

0

€1 = $1.07

0

Nov 300

450

€1 = $1.08

486

Dec 0

0

€1 = $1.08

0

1,200

$1,872

(iii) As set forth in (i), Business A's gross sales
are $3783.

(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 €100
of depreciation expense with respect to a truck. No
portion of the depreciation expense is an inventori-
able cost. The truck was purchased on January 15,
2020. The yearly average exchange rate for 2020
was €1 = $1.02. Under paragraph (c)(2)(i) of this
section, the €100 of depreciation is translated into
dollars at the historic rate. Under § 1.987-1(c)(3)(i),
the historic rate is the yearly average rate for 2020.
Accordingly, U.S. Corp takes into account depreci-
ation of $102 with respect to Business A in 2021.

Example 6. The facts are the same as in Example
5 except that the €100 of depreciation expense in-
curred during 2021 with respect to the truck is an
inventoriable cost. As a result, the depreciation ex-
pense 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 de-
preciation expense capitalized into inventory that is
sold during 2021 is reflected in Business A's euro
COGS and is translated at the €1 = $1.02 yearly
average exchange rate for 2020, the year in which
the truck was purchased. The portion of the depre-
ciation 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 €1 = $1.02
yearly average exchange rate for 2020.

Example 7. Business A purchased raw land on
October 16, 2020, for €8,000 and sold the land on
November 1, 2021, for €10,000. The yearly average
exchange rate was €1 = $1.02 for 2020 and €1 =
$1.05 for 2021. Under paragraph (c)(1) of this sec-
tion, the amount realized is translated into dollars at
the yearly average exchange rate for 2021 (€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 § 1.987-1(c)(3)(i) for such year (€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 para-
graph § 1.987-1(c)(1)(iii) to use spot rates in lieu of
yearly average rates. Accordingly, the amount real-
ized 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 con-
vention rate is €1 = $1.01 for October 2020 and is
€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
(€10,000 x $1.08), and the basis, translated at the
convention rate for October 2020, is $8,080 (€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).

##### § 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 cur-
rency. Only assets and liabilities reflected
on the books and records of the section
987 QBU under § 1.987-2(b) shall be
taken into account.

(b) Calculation of net unrecognized
section 987 gain or loss. Net unrecog-
nized 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 accu-
mulated unrecognized section 987 gain or
loss for all prior taxable years to which
these regulations apply as determined in
paragraph (c) of this section, and

(2) The section 987 QBU's unrecog-
nized section 987 gain or loss for the
current taxable year as determined in
paragraph (d) of this section.

(c) Net accumulated unrecognized sec-
tion 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 tax-

able years is the aggregate of the amounts
determined under § 1.987-4(d) for all
prior taxable years to which these regula-
tions apply, reduced by the amounts taken
into account under § 1.987-5 upon remit-
tances for all such prior taxable years.

(2) [Reserved].

(d) Calculation of unrecognized sec-
tion 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 func-
tional 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 termi-
nated. If a section 987 QBU is terminated
within the meaning of § 1.987-8 during
an owner's taxable year, the owner func-
tional currency net value of the section
987 QBU as provided in paragraph
(d)(1)(i)(A) of this section shall be deter-
mined on the date the section 987 QBU is
terminated.

(2) Step 2: Increase the amount deter-
mined 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 sec-
tion shall be increased by the total amount

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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 sec-
tion 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 aggre-
gate adjusted basis of all marked assets (as
defined in § 1.987-1(d)), after taking into
account § 1.988-1(a)(10), transferred to
the owner during the taxable year deter-
mined in the functional currency of the
section 987 QBU and translated into the
owner's functional currency at the spot
rate (as defined in § 1.987-1(c)(1)) appli-
cable to the date of transfer; and

(B) The aggregate adjusted basis of all
historic assets (as defined in § 1.987-
1(e)), after taking into account § 1.988-
1(a)(10), transferred to the owner during
the taxable year determined in the func-
tional 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 § 1.987-1(c)(3)).

(3) Step 3: Decrease the amount deter-
mined in steps 1 and 2 by the amount of
assets transferred from the owner to the
section 987 QBU-(i) In general. The ag-
gregate 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 deter-
mined 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 cur-
rency of the owner transferred to the sec-
tion 987 QBU during the taxable year; and

(B) The adjusted basis, determined in
the functional currency of the owner, of
any asset transferred to the section 987
QBU during the taxable year (after taking
into account § 1.988-1(a)(10)).

(4) Step 4: Decrease the amount deter-
mined 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 de-
creased by the aggregate amount of liabil-
ities 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
§ 1.987-1(c)(1)) applicable on the date of
transfer.

(5) Step 5: Increase the amount deter-
mined 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 in-
creased by the aggregate amount of liabil-
ities transferred by the owner to the sec-
tion 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
§ 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 in-
come or loss, respectively, computed un-
der § 1.987-3 for the taxable year.

(7) Step 7: Increase the amount deter-
mined in steps 1 through 6 by any ex-
penses that are not deductible in comput-
ing 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 ex-
pense or loss attributable to a section 987
QBU for the taxable year that is not de-
ductible 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 deter-
mined 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 attrib-
utable to a section 987 QBU for the tax-
able year that is not included in computing
the section 987 QBU's taxable income or
loss for the year.

(e) Determination of the owner func-
tional currency net value of a section 987
QBU-(1) In general. The owner func-
tional currency net value of a section 987
QBU on the last day of a taxable year
shall equal the aggregate amount of func-
tional currency and the adjusted basis of
each asset on the section 987 QBU's bal-
ance sheet on that day, less the aggregate
amount of each 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 de-
termined by:

(i) Preparing a balance sheet for the
relevant date from the section 987 QBU's
books and records (within the meaning of
§ 1.989(a)-1(d)), as recorded in the sec-
tion 987 QBU's functional currency and
showing all assets and liabilities reflected
on such books and records as provided in
§ 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 account-
ing principles; and

(iii) Translating the asset and liability
amounts on the adjusted balance sheet de-
scribed in paragraph (e)(1)(ii) of this sec-
tion 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 func-
tional 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 § 1.987-1(d)) shall be trans-
lated into the owner's functional currency
at the spot rate (as defined in § 1.987-
1(c)(1)) applicable to the last day of the
relevant taxable year.

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(ii) Historic item. A historic item (as
defined in § 1.987-1(e)) shall be trans-
lated into the owner's functional currency
at the historic rate (as defined in § 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. Ex-
cept as otherwise indicated, U.S. Corp
elects under § 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 ex-
ample, 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 ac-
tivities constitute a trade or business
within the meaning of § 1.989(a)-
1(b)(2)(ii)(A) and § 1.989(a)-1(c) and
therefore whether a section 987 QBU is
considered to exist.

Example 1. (i) On July 1, 2021, U.S. Corp es-
tablishes 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 ex-
changes the $1,000 for ¥100,000. On the same day,
Japan Branch borrows ¥10,000. For the taxable year
2021, Japan Branch earns ¥2,000 per month (total of
¥12,000 for the six-month period from July 1, 2021,
through December 31, 2021) for providing services
and incurs ¥333.33 per month (total of ¥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 =
¥100; the spot rate on December 31, 2021, is $1 =
¥120; and the average rate for the period of July 1,
2021, to December 31, 2021, is $1 =¥110.Thus, the
¥12,000 of services revenue when properly trans-
lated under § 1.987-3(c)(1) at the yearly average
exchange rate equals $109.09 (¥12,000 x ($1 /
¥110))=$109.09). The ¥2,000 of expenses trans-
lated at the same yearly average exchange rate
equals $18.18 (¥2,000 x ($1 / ¥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 unrec-
ognized section 987 gain or loss (as defined under
paragraph (b) of this section) is the branch's unrec-
ognized section 987 gain or loss for 2021 as deter-
mined in paragraph (d) of this section. The calcula-
tion under paragraph (d) of this section is made as
follows:

(iii) Step 1. Under paragraph (d)(1) of this sec-
tion, 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 para-
graph (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) ¥120,000;

(2) Raw land with a basis of ¥55,000 ($500
translated under § 1.987-2(d)(2) at the historic rate
of $1= ¥110); and

(3) Liabilities of ¥10,000.

(C) Under paragraph (e)(2) of this section, U.S.
Corp will translate these items as follows. The
¥120,000 is a marked asset and the ¥10,000 liability
is a marked liability (as each is defined in § 1.987-
1(d)). These items are translated into dollars on
December 31, 2021, using the spot rate on December
31, 2021, of $1 = ¥120. The raw land is a historic
asset (as defined in § 1.987-1(e)) and is translated
into dollars under paragraph (e)(2)(ii) of this section
at the historic rate, which under § 1.987-
1(c)(3)(1)(A) is the yearly average exchange rate of
$1 = ¥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:

Assets

Amount in ¥

Translation Rate

Amount in $

Yen

¥120,000

$1= ¥120 (spot rate-12/31/21)

$1,000.00

Land

55,000

$1=¥110 (yearly average rate-2021)

500.00

Total assets

$1,500.00

Liabilities

Bank Loan

¥10,000

$1= ¥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 sec-
tion, 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 para-
graph (d)(2)(ii) of this section. Because no such
amounts 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 ¥100,000) and

raw land with a basis of $500.00 (equal to ¥55,000,
translated under § 1.987-2(d)(2) at the historic rate
of $1 = ¥110). Thus, the $1,416.67 determined
under steps 1 and 2 is reduced by $1,500.00, result-
ing 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 sec-
tion, 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

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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. Accord-
ingly, the unrecognized section 987 loss of Japan
Branch for 2021 is ($174.24), the amount deter-
mined 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 § 1.987-
1(c)(1)(ii) for U.K. Branch to use a spot rate con-
vention (when permitted). Under the chosen conven-
tion, 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 pre-
ceding month. The yearly average exchange rate was
£1 = $0.90 for 2020, £1 = $1.00 for 2021, and £1 =
$1.10 for 2022. The closing balance sheet of U.K.
Branch in 2021 reflected the following assets:

(A) £100;

(B) A sales office purchased in 2020 with an
adjusted basis of £1,000;

(C) A delivery truck purchased in 2020 with an
adjusted basis of £200;

(D) Inventory of 100 units purchased in 2021
with a basis of £100; and

(E) Stock in ABC Corporation purchased in 2021
with a basis of £150, representing less than 10 per-
cent 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, £50 of long-term debt
entered into in 2020 with F Bank, an unrelated bank.

The office, truck, stock, and inventory are his-
toric assets (as defined in § 1.987-1(e)). The £100
and long-term debt are marked items (as defined in
§ 1.987-1(d)). Assume that U.S. Corp translated
U.K. Branch's 2021 closing balance sheet as fol-
lows:

Assets

Amount in £

Translation Rate

Amount in $

Pounds

£100.00

£1 = $1.05 (convention rate-Dec. 2021)

$105.00

Office

1,000.00

£1 = $0.90 (historic rate-2020)

900.00

Truck

200.00

£1 = $0.90 (historic rate-2020)

180.00

Stock

50.00

£1 = $1.00 (historic rate-2021)

150.00

Inventory

100.00

£1 = $1.00 (historic rate-2021)

100.00

Total assets

$1435.00

Liabilities

Bank Loan

£50.00

£1 = $1.05 (convention rate-Dec. 2021)

$52.50

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 £300
and purchased another 100 units of inventory for
£100. There is depreciation of £33 with respect to the

office and £40 with respect to the truck, and U.K.
Branch incurred £30 of business expenses during
2022. Neither the depreciation nor the business ex-
penses are inventoriable costs. All items of income
earned and expenses incurred during 2022 are re-

ceived and paid, respectively, in pounds. Under
§ 1.987-3, U.K. Branch's section 987 taxable in-
come or loss is determined as follows:

Item

Amount in £

Translation Rate

Amount in $

Gross receipts

£300.00

£1 = $1.10 (yearly average rate-2022)

$330.00

Less: COGS

(100.00)

£1 = $1.00 (historic rate-2021)

(100.00)

Gross income

$230.00

Dep: Office

(33.00)

£1 = $0.90 (historic rate-2020)

($29.70)

Truck

(40.00)

£1 = $0.90 (historic rate-2020)

(36.00)

Other expenses

(30.00)

£1 = $1.10 (yearly average rate-2022)

(33.00)

Total expenses

($98.70)

Section 987 taxable income

$131.30

Accordingly, U.K. Branch has $131.30 of sec-
tion 987 taxable income in 2022.

(iii) In December 2022, U.K. Branch transferred
£30 to U.S. Corp, and U.S. Corp transferred a com-
puter 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 sec-
tion, 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:

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Assets

Amount in £

Translation Rate

Amount in $

Pounds

£240.00

£1 = $1.15 (convention rate-Dec. 2022)

$276.00

Office

967.00

£1 = $0.90 (historic rate-2020)

870.30

Truck

160.00

£1 = $0.90 (historic rate-2020)

144.00

Inventory

100.00

£1 = $1.10 (historic rate-2022)

110.00

Computer

9.09

£1 = $1.10 (historic rate-2022)

10.00

Stock

150.00

£1 = $1.00 (historic rate-2021)

150.00

Total assets

$1,560.30

Liabilities

Bank Loan

£50.00

£1 = $1.15 (convention rate-Dec. 2022)

$57.50

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 sec-
tion, 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:

Asset

Amount in £

Translation Rate

Amount in $

£30

£30.00

£1 = $1.15 (convention rate-Dec. 2022)

$34.50

(C) Step 3: Decrease the aggregate amount de-
scribed 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 trans-
ferred from U.S. Corp to U.K. Branch during 2022 is
determined as follows:

Assets

Amount in $

Computer

$10.00

(D) Step 4. Under paragraph (d)(4) of this sec-
tion, 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 sec-
tion, 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 sec-
tion, 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 § 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
§ 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).

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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 § 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 €100. The tax basis of the
building and machine is translated into euros using
the historic rate, which is the yearly average ex-
change rate for 2020, the year of the transfer. Ac-
cordingly, the building and the machine have a tax
basis of €780 and €300, respectively, on December
31, 2020. The building and machine have annual
depreciation of €20 and €30, respectively. Business
A determines that 50 percent of the building depre-

ciation 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 inven-
tory. Relevant exchange rates for purposes of this
example are as follows:

Year

Yearly Average Exchange Rate

December 31 Spot Rate

2020

€1 = $1.00

€1 = $1.00

2021

€1 = $1.50

€1 = $2.00

2022

€1 = $2.50

€1 = $3.00

(ii) Operations in 2021. During 2021, Business
A recognizes €140 of revenue from sales of finished
goods. The related COGS is €70. Business A pays
€10 in salaries allocable to SG&A. Inventoriable
costs in 2021 include €10 of depreciation on the

building and €30 of depreciation on the machine.
Business A's balance sheet on December 31, 2021,
shows no liabilities and the following assets: cur-
rency of €160, the building with an adjusted basis of
€760, the machine with an adjusted basis of €270,

and ending inventory with a FIFO cost basis of €40,
comprising raw materials and finished goods.

(A) Determination of income. Under the simpli-
fied inventory method, Business A's income for
2021 is computed as follows:

Item

Amount in €

Translation Rate

Amount in $

Sales revenue

€140

€1 = $1.50 (yearly avg. rate-2021)

$210

COGS before adjustments

70

€1 = $1.50 (yearly avg. rate-2021)

$105

Adjustment for cost recovery deductions (see calculation below)

(20)

Adjustment for beginning inventory (none)

0

Adjusted COGS

$85

SG&amp;A

Depreciation on building (50%)

10

€1 = $1.00 (historic rate-2020)

$10

Salaries

10

€1 = $1.50 (yearly avg. rate-2021)

15

Total SG&amp;A

$25

Section 987 net income (revenue less COGS and SG&amp;A)

$100

###### COGS Adjustments

Adjustment for cost recovery deductions included in inventoriable costs

Depreciation

Historic Rate

2021 Yearly Avg. Rate

Difference in Translation Rates

Adjustment (Depreciation x Change in Rates)

Amount

€10 (building)

1.00

1.50

(0.50)

($5)

€30 (machine)

1.00

1.50

(0.50)

($15)

Total adjustment for cost recovery deductions

($20)

(B) Determination of OFCNV for 2020 and
2021.

Under the simplified inventory method, the OF-
CNV of Business A for 2020 and 2021 is determined

under paragraph (e) of this section as follows:

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OFCNV-End of 2021 Assets Amount in € Translation Rate Amount in $

Euros

€160

€1 = $2.00 (year-end spot rate-2021)

$320

Building

760

€1 = $1.00 (historic rate-2020)

760

Machine

270

€1 = $1.00 (historic rate-2020)

270

Inventory

40

€1 = $1.50 (yearly average rate-2021)

60

Total assets

$1,410

Liabilities

Total liabilities

$0

2021 ending OFCNV

$1,410

Assets

OFCNV-End of 2020

Amount in €

Translation Rate

Amount in $

Euros

€100

€1 = $1.00 (year-end spot rate-2020)

$100

Building

780

€1 = $1.00 (historic rate-2020)

780

Machine

300

€1 = $1.00 (historic rate-2020)

300

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 loss from prior years

0

Net unrecognized section 987 gain

$130

(iii) Operations in 2022. During 2022, Business
A recognizes €180 of revenue from sales of finished
goods. The related COGS is €96. Business A pays
€10 in salaries allocable to SG&A. Inventoriable
costs in 2022 include €30 of depreciation on the

machine and €10 of depreciation on the building.
Business A's balance sheet on December 31, 2022,
shows no liabilities and the following assets: cur-
rency of €260, the building with an adjusted basis of
€740, the machine with an adjusted basis of €240,

and ending inventory with a FIFO cost basis of €54,
comprising raw materials and finished goods.

(A) Determination of income. Under the simpli-
fied inventory method, Business A's income for
2022 is computed as follows:

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Item

Amount in €

Translation Rate

Amount in $

Sales revenue

€180

€1 = $2.50 (yearly avg. rate-2022)

$450

COGS before adjustments

96

€1 = $2.50 (yearly avg. rate-2022)

$240

Adjustment for cost recovery deductions (see calculation below)

(60)

Adjustment for beginning inventory (see calculation below)

(40)

Adjusted COGS

$140

SG&amp;A

Depreciation on building (50%)

10

€1 = $1.00 (historic rate-2020)

$10

Salaries

10

€1 = $2.50 (yearly avg. rate-2022)

25

Total SG&amp;A

$35

Section 987 net income (revenue less COGS and SG&amp;A)

$275

###### COGS Adjustments

####### Adjustment for cost recovery deductions

Depreciation Amount

Historic Rate

2022 Yearly Avg. Rate

Difference in Translation Rates

Adjustment (Depreciation x Change in Rates)

€10 (building)

1.00

2.50

(1.50)

($15)

€30 (machine)

1.00

2.50

(1.50)

($45)

Total adjustment for cost recovery deductions

($60)

####### Adjustment for beginning inventory

Prior Year Ending

2021

2022

Difference in

Adjustment (Inventory x Change in Rates)

Inventory

Yearly Avg. Rate

Yearly Avg. Rate

Translation Rates

€40

1.50

2.50

(1.00)

($40)

Total adjustment for beginning inventory

($40)

(B) Determination of OFCNV. Under the simpli-
fied inventory method, the OFCNV of Business A

for 2022 is determined under paragraph (e) of this
section as follows:

Assets

OFCNV-End of 2022

Amount in €

Translation Rate

Amount in $

Euros

€260

€1 = $3.00 (year-end spot rate-2022)

$780

Building

740

€1 = $1.00 (historic rate-2020)

740

Machine

240

€1 = $1.00 (historic rate-2020)

240

Inventory

54

€1 = $2.50 (yearly average rate-2022)

135

Total assets

$1,895

Liabilities

Total liabilities

$0

2022 ending OFCNV

$1,895

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(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 prior year

130

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 simpli-
fied inventory method, Business A's income for
2021 is computed as follows:

Item

Amount in €

Translation Rate

Amount in $

Sales revenue

€140

€1 = $1.50 (yearly avg. rate-2021)

$210

COGS before adjustments

70

€1 = $1.50 (yearly avg. rate-2021)

$105

Adjustment for cost recovery deductions (same as Example 1)

(20)

Adjustment for LIFO liquidation (none)

0

Adjusted COGS

$85

SG&amp;A

Depreciation on building (50%)

10

€1 = $1.00 (historic rate-2020)

$10

Salaries

10

€1 = $1.50 (yearly avg. rate-2021)

15

Total SG&amp;A

$25

Section 987 net income (revenue less COGS and SG&amp;A)

$100

(B) Determination of OFCNV for 2020 and
2021. Under the simplified inventory method, the

OFCNV of Business A for 2020 and 2021 is deter-
mined under paragraph (e) of this section as follows:

OFCNV-End of 2021 Assets Amount in € Translation Rate Amount in $

Euros

€160

€1 = $2.00 (year-end spot rate-2021)

$320

Building

760

€1 = $1.00 (historic rate-2020)

760

Machine

270

€1 = $1.00 (historic rate-2020)

270

Inventory

40

€1 = $1.50 (historic rate-2021)

60

Total assets

$1,410

Liabilities

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OFCNV-End of 2021

Assets

Amount in € Translation Rate Amount in $

Total liabilities

$0

2021 ending OFCNV

$1,410

Assets

OFCNV-End of 2020

Amount in €

Translation Rate

Amount in $

Euros

€100

€1 = $1.00 (year-end spot rate-2020)

$100

Building

780

€1 = $1.00 (historic rate-2020)

780

Machine

300

€1 = $1.00 (historic rate-2020)

300

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 (rele-
vant 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 loss from prior years

0

Net unrecognized section 987 gain

$130

(iii) Operations in 2022. The facts about Busi-
ness 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, Busi-
ness A's balance sheet on December 31, 2022, re-

flects a 2021 layer of inventory with a LIFO cost
basis of €40 and a 2022 layer of inventory with a
LIFO cost basis of €10.80, and Business A's COGS
is €99.20.

(A) Determination of income. Business A's in-
come for 2022 is computed as follows:

Item

Amount in €

Translation Rate

Amount in $

Sales revenue

€180

€1 = $2.50 (yearly avg. rate-2022)

$450

COGS before adjustments

99.20

€1 = $2.50 (yearly avg. rate-2022)

$248

Adjustment for cost recovery deductions (same as Example 3)

(60)

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Item

Amount in €

Translation Rate

Amount in $

Adjustment for LIFO liquidation (none)

0

Adjusted COGS

$188

SG&amp;A

Depreciation on building (50%)

10

€1 = $1.00 (historic rate-2020)

$10

Salaries

10

€1 = $2.50 (yearly avg. rate-2022)

25

Total SG&amp;A

$35

Section 987 net income (revenue less COGS and SG&amp;A)

$227

OFCNV-End of 2022 Assets

Amount in €

Translation Rate

Amount in $

Euros

€260.00

€1 = $3.00 (year-end spot rate-2022)

$780

Building

740.00

€1 = $1.00 (historic rate-2020)

740

Machine

240.00

€1 = $1.00 (historic rate-2020)

240

Inventory

10.80

€1 = $2.50 (historic rate-2022)

27

40.00

€1 = $1.50 (historic rate-2021)

60

Total assets

$1,847

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 prior years

130

Net unrecognized section 987 gain

$340

(iv) Operations in 2023. During 2023, Business
A recognizes revenue of €252 from sales of finished
goods. The related COGS is €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 €10 in salaries allocable
to SG&A. Inventoriable costs in 2023 include €10 of
depreciation on the building and €30 of depreciation
on the machine. Business A's balance sheet on De-

cember 31, 2023, shows no liabilities and the fol-
lowing assets: currency of €422, the building with an
adjusted basis of €720, the machine with an adjusted
basis of €210, and a 2021 layer of ending inventory
with a LIFO cost basis of €30, comprising raw

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materials and finished goods. The yearly average

exchange rate for 2023 is €1 = $3.50, and the spot
rate on December 31, 2023 is €1 = $4.00.

(A) Determination of income. Business A's in-
come for 2023 is computed as follows:

Item

Amount in €

Translation Rate

Amount in $

Sales revenue

€252

€1 = $3.50 (yearly avg. rate-2023)

$882

COGS before adjustments

140.80

€1 = $3.50 (yearly avg. rate-2023)

$492.80

Adjustment for cost recovery deductions (see calculation below)

(100.00)

Adjustment for LIFO liquidation (see calculation below)

(30.80)

Adjusted COGS

$362.00

SG&amp;A

Depreciation on building (50%)

10

€1 = $1.00 (historic rate-2020)

$10

Salaries

10

€1 = $3.50 (yearly avg. rate-2023)

35

Total SG&amp;A

$45

Section 987 net income

$475

###### COGS Adjustments

####### Adjustment for cost recovery deductions

Depreciation Amount

Historic Rate

2023 Yearly Avg. Rate

Difference in Translation Rates

Adjustment (Depreciation x Change in Rates)

€10 (building)

1.00

3.50

(2.50)

($25)

€30 (machine)

1.00

3.50

(2.50)

($75)

Total adjustment for cost recovery deductions

($100)

Adjustment for LIFO liquidation

LIFO Liquidation

Historic Rate

2023 Yearly Avg. Rate

Difference in Translation Rates

Adjustment (Liquidated Layer x Change in Rates)

Layer

€10.80 (2022)

2.50

3.50

(1.00)

($10.80)

€10 (2021)

1.50

3.50

(2.00)

($20.00)

Total adjustment for liquidation of LIFO layers

($30.80)

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

Assets

OFCNV-End of 2023

Amount in €

Translation Rate

Amount in $

Euros

€422

€1 = $4.00 (year-end spot rate-2023)

$1,688

Building

720

€1 = $1.00 (historic rate-2020)

720

Machine

210

€1 = $1.00 (historic rate-2020)

210

Inventory

30

€1 = $1.50 (historic rate-2021)

45

Total assets

$2,663

Liabilities

Total liabilities

$0

2023 ending OFCNV

$2,663

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(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 de-
termined 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 prior years

340

Net unrecognized section 987 gain

$681

####### § 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 own-
er's section 987 gain or loss recognized
with respect to the section 987 QBU for
the taxable year. Except as otherwise pro-
vided, 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 sec-
tion 987 gain or loss with respect to the
section 987 QBU determined under
§ 1.987-4 on the last day of such taxable
year (or, if earlier, on the day the section
987 QBU is terminated under § 1.987-8);
multiplied by

(2) The owner's remittance proportion
for the taxable year, as determined under
paragraph (b) of this section.

(b) Remittance proportion. The own-
er's remittance proportion with respect to
a section 987 QBU for a taxable year shall
equal:

(1) The remittance, as determined un-
der 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 re-
flected on its year-end balance sheet trans-

lated into the owner's functional currency
as provided in § 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 re-
mittance shall be determined in the own-
er's functional currency and shall equal
the excess, if any, of:

(i) The aggregate of all amounts trans-
ferred from the section 987 QBU to the
owner during the taxable year, as deter-
mined in paragraph (d) of this section;
over

(ii) The aggregate of all amounts trans-
ferred from the owner to the section 987
QBU during the taxable year, as deter-
mined in paragraph (e) of this section.

(2) Day when a remittance is deter-
mined. An owner's remittance from a sec-
tion 987 QBU shall be determined on the
last day of the owner's taxable year (or, if
earlier, on the day the section 987 QBU is
terminated under § 1.987-8).

(3) Termination. A termination of a
section 987 QBU as determined under
§ 1.987-8 is treated as a remittance of all
the gross assets of the section 987 QBU to
the owner on the date of such termination.
See § 1.987-8(e). Accordingly, the remit-
tance proportion in the case of a termina-
tion is 1.

(d) Aggregate of all amounts trans-
ferred 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 cur-
rency under § 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 § 1.987-
4(d)(5), shall be treated as a transfer of
assets from the section 987 QBU to the
owner in an amount equal to the amount
of such liabilities.

(e) Aggregate of all amounts trans-
ferred 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 cur-
rency under § 1.987-4(d)(3). Solely for
this purpose, the amount of liabilities
transferred from the section 987 QBU to
the owner determined under § 1.987-
4(d)(4) shall be treated as a transfer of
assets from the owner to the section 987
QBU in an amount equal to the amount of
such liabilities.

(f) Determination of owner's adjusted
basis in transferred assets-(1) In gen-
eral. The owner's adjusted basis in an

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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 func-
tional currency under the rules prescribed
in paragraphs (f)(2) and (f)(3) of this sec-
tion.

(2) Marked asset. The basis of a
marked asset shall be the amount deter-
mined by translating the section 987
QBU's functional currency basis of the
asset, after taking into account § 1.988-
1(a)(10), into the owner's functional cur-
rency at the spot rate (as defined in
§ 1.987-1(c)(1)) applicable to the date of
transfer.

(3) Historic asset. The basis of a his-
toric asset shall be the amount determined
by translating the section 987 QBU's

functional currency basis of the asset, af-
ter taking into account § 1.988-1(a)(10),
into the owner's functional currency at the
historic rate for the asset (as defined in
§ 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 be-
tween 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 § 1.987-4(d)(2)(ii)(B) and para-
graph (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 § 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 cur-
rency pursuant to § 1.987-4(e)(2), consisting of a
computer with a pound adjusted basis equivalent to
$500, a truck with a pound adjusted basis equivalent
to $2,000, and pounds equivalent to $2,850. In ad-
dition, 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 § 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 remit-
tance 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 as-
sets 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 of 2021, increased by amount of remittance

$5,850

(C) Computation of remittance propor-
tion. Under paragraph (b) of this section,
Business A must compute the remittance
proportion by dividing the $500 remit-
tance amount by the $5,850 sum of the
aggregate basis of Business A's gross as-

sets 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 sec-
tion 987 gain or loss that must be recog-
nized with respect to Business A is deter-

mined under paragraph (a) of this section
by multiplying the 0.085 remittance pro-
portion by the $80 of net unrecognized
section 987 gain. U.S. Corp's resulting
recognized section 987 gain for 2021 is
$6.80.

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Par. 5 Sections 1.987-6 through
1.987-11 are added to read as follows:

* * * * *

Sec.

1.987-6 Character and source of sec-
tion 987 gain or loss.

1.987-7 Section 987 aggregate part-
nerships.

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.

* * * * *

### § 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 In-
ternal Revenue Code, including sections
904(d), 907, and 954.

(2) Method required to characterize
and source section 987 gain or loss. The
owner must use the asset method set forth
in § 1.861-9T(g) to characterize and
source section 987 gain or loss. In apply-
ing 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 § 1.861-
9T(j) cannot be used.

(3) Coordination with section 954.
Solely for purposes of determining the
excess of foreign currency gains over for-
eign currency losses characterized as for-
eign 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 ref-
erence to assets that give rise to subpart F
income shall be treated as foreign cur-
rency gain or foreign currency loss attrib-
utable to section 988 transactions not di-
rectly related to the business needs of the
controlled foreign corporation.

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

Example 1. CFC is a controlled foreign corpora-
tion 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
§ 1.987-5. Applying the rules of this section, Busi-
ness 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 in-
come 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 § 1.954-2(g) that is taken into
account in determining the excess of foreign cur-
rency gain over foreign currency losses character-
ized 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 char-
acterized 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 for-
eign corporation for purposes of determining the
excess of foreign currency gains over foreign cur-
rency losses characterized as foreign personal hold-
ing company income under section 954(c)(1)(D).
Accordingly, CFC will aggregate the Sf10,000 sec-
tion 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 com-
pany income under section 954(c)(1)(D).

### § 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 de-
scribed in § 1.987-1(b)(4)(ii), through a
section 987 aggregate partnership.

(b) [Reserved].

(c) Coordination with subchapter K.
[Reserved].

§ 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 pro-
vides 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 prin-
ciples of this section.

(b) In general. Except as provided in
paragraph (c) of this section, a section 987
QBU terminates if the conditions de-
scribed 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 reason-
able 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 car-
ried on for profit.

(2) Substantially all assets transferred.
The section 987 QBU transfers substan-
tially 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 corpora-
tion 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 transac-
tions collectively own sufficient interests
in the corporation such that the corpora-
tion would continue to be considered a

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controlled foreign corporation if such per-
sons 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 transac-
tion described in section 381(a)).

(c) Transactions described in section
381(a)-(1) Liquidations. Notwithstand-
ing paragraph (b) of this section, a termi-
nation does not occur when the owner of a
section 987 QBU ceases to exist in a liq-
uidation described in section 332, except
in the following cases:

(i) The distributor is a domestic corpo-
ration and the distributee is a foreign cor-
poration.

(ii) The distributor is a foreign corpo-
ration 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 re-
organization described in section
381(a)(2), except in the following cases:

(i) The transferor is a domestic corpo-
ration and the acquiring corporation is a
foreign corporation.

(ii) The transferor is a foreign corpora-
tion and the acquiring corporation is a
domestic corporation.

(iii) The transferor is a controlled for-
eign corporation immediately before the
transfer, the acquiring corporation is a for-
eign 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 termina-
tion 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 § 1.987-5(c)(3).

(f) Examples. The following examples
illustrate the principles of this section. Ex-
cept as otherwise provided, U.S. Corp is a
domestic corporation that has the U.S.
dollar as its functional currency, and Busi-
ness A is a section 987 QBU.

Example 1. Cessation of operations. (i) Facts.
U.S. Corp is the owner of Business A , a sales office
of U.S. Corp in Country X. Business A ceases sales
activities on December 31, 2021. During 2022, Busi-
ness A sells all of the assets used in its sales activ-
ities 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 § 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 cor-
poration 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 con-
tribution.

(ii) Analysis. Because FC ceases to qualify as a
controlled foreign corporation as a result of a trans-
action after which persons that were related to FC
within the meaning of section 267(b) immediately

before the transaction collectively own sufficient in-
terests 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 trans-
fers all of its assets and liabilities to U.S. Corp.

(ii) Analysis. FC's liquidation causes a termina-
tion 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 be-
cause 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 § 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 ex-
change for a 95 percent interest in Entity A. DC2's
contribution is treated as a contribution to a partner-
ship 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 § 601.601(d)(2) of this
chapter. For purposes of this section, these deemed
transactions are not taken into account. See § 1.987-
2(c) and § 1.987-2(c)(10), Example 9.

(B) Under § 1.987-1(b)(5)(i), Entity A is con-
verted 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
§ 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 § 1.987-7. Accordingly, under § 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

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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 § 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 sub-
stantially all the assets of Business A were trans-
ferred 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
§ 1.987-2(c) (95 percent of the assets held by Busi-
ness 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 corpora-
tion under § 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 § 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 § 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 un-
der 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 qual-
ifies 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 ex-
change because the transfer of all of the assets of
Business A and Business B would cause termina-
tions 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 same consolidated group. The
cash received on the sale is recorded on the books of
U.S. Corp.

(ii) Analysis. Pursuant to § 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 be-
fore 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 para-
graph (b)(2) of this section.

### § 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 tax-
payer in accordance with the rules of
§ 1.987-1(g)(3) (if not required to be
made on a form published by the Com-
missioner regarding section 987) and such
reasonable records as are sufficient to es-
tablish the section 987 QBU's taxable in-
come 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 fol-
lowing 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 cur-
rency 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 con-
vention 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 de-
termined.

(5) The amount of the items of income,
gain, deduction, or loss attributed to the
section 987 QBU translated into the func-
tional currency of the owner.

(6) The amount of assets and liabilities
attributed to the section 987 QBU trans-
lated 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 cur-
rency of the owner.

(9) The amount of the unrecognized
section 987 gain or loss for the taxable
year.

(10) The amount of the net accumu-
lated unrecognized section 987 gain or
loss at the close of the taxable year.

(11) If a remittance is made, the com-
putations determined under § 1.861-9T(g)
for purposes of sourcing and characteriz-
ing the remittance under § 1.987-5.

(12) The transition information re-
quired to be determined under § 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 re-
garding section 987, must be maintained
and kept at all times available for inspec-
tion by the Internal Revenue Service for
so long as the contents thereof may be-
come 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 Com-
missioner for this purpose.

### § 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 § 1.987-
1(b)(4) on the transition date (as defined
in § 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 com-
ply with section 987 (the "prior section

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987 method") to the method prescribed by
these regulations pursuant to the fresh
start transition method set forth in para-
graph (b) of this section.

(b) Fresh start transition method-(1)
In general. Pursuant to the fresh start tran-
sition 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 termi-
nate 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 trans-
ferred from the owner to the section 987
QBU during the taxable year for purposes
of § 1.987-5(c)(1)(ii).

(2) Application of § 1.987-4. For pur-
poses of applying § 1.987-4 with respect
to a section 987 QBU described in para-
graph (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 deter-
mined under paragraph (b)(3) of this sec-
tion.

(3) Determination of historic rate. For
purposes of applying these regulations
with respect to a section 987 QBU de-
scribed in paragraph (b)(1) of this section
for taxable years beginning on or after the
transition date, the historic rate (as defined
in § 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 § 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 trans-
fer 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 his-
toric rate must be determined based on
reasonable assumptions (for example, as-
sumptions about turnover and aging of
accounts receivable), consistently applied.

(4) Example. The provisions of this
paragraph (b) are illustrated by the follow-
ing 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 pre-
scribed in the 1991 proposed section 987 regulations
to determine the section 987 gain or loss of Business
A. U.S. Corp contributed £6,000 to Business A on
January 1, year 1. On the same day, Business A
bought a truck for £4,000 and a computer for £1,000.
Business A had profits determined under § 1.987-
1(b)(1)(i) through (iii) of the 1991 proposed section
987 regulations of £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 regula-
tions. The yearly average exchange rate was £1 =
$1.10 in year 1, £1 = $1.20 in year 2, and £1 =
$1.30 in year 3. Business A incurred a £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 para-
graph (b) of this section. Pursuant to paragraph
(b)(1) of this section, Business A is deemed to ter-
minate 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 para-
graph (b)(2) of this section, for purposes of applying
§ 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 § 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 deter-
mines the historic rate for these pounds based on a
last-in, first-out cash flow assumption. Thus, it is
assumed that the £50 loss in each of year 4 and year
5 first reduces the £250 earned in year 3. Accord-
ingly, 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 fol-
lows:

Assets

Amount in £

Translation Rate

Amount in $

Pounds

£1,000

£1 = $1.10 (yearly average rate-year 1)

$1,100

Pounds

250

£1 = $1.10 (yearly average rate-year 1)

275

Pounds

250

£1 = $1.20 (yearly average rate-year 2)

300

Pounds

150

£1 = $1.30 (yearly average rate-year 3)

195

Truck

4,000

£1 = $1.10 (yearly average rate-year 1)

4,400

Computer

1,000

£1 = $1.10 (yearly average rate-year 1)

1,100

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 partic-

ular section 987 QBU, a taxpayer's prior
section 987 method was based on a rea-
sonable application of the method de-
scribed 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 with-

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out regard to paragraph (b) of this sec-
tion.

(2) Application of § 1.987-4. For pur-
poses of applying § 1.987-4 with respect
to a section 987 QBU described in para-
graph (c)(1) for the taxable year beginning
on the transition date, the owner func-
tional currency net value of the section
987 QBU on the last day of the preceding
taxable year under § 1.987-4(d)(1)(B)
shall be the amount that was determined
under § 1.987-4(d)(1)(A) of the 2006
proposed section 987 regulations for the
preceding taxable year. Additionally, for
purposes of applying § 1.987-4 with re-
spect 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 § 1.987-4(c) shall take into account
the aggregate of the amounts determined
under § 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
§ 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 pur-
poses of applying these regulations under
section 987 with respect to historic items
(as defined in § 1.987-1(e)), other than
inventory, that are reflected on the balance
sheet of the section 987 QBU on the tran-
sition date, a taxpayer may use the same
historic exchange rates as were used under
the taxpayer's application of the 2006 pro-
posed section 987 regulations in place of
the historic rates that otherwise would be
determined under § 1.987-1(c)(3), pro-
vided 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 follow-
ing 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 ap-
plication of the method described in the 2006 pro-
posed section 987 regulations to determine the sec-
tion 987 gain or loss of Business A. On January 1,
year 5, Business A transitions to the method pro-
vided in these regulations pursuant to the method
described in this paragraph (c). Business A's open-
ing balance sheet on January 1, year 5, includes
pounds, a truck acquired in year 2, inventory ac-
counted for under the FIFO method, and no liabili-
ties. 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 § 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 § 1.987-
1(d). Because the pounds are marked items, for pur-
poses of determining the owner functional currency
net value of Business A on the last day of year 5
pursuant to § 1.987-4(e), the pounds are translated
into dollars using the spot rate (as defined in
§ 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
§ 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 § 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 § 1.987-1(c)(3) of the 2006 pro-
posed 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 regula-
tions, the basis of the truck would have been trans-
lated into dollars using the historic rate described in
§ 1.987-1(c)(3), which is the yearly average ex-
change rate for year 5.

(v) The inventory held on Business A's balance
sheet on January 1, year 5, is a historic item under
§ 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 § 1.987-4(e), the FIFO
cost basis of the inventory is translated into dollars
using the historic rate, which pursuant to § 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 § 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 § 1.987-4(d)(1)(B) is the amount that was
determined under § 1.987-4(d)(1)(A) of the 2006
proposed section 987 regulations for year 4. Addi-
tionally, Business A's net unrecognized section 987
gain or loss for all prior years under § 1.987-4(c)
shall take into account the aggregate of the amounts
determined under § 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
§ 1.987-5 of the 2006 proposed section 987 regula-
tions upon a remittance for all such prior taxable
years.

(d) Adjustments to avoid double count-
ing. If a difference between the treatment
of any item under these regulations and
the treatment of the item under the tax-
payer'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 § 1.987-4(b) for the
first taxable year for which these regula-
tions 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 Informa-
tion" to its timely filed return for the first
taxable year to which these regulations
under section 987 apply providing the fol-
lowing information:

(i) A description of each section 987
QBU to which these rules apply, the sec-
tion 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 tax-
payer 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 sec-
tion, a statement regarding whether his-
toric items (as defined in § 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 applica-
tion of the 2006 proposed regulations or at
the historic rates determined under
§ 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 in-
formation is reported on a form. Para-
graph (e) of this section shall not apply to

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the extent the information described in
such paragraph is required to be reported
on a form published by the Commissioner.

#### § 1.987-11 Effective/applicability date.

(a) In general. Except as otherwise
provided in this section, §§ 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 fol-
lowing December 7, 2016.

(b) Application of these regulations to
taxable years beginning after December
7, 2016. A taxpayer may apply these reg-
ulations under section 987 to taxable years
beginning after December 7, 2016, pro-
vided the taxpayer consistently applies
these regulations to such taxable years
with respect to all section 987 QBUs di-
rectly or indirectly owned by the taxpayer
on the transition date (as defined in para-
graph (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 cor-
poration, as defined in section 957, in
which a member owns more than 50 per-
cent 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.

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

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

* * * * *

§ 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.

* * * * *

Par. 7. Section 1.988-1 is amended by:

1\. Adding paragraph (a)(4).

2\. Revising paragraph (a)(10)(ii).

3\. Adding two sentences to the end of
paragraph (i).

The additions and revision read as fol-
lows:

§ 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
§ 1.987-1(b)(5), or of an entity disre-
garded as an entity separate from its
owner for Federal income tax purposes
(DE), that are not attributable to an eligi-
ble QBU as defined in § 1.987-1(b)(3).

(ii) Section 987 Aggregate Partner-
ships. For purposes of applying section
988 and the applicable regulations to
transactions involving assets and liabili-
ties 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 § 1.987-1(b)(4)) shall be
treated as owning their share of such as-
sets 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 as-
sets and liabilities described in paragraph
(a)(4)(i) of this section that are held by a
DE, the owner of the DE (within the
meaning of § 1.987-1(b)(4)) shall be
treated as owning all such assets and lia-
bilities.

(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 part-
nership, 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 § 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 § 1.987-2(b). The F stock
held by P, and the yen liability incurred to acquire
the F stock, are also recorded on the books and
records of P but, pursuant to § 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 liabil-
ities 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 respec-
tive shares of such stock and liability pursuant to
§ 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 § 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 de-
fined under § 1.987-2(c)) of such cur-
rency 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 char-
acter 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 § 1.988-2

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(without regard to § 1.988-2(b)(8)) as if the
nonfunctional currency or item described in
paragraph (a)(2) of this section had been
sold or otherwise transferred at fair market
value between unrelated taxpayers. For pur-
poses of the preceding sentence, a taxpayer
must use a translation rate that is consistent
with the translation conventions of the sec-
tion 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 transac-
tion 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 § 1.987-11(b) a
taxpayer applies §§ 1.987-1 through
1.987-11 beginning in a taxable year prior
to the earliest taxable year described in
§ 1.987-11(a), then the revisions to para-
graphs (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.

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

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

* * * * *

(b) * * *

(2) Proper reflection on the books of
the taxpayer or qualified business unit-
(i) In general. For purposes of paragraph
(b)(1) of this section, the principles of
§ 1.987-2(b) shall apply in determining
whether an asset, liability, or item of in-
come or expense is reflected on the books
and records of a qualified business unit.

(ii) Effective/applicability date. Gener-
ally, 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 § 1.987-11(b) a tax-
payer applies §§ 1.987-1 through
1.987-11 beginning in a taxable year prior
to the earliest taxable year described in
§ 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.

* * * * *

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:

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

(b) * * *

(2) * * *

(i) Persons-(A) Corporations. A cor-
poration 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 § 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. Gener-
ally, 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 § 1.987-
11(b) a taxpayer applies §§ 1.987-1
through 1.987-11 beginning in a taxable
year prior to the earliest taxable year de-
scribed in § 1.987-11(a), then the effec-
tive 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 § 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. Gener-
ally, 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 § 1.987-
11(b) a taxpayer applies §§ 1.987-1
through 1.987-11 beginning in a taxable
year prior to the earliest taxable year de-
scribed in § 1.987-11(a), then the revi-
sions 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.

* * * * *

## § 1.989(c)-1 [Removed]

Par. 10. Section 1.989(c)-1 is re-
moved.

PART 602 - OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT

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

Authority: 26 U.S.C. 7805.

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

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where identified and described * * * * *

Current OMB Control No.

1.987-1

1545-2265

1.987-3

1545-2265

1.987-9

1545-2265

1.987-10 * * * * *

1545-2265

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John Dalrymple,
Deputy Commissioner for Services and
Enforcement.

Approved November 14, 2016

Mark J. Mazur,
Assistant Secretary of the Treasury (Tax
Policy).

(Filed by the Office of the Federal Register on December 7,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 8, 2016, 81 F.R. 88806)

### T.D. 9795

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

### Recognition and Deferral of Section 987 Gain or Loss

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains
temporary regulations under section 987
of the Internal Revenue Code (Code) re-
lating to the recognition and deferral of
foreign currency gain or loss under sec-
tion 987 with respect to a qualified busi-
ness unit (QBU) in connection with cer-
tain QBU terminations and certain other
transactions involving partnerships. This
document also contains temporary regula-
tions under section 987 providing: an an-
nual deemed termination election for a
section 987 QBU; an elective method,
available to taxpayers that make the an-
nual deemed termination election, for
translating all items of income or loss with
respect to a section 987 QBU at the yearly
average exchange rate; rules regarding the
treatment of section 988 transactions of a
section 987 QBU; rules regarding QBUs
with the U.S. dollar as their functional
currency; rules regarding combinations
and separations of section 987 QBUs;
rules regarding the translation of income
used to pay creditable foreign income tax-
es; and rules regarding the allocation of
assets and liabilities of certain partner-
ships for purposes of section 987. Finally,
this document contains temporary regula-

tions under section 988 requiring the de-
ferral of certain section 988 loss that
arises with respect to related-party loans.
The text of these temporary regulations
also serves as the text of the proposed
regulations set forth in the Proposed Rules
section in this issue of the Bulletin. In
addition, in the Rules and Regulations
section of this issue of the Bulletin, final
regulations are being issued under section
987 to provide general guidance under
section 987 regarding the determination of
the taxable income or loss of a taxpayer
with respect to a QBU.

DATES: Effective date. These regulations
are effective on December 7, 2016.

Applicability date. For dates of applicabil-
ity, see §§ 1.987-1T(h), 1.987-2T(e),
1.987-3T(f), 1.987-4T(h), 1.987-6T(d),
1.987-7T(d), 1.987-8T(g), 1.987-12T(j),
1.988-1T(j), and 1.988-2T(j).

FOR FURTHER INFORMATION CON-
TACT:Steven D. Jensen at (202) 317-
6938 (not a toll-free number).

## SUPPLEMENTARY INFORMATION: Paperwork Reduction Act

These temporary regulations are being
issued without prior notice and public pro-
cedure pursuant to the Administrative
Procedure Act (5 U.S.C. 553). For this
reason, the collection of information con-
tained in these regulations has been re-
viewed and, pending receipt and evalua-
tion of public comments, approved by the
Office of Management and Budget under
control number 1545-2265. Responses to
this collection of information are manda-
tory.

An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less the collection of information displays
a valid control number.

For further information concerning this
collection of information, the accuracy of
the estimated burden and suggestions for
reducing this burden, and where to submit
comments on the collection of informa-
tion, please refer to the preamble to the
cross-referencing notice of proposed rule-
making published in the Proposed Rules
section of this issue of the Bulletin.

Books and records relating to a collec-
tion of information must be retained as

long as their contents may become mate-
rial 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 temporary reg-
ulations under section 987 of the Code
relating to the recognition and deferral of
foreign currency gain or loss under sec-
tion 987 with respect to a QBU in con-
nection with certain QBU terminations
and certain other transactions involving
partnerships. This document also contains
temporary regulations under section 987
providing (i) an annual deemed termina-
tion election for a section 987 QBU; (ii)
an elective method, available to taxpayers
that make the annual deemed termination
election, for translating all items of in-
come or loss with respect to a section 987
QBU at the yearly average exchange rate;
(iii) rules regarding the treatment of sec-
tion 988 transactions of a section 987
QBU; (iv) rules regarding QBUs with the
U.S. dollar as their functional currency;
(v) rules regarding combinations and sep-
arations of section 987 QBUs; (vi) rules
regarding the translation of income used
to pay creditable foreign income taxes;
and (vii) rules regarding the allocation of
assets and liabilities of certain partner-
ships for purposes of section 987. Finally,
this document contains temporary regula-
tions under section 988 requiring the de-
ferral of certain section 988 loss that
arises with respect to related-party loans.

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 such QBU is deter-
mined by computing the taxable income
or loss of each QBU separately in its
functional currency and translating such
income or loss at the appropriate ex-
change rate. Section 987 further requires
the taxpayer to make "proper adjust-
ments" (as prescribed by the Secretary of
the Treasury (the Secretary)) for transfers
of property between QBUs having differ-
ent functional currencies, including by
treating post-1986 remittances from each
such QBU as made on a pro rata basis out

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of post-1986 accumulated earnings, by
treating section 987 gain or loss as ordi-
nary income or loss, and by sourcing such
gain or loss by reference to the source of
the income giving rise to post-1986 accu-
mulated earnings.

Section 989(c) directs the Secretary to
"prescribe such regulations as may be
necessary or appropriate to carry out the
purposes of [subpart J], including regula-
tions ... limiting the recognition of for-
eign currency loss on certain remittances
from qualified business units . . . [and]
providing for the appropriate treatment of
related party transactions (including trans-
actions between qualified business units
of the same taxpayer) ... . "

On September 6, 2006, the Treasury
Department and the IRS issued proposed
regulations under section 987 (REG-
208270-86, 71 FR 52876) (the 2006 pro-
posed regulations). The Treasury Depart-
ment and the IRS received many written
comments in response to the 2006 pro-
posed regulations and, after consideration
of those comments, are issuing final reg-
ulations (TD 9794) under section 987 (the
final regulations) that are being published
contemporaneously with these temporary
regulations. These temporary regulations
also reflect the consideration of comments
received on the 2006 proposed regula-
tions, as well as other considerations de-
scribed in this preamble.

### Explanation of Provisions

#### 1. Deferral of Section 987 Gain or Loss on Certain Terminations and Other Transactions Involving Partnerships

##### A. Background

Under the final regulations, the owner
of a section 987 QBU that terminates in-
cludes in income all of the net unrecog-
nized section 987 gain or loss with respect
to the section 987 QBU in the year it
terminates. See §§ 1.987-5(c)(3) and
1.987-8(e). Section 1.987-8(b) and (c)
describe the circumstances in which a sec-
tion 987 QBU terminates, which include
the transfer (or deemed transfer) of sub-
stantially all of the assets of the section
987 QBU and when the section 987
QBU's owner ceases to exist (except in
connection with certain liquidations or
reorganizations described in section

381(a)). Under these rules, a termination
can result solely from a transfer of a sec-
tion 987 QBU between related parties or,
when a QBU is owned by an entity that is
disregarded as an entity separate from its
owner for Federal tax purposes (DE),
from the deemed transfer that occurs
when an election is made to treat the DE
as a corporation for Federal tax purposes,
notwithstanding that the QBU's assets
continue to be used in the same trade or
business.

The preamble to the 2006 proposed
regulations requested comments regarding
whether inbound liquidations under sec-
tion 332 and inbound asset reorganiza-
tions under section 368(a) should result in
terminations of section 987 QBUs. The
preamble also requested comments on the
interaction of the rules of § 1.1502-13
regarding intercompany transactions with
the 2006 proposed regulations, including
whether section 987 gain or loss resulting
from the transfer of assets and liabilities
of a section 987 QBU between members
of the same consolidated group in a sec-
tion 351 transaction should be deferred
under § 1.1502-13. Many comments rec-
ommended that such a section 351 ex-
change should not trigger the recognition
of section 987 gain or loss.

Because a termination can result in the
deemed remittance of all the assets of a
section 987 QBU in circumstances in
which the assets continue to be used by a
related person in the conduct of the same
trade or business that formerly was con-
ducted by the section 987 QBU, termina-
tions can facilitate the selective recogni-
tion of section 987 losses. Section
989(c)(2) provides the Treasury Depart-
ment and the IRS with authority to
"limit[] the recognition of foreign cur-
rency loss on certain remittances from
qualified business units." The Treasury
Department and the IRS have determined
that terminations of section 987 QBUs
generally should not be permitted to
achieve the selective recognition of losses
when the assets and liabilities of the sec-
tion 987 QBU are transferred to a related
person and remain subject to section 987
in the hands of the transferee, as in the
case, for example, of a section 351 trans-
fer of a section 987 QBU within a consol-
idated group. Similar policy consider-
ations arise when the transfer of a

partnership interest to a related person re-
sults in deemed transfers that cause the
recognition of section 987 loss with re-
spect to a section 987 QBU owned
through the partnership, notwithstanding
that the trade or business of the section
987 QBU continues without interruption
and remains subject to section 987. In
order to address these policy concerns, as
described in greater detail in Part 1.C of
this Explanation of Provisions, the tempo-
rary regulations defer section 987 losses
resulting from certain termination events
and partnership transactions in which the
assets and liabilities of the section 987
QBU remain within a single controlled
group (defined as all persons with the re-
lationships to each other described in sec-
tions 267(b) or 707(b)) and remain subject
to section 987.

The Treasury Department and the IRS
also acknowledge, however, that part of
the rationale for deferring section 987
losses - that is, the continuity of owner-
ship of the section 987 QBU within a
single controlled group - applies equally
to section 987 gains that otherwise would
be triggered when taxpayers transfer a
section 987 QBU within a single con-
trolled group. Thus, consistent with the
recommendations of comments on the
2006 proposed regulations, the temporary
regulations generally apply to defer the
recognition of section 987 gains as well as
losses when the transferee is subject to
section 987 with respect to the assets of
the section 987 QBU. The Treasury De-
partment and the IRS have determined,
however, that gain should not be deferred
to the extent the assets of a section 987
QBU are transferred by a U.S. person to a
related foreign person. Since recognition
of the deferred gain generally would occur
only as a result of remittances to the for-
eign owner, the IRS could face adminis-
trative difficulty in attempting to ensure
that such deferred gain is appropriately
recognized and not indefinitely deferred.
Treating gains differently than losses in
the context of transfers to related for-
eign persons generally is consistent with
the policies underlying sections 267 and
367. In particular, this rule is consistent
with the policy of recognizing foreign
currency gains and not losses with re-
spect to property transferred outbound

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in a nonrecognition transaction. See sec-
tion 367(a)(3)(B)(iii).

In addition, the Treasury Department
and the IRS have determined that selec-
tive recognition of losses should not be
permitted in the context of certain out-
bound transfers even when the assets do
not remain subject to section 987 in the
hands of the transferee (because, for ex-
ample, the transferee has the same func-
tional currency as the QBU). Accordingly,
consistent with the principles of sections
267 and 367(a), the temporary regulations
also provide special rules to prevent the
selective recognition of section 987 losses
in certain other transactions involving out-
bound transfers.

#### B. Scope of application of § 1.987-12T

Section 1.987-12T provides for the de-
ferral of certain net unrecognized section
987 gain or loss that otherwise would be
recognized in connection with specified
events under § 1.987-5, which governs
the recognition of section 987 gain or loss
by the owner of a section 987 QBU to
which the final regulations apply. In addi-
tion, because the policy concerns that mo-
tivate § 1.987-12T exist regardless of
whether section 987 gain or loss is com-
puted pursuant to the final regulations or
some other reasonable method, § 1.987-
12T applies to any foreign currency gain
or loss realized under section 987(3), in-
cluding foreign currency gain or loss re-
alized under section 987 with respect to a
QBU to which the final regulations gen-
erally are not applicable. In order to
achieve this, the temporary regulations
specify that references in § 1.987-12T to
section 987 gain or loss refer to any for-
eign currency gain or loss realized under
section 987(3) and that references to a
section 987 QBU refer to any eligible
QBU (as defined in § 1.987-1(b)(3)(i), but
without regard to § 1.987-1(b)(3)(ii)) that
is subject to section 987. Additionally, the
temporary regulations specify that refer-
ences in § 1.987-12T to the recognition of
section 987 gain or loss under § 1.987-5
encompass any determination and recog-
nition of gain or loss under section 987(3)
that would occur but for § 1.987-12T.

Accordingly, the temporary regulations
require an owner of a QBU that is not
subject to § 1.987-5 to adapt the rules set
forth in § 1.987-12T to recognize section
987 gains or losses consistent with the
principles of § 1.987-12T.

The policy concerns regarding selec-
tive realization of section 987 losses do
not apply, however, with respect to a sec-
tion 987 QBU that has made the annual
deemed termination election described in
Part 2 of this Explanation of Provisions,
because all section 987 gain and loss is
recognized annually under that election.
Accordingly, § 1.987-12T is not applica-
ble to section 987 gain or loss of a section
987 QBU with respect to which the annual
deemed termination election is in effect.

Finally, in order to avoid any compli-
ance burden associated with applying
§ 1.987-12T in circumstances involving
relatively small amounts of section 987
gain or loss, § 1.987-12T includes a de
minimis rule. That rule provides that
§ 1.987-12T does not apply to a section
987 QBU if the net unrecognized section
987 gain or loss of the section 987 QBU
that, as a result of § 1.987-12T, would not
be recognized under § 1.987-5 does not
exceed $5 million.

Section 1.987-12T defers the recogni-
tion of section 987 gains and losses in
connection with two types of specified
events, which are referred to as “deferral
events" and "outbound loss events." Parts
1.C and 1.D of this Explanation of Provi-
sions describe the rules governing deferral
events and outbound loss events, respec-
tively.

#### C. Deferral events

As described in greater detail below,
the temporary regulations provide that,
notwithstanding § 1.987-5, the owner of a
section 987 QBU with respect to which a
deferral event occurs (a deferral QBU)
must defer section 987 gain or loss that
otherwise would be taken into account
under § 1.987-5 in connection with the
deferral event to the extent determined
under § 1.987-12T(b)(3) and (c). Such
deferred gain or loss is taken into account

based on subsequent events in accordance
with § 1.987-12T(c).

#### i. Deferral Events

The temporary regulations provide that
a deferral event with respect to a section
987 QBU means any transaction or series
of transactions that satisfy two conditions.
Under the first condition, the transaction
or series of transactions must be described
in one of two categories. The first cate-
gory, which is set forth in § 1.987-
12T(b)(2)(ii)(A), is any termination of a
section 987 QBU other than (i) a termina-
tion described in § 1.987-8(b)(3) (that is,
a termination that results from the owner
of the section 987 QBU ceasing to be a
controlled foreign corporation (as defined
in section 957(a)) (CFC) after certain
related-party transactions); (ii) a termina-
tion described in § 1.987-8(c) (that is, a
termination that results from a liquidation
or asset reorganization described in sec-
tion 381(a) involving an inbound or out-
bound transfer, a transfer by a CFC to a
related non-CFC foreign corporation, or a
transfer to a transferee that has the same
functional currency as the section 987
QBU);11 or (iii) a termination described
solely in § 1.987-8(b)(1) (that is, a termi-
nation that results solely from the cessa-
tion of the trade or business of the section
987 QBU). Thus, the first category gener-
ally involves terminations that occur as a
result of a transfer of substantially all the
assets of a section 987 QBU other than a
transfer as part of a transaction described
in section 381(a) in which the owner
ceases to exist. (A termination that results
from an outbound section 381(a) transac-
tion, however, may be an outbound loss
event.)

The second category, which is de-
scribed in § 1.987-12T(b)(ii)(B), en-
compasses certain partnership transac-
tions that result in a net deemed transfer
from a section 987 QBU to its owner as
a result of which section 987 gain or
loss otherwise would be recognized un-
der § 1.987-5. The second category re-
fers to two types of transactions involv-
ing partnerships.

11The transfer of a section 987 QBU as part of a liquidation or asset reorganization described in section 381(a) in which the transferor and transferee have the same tax status is not a
termination under § 1.987-8(b) and (c) and, therefore, cannot constitute a deferral event under the first category.

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First, the second category includes a
disposition of part of an interest in a DE or
partnership. Under § 1.987-2(c)(5), a
transfer of part of an interest in a DE or
section 987 aggregate partnership results
in deemed transfers to the owner of a
section 987 QBU held through that DE or
partnership that may result in a remit-
tance, but that generally do not cause a
termination. For an illustration of the ap-
plication of § 1.987-12T to a deferral
event resulting from the conversion of a
disregarded entity into a section 987 ag-
gregate partnership, see § 1.987-12T(h),
Example 4.

The second type of transaction in-
cluded in the second category is a contri-
bution of assets by a related person to a
partnership or DE through which a section
987 QBU is held, provided that the con-
tributed assets are not included on the
books and records of an eligible QBU and
the contribution causes a net transfer from
a section 987 QBU owned through the
partnership or DE. The rules of § 1.987-2
must be applied to determine whether the
contribution would cause a net transfer
from any section 987 QBUs held through
a partnership. For example, if two partners
(Partner A and Partner B) each own a 50%
interest in an existing section 987 aggre-
gate partnership with a single section 987
QBU, and Partner A contributes cash that
is included on the books of the section 987
QBU after the contribution and Partner B
contributes an equal amount of non-
portfolio stock, the contributions would
not cause either Partner A nor Partner B to
have a net transfer from the section 987
QBU under § 1.987-2 and there would be
no section 987 gain or loss to defer. As a
result of the broad scope of application for
§ 1.987-12T specified in § 1.987-
12T(a)(2), the second category includes
transactions involving partnerships that
are not section 987 aggregate partnerships
even though QBUs that are held through
such partnerships generally are not subject
to the final regulations. Accordingly,
§ 1.987-12T applies to a disposition of a
partnership interest or a contribution to a
partnership if it otherwise would result in
recognition of gain or loss under a taxpay-
er's reasonable method of applying sec-
tion 987.

The second condition described in
§ 1.987-12T(b)(2) is that, immediately af-

ter the transaction or series of transac-
tions, assets of the section 987 QBU are
reflected on the books and records of a
successor QBU. For this purpose, a suc-
cessor QBU with respect to a section 987
QBU (original QBU) generally means a
section 987 QBU on whose books and
records assets of the original QBU are
reflected immediately after the deferral
event, provided that, immediately after the
deferral event, the section 987 QBU is
owned by a member of the controlled
group that includes the person that owned
the original QBU immediately before the
deferral event. This relatedness require-
ment would not be met, for example, if the
person that owned the original QBU
ceased to exist in connection with the de-
ferral event.

However, if the owner of the original
QBU is a U.S. person, then a successor
QBU does not include a section 987 QBU
owned by a foreign person, except in the
case of a deferral event that is solely de-
scribed in the second category of transac-
tions involving partnership and DE inter-
ests. This limitation on the definition of a
successor QBU in the context of outbound
transfers serves two purposes. First, con-
sistent with the general policy of recog-
nizing foreign currency gains upon an out-
bound transfer, the limitation ensures that
section 987 gain is recognized to the ex-
tent section 987 QBU assets are trans-
ferred outbound in connection with a
termination. Second, the limitation coor-
dinates the deferral event rules with the
outbound loss event rules described in
Part 1.D of this Explanation of Provisions,
which contain different rules for the rec-
ognition of section 987 loss attributable to
assets of a section 987 QBU that are trans-
ferred outbound in connection with a ter-
mination of the section 987 QBU.

ii. Recognition of Section 987 Gain or
Loss Under § 1.987-5 in the Taxable
Year of a Deferral Event

The temporary regulations provide
that, in the taxable year of a deferral
event, the owner of the deferral QBU gen-
erally recognizes section 987 gain or loss
as determined under § 1.987-5, except
that, solely for purposes of applying
§ 1.987-5, all assets and liabilities of the
deferral QBU that, immediately after the

deferral event, are properly reflected on
the balance sheet of a successor QBU are
treated as not having been transferred and
therefore as remaining on the balance
sheet of the deferral QBU, notwithstand-
ing the deferral event. The effect of these
rules is that, in the taxable year of a de-
ferral event, only assets and liabilities of
the deferral QBU that are not reflected on
the books and records of a successor QBU
immediately after the deferral event are
taken into account in determining the
amount of a remittance from the deferral
QBU. Section 987 gain or loss that, as a
result of these rules, is not recognized
under § 1.987-5 in the taxable year of the
deferral event is referred to as deferred
section 987 gain or loss. As discussed in
Part 1.D of this Explanation of Provisions,
if the deferral event also constitutes an
outbound loss event, the amount of loss
recognized by the owner may be further
limited under the rules applicable to out-
bound loss events.

iii. Recognition of Deferred Section 987
Gain or Loss in the Taxable Year of a
Deferral Event and in Subsequent
Taxable Years

The temporary regulations provide
rules for determining when a deferral
QBU owner recognizes deferred section
987 gain or loss. For this purpose, a de-
ferral QBU owner means, with respect to
a deferral QBU, the owner of the deferral
QBU immediately before the deferral
event with respect to the deferral QBU or
the owner's qualified successor. The tem-
porary regulations define a qualified suc-
cessor with respect to a corporation (trans-
feror corporation) as another corporation
(acquiring corporation) that acquires the
assets of the transferor corporation in a
transaction described in section 381(a),
but only if (A) the acquiring corporation is
a domestic corporation and the transferor
corporation was a domestic corporation,
or (B) the acquiring corporation is a CFC
and the transferor corporation was a CFC.
A qualified successor of a corporation in-
cludes a qualified successor of a qualified
successor of the corporation.

As described in the remainder of this
Part 1.C.iii, the temporary regulations pro-
vide that deferred section 987 gain or loss
is recognized upon subsequent remit-

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tances from a successor QBU, or upon a
deemed remittance that occurs when a
successor QBU ceases to be owned by
a member of the deferral QBU owner's
controlled group, subject to an exception
that applies when a successor QBU termi-
nates in an outbound transfer. In general,
these rules depend on the continued exis-
tence of a deferral QBU owner (which
includes a qualified successor) and a suc-
cessor QBU and preserve the location of
the deferred section 987 gain or loss as
gain or loss of the deferral QBU owner.

#### a. Subsequent remittances

A deferral QBU owner generally rec-
ognizes deferred section 987 gain or loss
in the taxable year of a remittance from a
successor QBU to the owner of the suc-
cessor QBU (successor QBU owner). The
amount of deferred section 987 gain or
loss that a deferral QBU owner recognizes
upon a remittance is the outstanding de-
ferred section 987 gain or loss (that is, the
deferred section 987 gain or loss not pre-
viously recognized) multiplied by the re-
mittance proportion of the successor QBU
owner with respect to the successor QBU
for the taxable year as determined under
§ 1.987-5(b) and, to the extent relevant,
§ 1.987-12T. For an illustration of this
rule, see § 1.987-12T(h), Example 5.

In certain cases, there may be multiple
successor QBUs with respect to a single
deferral QBU. For instance, there may be
multiple successor QBUs if the owner of a
section 987 aggregate partnership interest
transfers part of its interest or if a succes-
sor QBU separates into two or more sep-
arated QBUs under § 1.987-2T(c)(9)(ii).
To ensure that a deferral QBU owner rec-
ognizes the appropriate amount of de-
ferred section 987 gain or loss in connec-
tion with a remittance in such cases, the
temporary regulations provide that multi-
ple successor QBUs of the same deferral
QBU are treated as a single successor
QBU for purposes of determining the
amount of deferred section 987 gain or
loss that is recognized.

For example, if the owner (Corp A) of
a section 987 aggregate partnership inter-
est transfers part of its interest to another
member of Corp A's consolidated group
(Corp B), the transfer would give rise to a
deferral event with respect to the section
987 QBU (QBU A) that Corp A indirectly

owns through the partnership. QBU A
would be considered a deferral QBU, and
Corp A would be considered a deferral
QBU owner. In addition, QBU A would
be considered a successor QBU with re-
spect to itself, and the section 987 QBU
(QBU B) that Corp B owns indirectly
through the partnership interest it acquired
also would be considered a successor
QBU with respect to QBU A. In determin-
ing the amount of deferred section 987
gain or loss recognized upon subsequent
remittances from successor QBUs, the
two successor QBUs are treated as a sin-
gle successor QBU, such that their remit-
tance proportion is determined under
§ 1.987-5 on a combined basis, taking
into account the assets and remittances of
both successor QBUs.

b. Deemed remittance when a successor
QBU ceases to be owned by a member
of the deferral QBU owner's controlled
group

Solely for purposes of determining a
deferral QBU owner's recognition of any
outstanding deferred section 987 gain or
loss, a successor QBU owner is treated as
having a remittance proportion of 1 in a
taxable year in which its successor QBU
ceases to be owned by a member of a
controlled group that includes the deferral
QBU owner, including as a result of the
deferral QBU owner ceasing to exist with-
out having a qualified successor. Accord-
ingly, a deferral QBU owner would rec-
ognize all outstanding deferred section
987 gain or loss upon a successor QBU
ceasing to be owned by a member of the
deferral QBU owner's controlled group if
there is only one successor QBU, but
would recognize only a proportional
amount if there are multiple successor
QBUs, one or more of which remain in the
deferral QBU owner's controlled group.

#### c. Recognition of deferred section 987 loss in certain outbound successor QBU terminations

Notwithstanding that deferred section
987 gain or loss generally is recognized
upon remittances from a successor QBU,
§ 1.987-12T(c)(3) provides that, if assets
of a successor QBU are transferred (or
deemed transferred) in an exchange that
would constitute an outbound loss event if

the successor QBU had a net accumulated
section 987 loss at the time of the ex-
change, the deferral QBU owner recog-
nizes any outstanding deferred section
987 loss on a similar basis as it would if it
originally had transferred the deferral
QBU in an outbound loss event. Any out-
standing deferred section 987 loss with
respect to the deferral QBU that, as a
result of this rule, is not recognized is
recognized by the deferral QBU owner in
the first taxable year in which the deferral
QBU owner (including any qualified suc-
cessor) and the acquirer of the assets of
the successor QBU (or any qualified
successor) cease to be members of the
same controlled group. Section 1.987-
12T(c)(4) ensures that the policy concerns
that motivate the treatment of outbound
loss events under the temporary regula-
tions apply in comparable circumstances
involving successor QBUs. See Part 1.D
of this Explanation of Provisions for an
explanation of outbound loss events.

#### d. Special rules regarding successor QBUs

The temporary regulations include
three special rules regarding successor
QBUs that are relevant to the recognition
of deferred section 987 gain or loss. First,
if a section 987 QBU is a successor QBU
with respect to a deferral QBU that is a
successor QBU with respect to another
deferral QBU, the first-mentioned section
987 QBU is considered a successor QBU
with respect to the second-mentioned de-
ferral QBU. For example, if QBU A is a
successor QBU with respect to QBU B,
and QBU B is a successor QBU with
respect to QBU C, then QBU A is a suc-
cessor QBU with respect to QBU C.

Second, if a successor QBU with re-
spect to a deferral QBU separates into two
or more separated QBUs (as defined in
§ 1.987-2T(c)(9)(iii)), each separated
QBU is considered a successor QBU with
respect to the deferral QBU.

Third, if a successor QBU with respect
to a deferral QBU combines with another
section 987 QBU of the same owner, re-
sulting in a combined QBU (as defined in
§ 1.987-2T(c)(9)(i)), the combined QBU
is considered a successor QBU with re-
spect to the deferral QBU.

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## iv. Source and Character of Deferred Section 987 Gain and Loss

The temporary regulations provide that
the source and character of deferred sec-
tion 987 gain or loss is determined under
§ 1.987-6 as if such gain or loss had been
recognized with respect to the deferral
QBU under § 1.987-5 on the date of the
deferral event that gave rise to the de-
ferred section 987 gain or loss. Thus, the
source and character of deferred section
987 gain or loss is determined under
§ 1.987-6 without regard to the timing
rules of § 1.987-12T.

## D. Outbound loss events

Section 1.987-12T(d) of the temporary
regulations contains rules that defer sec-
tion 987 loss to the extent assets of a
section 987 QBU are transferred outbound
to a related foreign person in connection
with an "outbound loss event." Specifi-
cally, the temporary regulations provide
that, notwithstanding § 1.987-5, the
owner of a section 987 QBU with respect
to which an outbound loss event occurs
(outbound loss QBU) includes in taxable
income in the year of the outbound loss
event section 987 loss with respect to that
section 987 QBU only to the extent
provided in § 1.987-12T(d)(3). Sections
1.987-12T(d)(4) and (5) provide rules for
the subsequent recognition of losses that
are deferred under § 1.987-12T(d) that
differ from the remittance-based rules
that generally apply following deferral
events.

Like the definition of deferral event, an
outbound loss event includes two catego-
ries of transactions with respect to a sec-
tion 987 QBU with net unrecognized sec-
tion 987 loss. First, an outbound loss
event includes any termination of the sec-
tion 987 QBU in connection with a trans-
fer of assets of the section 987 QBU by a
U.S. person to a foreign person that was a
member of the same controlled group as
the U.S. transferor immediately before the
transaction or, if the transferee did not
exist immediately before the transaction,
immediately after the transaction (related
foreign person). The second category of
outbound loss events includes any transfer
by a U.S. person of part of an interest in a
section 987 aggregate partnership or DE

through which the U.S. person owns the
section 987 QBU to a related foreign per-
son that has the same functional currency
as the section 987 QBU. The second cat-
egory also includes a contribution of as-
sets by such a related foreign person to the
partnership or DE if the contribution has
the effect of reducing the U.S. person's
interest in the section 987 QBU (and
therefore causes a deemed transfer of as-
sets and liabilities to the U.S. person from
the section 987 QBU) and the contributed
assets are not included on the books and
records of an eligible QBU of the partner-
ship or DE. The second category would be
implicated, for example, if a U.S. person
transferred part of the interest in a DE
through which it owned a section 987
QBU to a foreign corporation that had the
same functional currency as the section
987 QBU in an outbound section 351
transaction.

Under these rules, the owner of the
outbound loss QBU recognizes section
987 loss in the taxable year of the out-
bound loss event as determined under
§ 1.987-5 and the deferral event rules of
§ 1.987-12T(b) and (c), except that, solely
for purposes of applying § 1.987-5, cer-
tain assets and liabilities of the outbound
loss QBU are treated as not having been
transferred and therefore as remaining on
the balance sheet of the section 987 QBU,
notwithstanding the outbound loss event.
In the first category of outbound loss
event (involving outbound asset transfers
resulting in terminations), assets and lia-
bilities that, immediately after the out-
bound loss event, are properly reflected on
the books and records of the related for-
eign person or a section 987 QBU of the
related foreign person are treated as not
having been transferred. In the second cat-
egory of outbound loss event (involving
certain partnership and DE transactions),
assets and liabilities that, immediately af-
ter the outbound loss event, are reflected
on the books and records of the eligible
QBU from which the assets and liabilities
of the outbound loss QBU are allocated,
and not on the books and records of a
section 987 QBU, are treated as not hav-
ing been transferred. The difference be-
tween the amount that otherwise would
have been recognized and the amount ac-
tually recognized under this rule is re-
ferred to as outbound section 987 loss.

Although an outbound loss event in the
second category also would constitute a
deferral event, the rules governing defer-
ral events only defer section 987 loss of a
deferral QBU to the extent assets and lia-
bilities are reflected on the books and re-
cords of a successor QBU immediately
after the deferral event. Assets and liabil-
ities of a deferral QBU that are reflected
on the books and records of an eligible
QBU of a partnership and allocated to a
partner that has the same functional cur-
rency as the eligible QBU, as would occur
in an outbound loss event, are not re-
flected on the books and records of a
successor QBU and so would not cause
section 987 loss to be deferred under the
deferral event rules. Thus, there is no
overlap in terms of the effect of the out-
bound loss event rules and the deferral
event rules.

If an outbound loss event results from
the transfer of assets of the outbound loss
QBU in a nonrecognition transaction, the
basis of the stock that is received in the
transaction is increased by an amount
equal to the outbound section 987 loss. In
effect, this rule converts a section 987 loss
into an unrealized stock loss, which may
be recognized upon a recognition event
with respect to the stock. This treatment is
similar to the treatment under section
367(a) of foreign currency losses with re-
spect to foreign-currency denominated
property that is transferred outbound in a
nonrecognition event to a foreign corpo-
ration that has as its functional currency
the currency in which the property is de-
nominated. Outbound section 987 loss at-
tributable to an outbound loss event that
does not occur in connection with a non-
recognition transaction is recognized by
the owner of the outbound loss QBU in
the first taxable year in which the owner
(or any qualified successor) and the re-
lated foreign person that participated in
the outbound loss event (or any qualified
successor) cease to be members of the
same controlled group. In many circum-
stances this treatment will provide similar
results as converting section 987 loss into
stock basis as in the case of outbound loss
events that result from a nonrecognition
transaction.

The temporary regulations provide
that, if loss is recognized on the sale or
exchange of stock within two years of an

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outbound loss event that gave rise to an
adjustment to the basis of the stock, then,
to the extent of the outbound section 987
loss, the source and character of the loss
recognized on the sale or exchange will be
determined under § 1.987-6 as if such
loss were section 987 loss recognized pur-
suant to § 1.987-5 without regard to
§ 1.987-12T on the date of the outbound
loss event.

### E. Anti-abuse rule

The temporary regulations provide an
anti-abuse rule to address transactions
structured to avoid the deferral rules in
§ 1.987-12T. This rule provides that no
section 987 loss is recognized under
§ 1.987-5 in connection with a transaction
or series of transactions that are under-
taken with a principal purpose of avoiding
the purposes of § 1.987-12T. This rule
would apply, for example, if, with a prin-
cipal purpose of recognizing a deferred
section 987 loss, a taxpayer engaged in a
transaction that caused a deferral QBU
owner to cease to exist without a qualified
successor or caused a successor QBU to
cease to exist, such that deferred section
987 loss otherwise would be recognized
under § 1.987-12T(c).

### F. Coordination with fresh start transition method

The temporary regulations require ad-
justments to coordinate the application of
§ 1.987-12T with the fresh start transition
method described in § 1.987-10(b) for
transitioning to the final regulations. If a
deferral QBU owner is required under
§ 1.987-10(a) to apply the fresh start tran-
sition method with respect to the deferral
QBU on the transition date, or if a deferral
QBU owner would have been so required
if it had owned the deferral QBU on the
transition date, the outstanding deferred
section 987 gain or loss of the deferral
QBU owner with respect to the deferral
QBU must be adjusted on the transition
date to equal the amount of outstanding
deferred section 987 gain or loss that the
deferral QBU owner would have had with
respect to the deferral QBU on the transi-
tion date if, immediately before the defer-
ral event, the deferral QBU had transi-
tioned to the final regulations pursuant to

the fresh start transition method. Addi-
tionally, if the owner of an outbound loss
QBU is required under § 1.987-10(a) to
apply the fresh start transition method
with respect to the outbound loss QBU on
the transition date, or if the owner would
have been so required if it had owned the
outbound loss QBU on the transition date,
the basis of any stock that was subject to
a basis adjustment under § 1.987-12T as a
result of the outbound loss event must be
adjusted to equal the basis that such stock
would have had on the transition date if,
immediately prior to the outbound loss
event, the outbound loss QBU had transi-
tioned to the final regulations pursuant to
the fresh start transition method. Out-
bound section 987 loss that is not reflected
in stock basis but that will be recognized
when the owner and the related foreign
person that participated in the outbound
loss event cease to be members of the
same controlled group must be adjusted in
a similar manner. These adjustments to
coordinate the application of § 1.987-12T
with the fresh start transition method must
be made even if the deferral QBU owner
or the owner of the outbound loss QBU
continues to own the deferral QBU or the
outbound loss QBU on the transition date,
as in the case of a deferral event or out-
bound loss event resulting from a transfer
of part of an interest in a section 987
aggregate partnership that does not result
in the termination of the deferral QBU or
outbound loss QBU.

### G. Effective date

The temporary regulations under
§ 1.987-12T generally apply to any defer-
ral event or outbound loss event that oc-
curs on or after January 6, 2017. How-
ever, if the deferral event or outbound loss
event is undertaken with a principal pur-
pose of recognizing section 987 loss, the
30 day delayed effective date does not
apply and § 1.987-12T is effective imme-
diately on December 7, 2016.

### 2. Annual Deemed Termination Election

A comment on the 2006 proposed reg-
ulations recommended that taxpayers be
permitted to make a one-time election un-
der § 1.987-5 to deem a section 987 QBU
as having terminated at the end of each

year, thereby requiring the owner to rec-
ognize all section 987 gains or losses with
respect to the QBU on an annual basis.
The comment suggested that such an elec-
tion would allow taxpayers to reduce the
complexity and administrative cost of
complying with section 987 because tax-
payers would not be required to track
transactions between an owner and its sec-
tion 987 QBU or unrecognized section
987 gains and losses carried over from
previous years.

The Treasury Department and the IRS
have determined that an annual deemed
termination election would not obviate the
need to track transactions between an
owner and its section 987 QBU, since the
net transfer would remain relevant to the
annual calculation of section 987 gain or
loss. Nonetheless, the Treasury Depart-
ment and the IRS agree that an annual
deemed termination election could en-
hance administrability of the final regula-
tions by reducing the recordkeeping re-
quirements necessary to apply the final
regulations. Additionally, when an annual
deemed termination election is in effect,
taxpayers could not strategically time re-
mittances in order to selectively recognize
section 987 losses but not section 987
gains. Eliminating this planning opportu-
nity would obviate the need for the defer-
ral provisions of § 1.987-12T. Further-
more, as discussed in Part 3 of this
Explanation of Provisions, an annual
deemed termination election would ad-
dress a policy concern with permitting the
hybrid approach to section 987 suggested
by comments on the 2006 proposed regu-
lations.

Based on the foregoing considerations,
§ 1.987-8T(d) provides an election for a
taxpayer to deem its section 987 QBUs to
terminate on the last day of each taxable
year for which the election is in effect.
Because the considerations supporting an
annual deemed termination election gen-
erally are relevant regardless of whether a
taxpayer is subject to the final regulations,
the election under § 1.987-8T(d) is avail-
able to any taxpayer without regard to the
applicability of the final regulations to that
taxpayer or any of its section 987 QBUs.
A section 987 QBU to which this election
applies is treated as having made a remit-
tance of all of its gross assets to its owner
immediately before the section 987 QBU

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terminates on the last day of each taxable
year, resulting in the recognition of any
net unrecognized section 987 gain or loss
of the section 987 QBU. See §§ 1.987-
5(c)(3) and 1.987-8(e). The owner is then
treated as having transferred all of the
assets and liabilities of the terminated sec-
tion 987 QBU to a new section 987 QBU
on the first day of the following taxable
year.

As noted in Part 1 of this Explanation
of Provisions, the temporary regulations
provide that the deferral provisions of
§ 1.987-12T do not apply with respect to
section 987 QBUs for which the annual
deemed termination election is in effect.
Consequently, a taxpayer that finds the
annual deemed termination election pref-
erable to § 1.987-12T based on ease of
compliance or other reasons may make
the annual deemed termination election.
Moreover, as discussed in Part 3 of this
Explanation of Provisions, a taxpayer that
makes the annual deemed termination
election with respect to a section 987
QBU may reduce the compliance burden
associated with computing taxable income
or loss under the final regulations by elect-
ing to translate taxable income or loss of
the section 987 QBU into the owner's
functional currency at the yearly average
exchange rate without any adjustments.

The Treasury Department and the IRS
have determined that special consistency
and effective date rules are needed for the
annual deemed termination election to
prevent taxpayers from using the election
to selectively recognize section 987 losses
without recognizing section 987 gains.
Unless the annual deemed termination
election is required to be made with re-
spect to all section QBUs owned by re-
lated persons at the time of the election,
taxpayers could choose to make the elec-
tion only with respect to section 987
QBUs that have net unrecognized section
987 losses at the time of the election.
Accordingly, § 1.987-1T(g)(2)(i)(B)(1)
provides that the annual deemed termina-
tion election generally applies to all sec-
tion 987 QBUs owned by an electing tax-
payer, as well as to all section 987 QBUs
owned by any person that has a relation-
ship to the taxpayer described in section
267(b) or section 707(b) (substituting
"and the profits interest" for "or the profits
interest" in section 707(b)(1)(A) and sub-

stituting "and profits interests" for "or
profits interests" in section 707(b)(1)(B))
on the last day of the first taxable year for
which the election applies to the taxpayer
(a related person).

A taxpayer that is subject to the final
regulations and that must transition to the
final regulations under the fresh start tran-
sition method of § 1.987-10(b) (fresh start
taxpayer) may make the annual deemed
termination election only if the first tax-
able year for which the election would
apply is either (i) the first taxable year
beginning on or after the transition date
(as defined in § 1.987-11(c)) with respect
to the taxpayer or (ii) a subsequent taxable
year in which the "taxpayer's controlled
group aggregate section 987 loss" (if any)
does not exceed $5 million. For this pur-
pose, a "taxpayer's controlled group ag-
gregate section 987 loss" means the ag-
gregate net amount of section 987 gain or
loss that would be recognized pursuant to
the election under § 1.987-8T(d) by the
taxpayer and all related persons in the first
taxable year of each person for which the
election would apply.

Taxpayers that used a method based on
a reasonable application of the 2006 pro-
posed regulations prior to the transition
date, and which therefore are not subject
to the fresh start transition method pursu-
ant to § 1.987-10(c), and taxpayers for
which the final regulations are not appli-
cable, must follow the election rules for
fresh start taxpayers if any related party is
a fresh start taxpayer. If no related party is
a fresh start taxpayer, the annual deemed
termination election may be made only if
the first taxable year for which the elec-
tion would apply is either (i) the first
taxable year beginning on or after Decem-
ber 7, 2016, in which the election is rele-
vant in determining section 987 taxable
income or loss or section 987 gain or loss
or (ii) a subsequent taxable year in which
the "taxpayer's controlled group aggre-
gate section 987 loss" (if any) does not
exceed $5 million.

If a taxpayer makes the annual deemed
termination election, the election will ap-
ply to the first taxable year of a related
person that ends with or within a taxable
year of the taxpayer to which the taxpay-
er's election applies. Once made, the an-
nual deemed termination election may not
be revoked.

As provided in § 1.987-1T(g)(2)(i)(B)(2),
the special consistency and effective date
rules in § 1.987-1T(g)(2)(i)(B)(1) do not
apply and a taxpayer may make a separate
election under § 1.987-8T(d) with respect
to any section 987 QBU owned by the
taxpayer if the first taxable year for which
the election would apply to the taxpayer
with respect to the section 987 QBU is a
taxable year in which the deemed termi-
nation results in the recognition of section
987 gain with respect to the section 987
QBU or the deemed termination results in
the recognition of $1 million or less of
section 987 loss with respect to the section
987 QBU.

3\. Election to Translate All Items at the
Yearly Average Exchange Rate

As discussed in the preamble to the
final regulations, comments on the 2006
proposed regulations recommended a hy-
brid approach that would combine the
methodology of the regulations proposed
under section 987 in 1991 (INTL-965-
86, 56 FR 48457) for computing a section
987 QBU's net income with the method-
ology of the 2006 proposed regulations
for computing section 987 gain or loss.
Under the proposed hybrid approach, sec-
tion 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 own-
er's functional currency at the yearly av-
erage exchange rate without any adjust-
ments.

Although a hybrid approach would
simplify the calculation of section 987
taxable income or loss, the preamble to
the final regulations observes that the hy-
brid approach gives rise to offsetting ef-
fects in section 987 taxable income or loss
and in the foreign exchange exposure pool
(FEEP) that raise concerns similar to
those addressed by Congress in enacting
section 1092. In particular, under the hy-
brid approach, exchange rate effects with
respect to historic assets would be re-
flected 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 be rec-
ognized only upon remittances. Thus, off-
setting effects arising from a single asset
would be taken into account at different
times. The Treasury Department and the

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IRS have determined that it would be in-
appropriate for regulations under section
987 to permit distortions to section 987
taxable income or loss that have the effect
of causing potentially large offsetting
amounts of loss or gain to be reflected in
the FEEP with respect to the same asset,
since the loss or gain in the FEEP would
be recognized only upon voluntary remit-
tances from the QBU.

Nonetheless, the Treasury Department
and the IRS acknowledge the concerns
expressed in comments regarding the
complexity of the 2006 proposed regula-
tions that underlie the recommendation to
adopt the hybrid approach. Concerns
about offsetting amounts recognized at
different times under the hybrid approach
would not arise for taxpayers that make
the annual deemed termination election
set forth in § 1.987-8T(d). A taxpayer
that recognizes all section 987 gain or loss
with respect to its section 987 QBUs an-
nually would take into account in recog-
nized section 987 gain or loss the ex-
change rate effects with respect to historic
assets that are reflected in the FEEP in the
same taxable year in which the offsetting
effects are taken into account in section
987 taxable income or loss. Although the
hybrid approach could result in differ-
ences in character of exchange gain or
loss relative to the final regulations even
for taxpayers that make the annual
deemed termination election, the Treasury
Department and the IRS have determined
that the administrative convenience of al-
lowing taxpayers to translate a section 987
QBU's taxable income at the yearly aver-
age exchange rate outweighs that consid-
eration.

Accordingly, the temporary regulations
provide that a taxpayer that is otherwise
generally subject to the final regulations
may elect to apply the hybrid approach
with respect to a section 987 QBU that is
subject to the annual deemed termination
election. In particular, § 1.987-3T(d) pro-
vides that, notwithstanding the rules of
§ 1.987-3(c) for translating items deter-
mined under § 1.987-3(b) in a section 987
QBU's functional currency into the own-
er's functional currency, a taxpayer may
elect to translate all items of income, gain,
deduction, and loss of a section 987 QBU
with respect to which the annual deemed
termination election described in § 1.987-

8T(d) is in effect into the owner's func-
tional currency, if necessary, at the yearly
average exchange rate for the taxable
year. An owner of multiple section 987
QBUs may make the election described in
§ 1.987-3T(d) with respect to all of its
section 987 QBUs or only certain desig-
nated section 987 QBUs.

### 4. Section 988 Transactions of a Section 987 QBU

#### A. Background regarding the treatment of section 988 transactions under the proposed regulations

The 2006 proposed regulations re-
flected a two-pronged approach to the ap-
plication of section 988 to transactions of
a section 987 QBU, with different conse-
quences generally depending on whether a
transaction is denominated in (or deter-
mined by reference to) the owner's func-
tional currency or a currency that is a
nonfunctional currency with respect to
both the owner and the section 987 QBU
(third currency). As a general rule,
§ 1.987-3(e)(1) of the 2006 proposed reg-
ulations provided that section 988 applies
to section 988 transactions attributable to
a section 987 QBU and that the timing of
any gain or loss is determined under the
applicable provisions of the Code, but the
2006 proposed regulations did not clearly
specify whether section 988 gain or loss
would be determined with respect to the
functional currency of the section 987
QBU or the owner's functional currency.
Assets and liabilities giving rise to section
988 transactions were defined under pro-
posed § 1.987-1(d) and (e) as historic
items. Under § 1.987-3(e)(2) of the 2006
proposed regulations, transactions of a
section 987 QBU described in section
988(c)(1)(B)(i) (relating to the acquisition
of, or becoming an obligor under, a debt
instrument), section 988(c)(1)(B)(ii) (re-
lating to accrual of items of expense or
gross income or receipts) or section
988(c)(1)(C) (relating to the disposition of
nonfunctional currency) that are denomi-
nated in (or determined by reference to)
the owner's functional currency, however,
were not treated as section 988 transac-
tions of the section 987 QBU, and no gain
or loss was recognized under section 988
with respect to such transactions. Assets

and liabilities giving rise to such transac-
tions were required to be reflected on the
balance sheet of the section 987 QBU in
the owner's functional currency under
§ 1.987-2(d)(2) of the 2006 proposed reg-
ulations.

Additionally, § 1.987-3(d) of the 2006
proposed regulations provided that an
item of income, gain, deduction, or loss of
a section 987 QBU denominated in a cur-
rency other than the functional currency
of the owner is translated at the spot rate
on date the item is appropriately taken
into account. Under § 1.987-3(c) of the
2006 proposed regulations, an item of in-
come, gain, deduction, or loss of a section
987 QBU denominated in the owner's
functional currency is not translated and is
taken into account by the section 987
QBU in the owner's functional currency.

One comment indicated that the 2006
proposed regulations were unclear regard-
ing the interaction of the rules for the
treatment of section 988 transactions de-
nominated in a third currency with the
treatment of assets that give rise to section
988 transactions as historic assets. Upon
the disposition of a historic asset, the 2006
proposed regulations required translation
of the basis of the historic asset at the
historic rate and the amount realized with
respect to the asset at the yearly average
exchange rate for the taxable year of the
disposition or, if properly elected, the ap-
propriate spot rate. Yet, § 1.987-3(f), Ex-
ample 10 of the 2006 proposed regula-
tions illustrated the determination of
section 988 gain or loss on a third-
currency section 988 transaction in, and
by reference to, the section 987 QBU's
functional currency and translation of that
amount into the owner's functional cur-
rency at the yearly average exchange rate.
Under the approach of the example, his-
toric asset basis is effectively translated at
the yearly average exchange rate rather
than the appropriate historic rate.

B. General rules for section 988
transactions in the temporary
regulations

In light of the comment regarding the
uncertain application of section 988 to
transactions of a section 987 QBU under
the 2006 proposed regulations and further
consideration of the appropriate rules, the

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temporary regulations clarify and elabo-
rate upon the application of section 988 to
transactions attributable to a section 987
QBU. In this regard, the Treasury Depart-
ment and the IRS have determined that
computing section 988 gain or loss by
reference to the functional currency of the
section 987 QBU, rather than the owner's
functional currency, and translating that
amount at the yearly average exchange
rate would be inconsistent with the treat-
ment of items that give rise to section 988
transactions as historic items. Such items
were treated as historic items under the
2006 proposed regulations because they
do not economically expose the owner to
fluctuations in the section 987 QBU's
functional currency.

Taking these considerations into ac-
count, the Treasury Department and the
IRS have determined that it is appropriate
to continue to treat assets and liabilities
giving rise to section 988 transactions of a
section 987 QBU as historic items under
§§ 1.987-1(d) and (e) of the final regula-
tions. Thus, for example, a note denomi-
nated in a nonfunctional currency that
gives rise to a section 988 transaction
when acquired is a historic asset. How-
ever, the temporary regulations generally
provide that section 988 gain or loss aris-
ing from section 988 transactions of a
section 987 QBU is determined by refer-
ence to the owner's functional currency,
rather than the functional currency of the
section 987 QBU. See § 1.987-3T(b)(4)
(i). Accordingly, in determining section
988 gain or loss with respect to a section
988 transaction of a section 987 QBU, the
amounts required under section 988 to be
translated on the applicable booking date
or payment date with respect to the sec-
tion 988 transaction are translated from
the currency in which the amounts are
denominated (or by reference to which
they are determined) into the owner's
functional currency at the rate required
under section 988 and the section 988
regulations, which provide for translation
at the appropriate spot rate.

When a section 987 QBU recognizes
gain or loss on the disposition of a historic
asset that gives rise to a section 988 trans-
action, some or all of the total gain or loss
that is realized on the disposition may be
section 988 gain or loss that, under section
988, is ordinary income that is sourced by

reference to the residence of the section
987 QBU. For example, on the disposition
of a nonfunctional currency note, the total
gain or loss realized may be comprised of
section 988 gain or loss that reflects ex-
change rate changes and other gain or loss
that reflects other factors, such as changes
in prevailing interest rates or in the cred-
itworthiness of the note issuer. The total
gain or loss on the disposition of a historic
asset that gives rise to a section 988 trans-
action is determined under the general
rules of section 987 by reference to the
functional currency of the section 987
QBU. Section 988 gain or loss on the note
is determined under §§ 1.988-2(b)(5) and
(8) and 1.987-3T(b)(4)(i) by comparing
the section 987 QBU's acquisition price
for the note in nonfunctional currency
translated into the owner's functional cur-
rency at the spot rates on the date of
acquisition and the date of disposition,
respectively. See § 1.987-3T(e), Example
11. To provide for consistent translation
rates for determining both the total gain or
loss on such a historic asset and the por-
tion of the total gain or loss that is section
988 gain or loss, § 1.987-3T(c)(2)(ii)
specifies that the spot rate also must be
used to translate the amount received with
respect to a historic asset if the acquisition
of the historic asset gave rise to a section
988 transaction. Additionally, consistent
with the regulations under § 1.988-1(d)
regarding the use of spot rate conventions
for section 988 transactions, § 1.987-
1T(c)(1)(ii)(B) specifies that the election
in § 1.987-1(c)(1)(ii)(A) to use a spot rate
convention generally does not apply for
purposes of determining section 987 tax-
able income or loss with respect to a his-
toric item (as defined in § 1.987-1(e)) if
acquiring, accruing, or entering into such
item gave rise to a section 988 transaction
or a specified owner functional currency
transaction (discussed in this Part B).

Because assets and liabilities that give
rise to section 988 transactions generally
are historic items that have a spot rate as
the historic rate under § 1.987-1T(c)(3)
(i)(E), such assets and liabilities are trans-
lated at historic rates and do not give rise
to section 987 gain or loss. Thus, when the
general rules for section 988 transactions
of a section 987 QBU apply, the owner
will take into account under subpart J for-
eign currency exposure with respect to a

section 988 transaction of a section 987
QBU only to the extent of the owner's
economic exposure to fluctuations of its
functional currency relative to the cur-
rency in which the section 988 transaction
is denominated.

Additionally, consistent with the 2006
proposed regulations, the temporary regu-
lations confirm that certain transactions
that are denominated in (or determined by
reference to) the owner's functional cur-
rency are not subject to section 988. Spe-
cifically, § 1.987-3T(b)(4)(ii) provides
that specified owner functional currency
transactions, which are defined as transac-
tions described in section 988(c)(1)(B)(i)
or (ii) or section 988(c)(1)(C) (including
the acquisition of nonfunctional currency
described in § 1.988-1(a)(1)) that are de-
nominated in (or determined by reference
to) the owner's functional currency, other
than certain transactions described in
§ 1.987-3T(b)(4)(iii)(A) that are subject
to a mark-to-market regime (discussed in
Part 4.C of this Explanation of Provi-
sions), are not treated as section 988 trans-
actions. Although the temporary regula-
tions do not follow the 2006 proposed
regulations in specifying that assets and
liabilities that give rise to specified owner
functional currency transactions must be
reflected on the balance sheet of the sec-
tion 987 QBU in the owner's functional
currency, the temporary regulations treat
items that give rise to specified owner
functional currency transactions as his-
toric items that generally have a spot rate
as the historic rate under § 1.987-
1T(c)(3)(i)(E) and provide under § 1.987-
3T(b)(2)(ii) that the basis and amount re-
alized of a historic asset that gives rise to
a specified owner functional currency
transactions are not translated if denomi-
nated in the owner's functional currency.
Together, these rules have the same effect
as the treatment of specified owner func-
tional currency transactions under the
2006 proposed regulations.

C. Special rules to allow greater
conformity with the financial accounting
treatment for certain section 988
transactions

As discussed in the preamble to the
final regulations, under the financial ac-
counting standard described in Account-

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ing Standards Codification, Foreign Cur-
rency Matters, section 830 (ASC 830),
gains and losses from changes in ex-
change rates with respect to transactions
that are denominated in a currency other
than the entity's functional currency are
referred to as "transaction" gains and
losses. The category of foreign currency
transactions that give rise to transaction
gains and losses for financial accounting
purposes overlaps considerably with the
definition of a section 988 transaction for
tax purposes, such that transaction gains
and losses under financial accounting
rules are conceptually similar to section
988 gains and losses. The financial ac-
counting rules require the inclusion of
transaction gains and losses in net income
for the period in which the exchange rate
changes occur. See ASC 830-20-35-1.
Moreover, transaction gain or loss is al-
ways determined by reference to the func-
tional currency of the entity that entered
into the transaction. Thus, the financial
accounting rules differ from the general
tax rules applicable to section 988 trans-
actions entered into by a section 987 QBU
in two respects. First, the financial ac-
counting rules require transaction gain or
loss to be determined on a mark-to-market
basis, whereas gain or loss from a section
988 transaction generally is not recog-
nized until there is a realization event un-
der general tax principles and the applica-
ble provisions of the Code. Second, the
financial accounting rules require transac-
tion gain or loss to be determined by ref-
erence to the entity's functional currency,
even when it differs from the reporting
currency used in the consolidated finan-
cial statements and the transaction is de-
nominated in the reporting currency.

As noted in the preamble to the final
regulations, comments on the 2006 pro-
posed regulations expressed a preference
for greater consistency of the section 987
regulations with financial accounting
rules. Taking these comments into ac-
count, the Treasury Department and the
IRS have determined that providing treat-
ment similar to the financial accounting
treatment for certain section 988 transac-
tions of section 987 QBUs will enhance
administrability of the section 987 regula-
tions with respect to such transactions and
is consistent with the policies of sections
987 and 988.

Accordingly, as discussed in Part 1.C.i
of this Explanation of Provisions, the tem-
porary regulations permit a taxpayer to
elect to determine section 987 gain or loss
with respect to qualified short-term sec-
tion 988 transactions (described in Part
1.C.i of this Explanation of Provisions) of
a section 987 QBU under a foreign cur-
rency mark-to-market method of account-
ing. In addition, as discussed in Part 4.C.ii
of this Explanation of Provisions, the tem-
porary regulations provide that section
988 gain or loss with respect to qualified
short-term section 988 transactions that
are accounted for under a mark-to-market
method of accounting for Federal tax pur-
poses (including the elective method de-
scribed in Part 1.C.i of this Explanation of
Provisions) is determined in, and by ref-
erence to, the functional currency of the
section 987 QBU rather than the func-
tional currency of its owner.

#### i. Election to Apply a Foreign Currency Mark-to-Market Method of Accounting for Certain Section 988 Transactions

The Treasury Department and the IRS
have determined that allowing a taxpayer
to mark to market foreign currency gain or
loss with respect to qualified short-term
section 988 transactions of a section 987
QBU will enhance administrability by
aligning the timing for recognizing gain or
loss with respect to such transactions with
the financial accounting rules. Accord-
ingly, a taxpayer may elect, on a QBU-
by-QBU basis, under § 1.987-3T(b)(4)
(iii)(C) to apply the foreign currency
mark-to-market method of accounting to
qualified short-term section 988 transac-
tions. Under this election, the timing of
section 988 gain or loss is determined for
applicable transactions under the princi-
ples of section 1256(a)(1). Thus, when the
election applies, section 988 gain or loss
with respect to a qualified short-term sec-
tion 988 transaction is recognized on an
annual basis, but other gain or loss with
respect to any property underlying the
transaction (e.g., gain or loss on a debt
instrument due to interest rate fluctua-
tions) is determined under the otherwise
applicable recognition provisions.

A qualified short-term section 988
transaction is defined in § 1.987-3T(b)(4)
(iii)(B) as a section 988 transaction, in-

cluding a transaction denominated in the
owner's functional currency, that both (1)
occurs in the ordinary course of the sec-
tion 987 QBU's business and (2) has an
original term of one year or less on the
day it is entered into by the section 987
QBU. The holding of currency that is non-
functional currency (within the meaning
of section 988(c)(1)(C)(ii)) to the section
987 QBU in the ordinary course of a sec-
tion 987 QBU's trade or business also is
treated as a qualified short-term section
988 transaction.

ii. Special Rule Requiring Gain or Loss
from Certain Section 988 Transactions
that are Subject to a Mark-to-Market
Method of Accounting to be Determined
by Reference to the Functional Currency
of the Section 987 QBU

The temporary regulations include a
special rule for determining section 988
gain or loss with respect to qualified short-
term section 988 transactions (as de-
scribed in Part 4.C.i of this Explanation of
Provisions) of a section 987 QBU that are
accounted for under a mark-to-market
method of accounting. Specifically,
§ 1.987-3T(b)(4)(iii)(A) provides that
section 988 gain or loss with respect to
qualified short-term section 988 transac-
tions of a section 987 QBU, and certain
related hedges, that are accounted for un-
der a mark-to-market method of account-
ing under section 475, section 1256, or
§ 1.987-3T(b)(4)(iii)(C) (discussed in
Part 4.C.i of this Explanation of Provi-
sions) is determined in, and by reference
to, the functional currency of the section
987 QBU rather than the owner's func-
tional currency. Items that give rise to
qualified short-term section 988 transac-
tions for which section 988 gain or loss is
determined under § 1.987-3T(b)(4)(iii)
(A) by reference to the section 987 QBU's
functional currency are treated as marked
items under § 1.987-1T(d)(3), with the
result that gain or loss attributable to such
items is translated at the yearly average
exchange rate and that such items give
rise to net unrecognized section 987 gain
or loss.

Under the rules for qualified short-term
section 988 transactions accounted for un-
der a mark-to-market method of account-
ing, a section 987 QBU owner will take
into account the full amount of its eco-

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nomic foreign currency exposure arising
from such transactions, but the effects of
such exposure generally will be bifurcated
into a component reflected in section 987
taxable income or loss and a component
reflected in the FEEP pool and recognized
upon a remittance. These components
could offset each other if the currency in
which the section 988 transaction is de-
nominated and the owner's functional cur-
rency moved in opposite directions rela-
tive to the section 987 QBU's functional
currency. Restricting this treatment to
qualified short-term section 988 transac-
tions accounted for under a mark-to-
market method of accounting limits the
potential for abusive planning. In particu-
lar, the restriction to transactions ac-
counted for under a mark-to-market
method of accounting prevents selective
realization of section 988 losses that
would be taken into account in section
987 taxable income or loss in situations in
which an offsetting gain is reflected in the
FEEP. Additionally, short-term, ordinary-
course section 988 transactions are less
likely than other section 988 transactions
to give rise to substantial offsetting effects
in section 987 taxable income or loss and
in the FEEP.

### 5. Application of Section 987 to QBUs with the U.S. Dollar as a Functional Currency

Consistent with the opening clause of
section 987, which indicates that section
987 applies to the determination of the
taxable income of any taxpayer "having 1
or more qualified business units with a
functional currency other than the dollar,"
§ 1.987-1T(b)(6)(i) sets forth a general
rule that section 987 and the regulations
thereunder do not apply with respect to an
eligible QBU (determined without regard
to the scope limitations of § 1.987-
1(b)(3)(ii)) that has the U.S. dollar as its
functional currency and that would be
subject to section 987 if it had a functional
currency other than the U.S. dollar (dollar
QBU).

The Treasury Department and the IRS
have determined, however, that it is ap-
propriate for a CFC that is the owner of a
dollar QBU to recognize foreign currency
gain or loss with respect to transactions of
the dollar QBU that would be section 988

transactions if entered into directly by the
owner. Accordingly, pursuant to the au-
thority granted in section 985(a), § 1.987-
1T(b)(6)(ii)(A) provides that the CFC
owner of a dollar QBU will be subject to
section 988 with respect to any item that is
properly reflected on the books and re-
cords of the dollar QBU and that would
give rise to a section 988 transaction if
such item were acquired, accrued, or en-
tered into directly by the owner of the
dollar QBU. For purposes of applying sec-
tion 988 to such items, § 1.987-
1T(b)(6)(ii)(A) provides that such items
are treated as properly reflected on the
books and records of the dollar QBU's
owner. Thus, except as provided in the
special rule described later in this Part 5 of
this Explanation of Provisions for com-
puting income that is effectively con-
nected with the conduct of a trade or busi-
ness within the United States (ECI), a
CFC would determine section 988 gain or
loss from transactions of a dollar QBU by
reference to the CFC's functional cur-
rency. For example, for purposes of deter-
mining its earnings and profits, a CFC that
has a euro functional currency and that is
the owner of a dollar QBU with a U.S.
dollar-denominated liability would apply
section 988 with respect to that U.S.
dollar-denominated liability, measuring
section 988 gain or loss on the section 988
transaction arising from the liability by
reference to the euro.

As a result of treating such items as
properly reflected on the books and re-
cords of the CFC, instead of those of the
dollar QBU, the CFC's section 988 gain
or loss with respect to such items gener-
ally would be treated as foreign source
income because section 988(a)(3) gener-
ally provides that the source of section
988 gain or loss is determined by refer-
ence to the residence of the taxpayer or
QBU on whose books the asset, liability,
or other item giving rise to the section 988
transaction is properly reflected. Section
1.988-4 then would apply to determine
whether the section 988 gain or loss
would be treated as ECI. Because a QBU
with ECI must have the U.S. dollar as its
functional currency (§ 1.985-1(b)(1)(v)),
section 988 gain or loss measured by ref-
erence to the owner CFC's functional cur-
rency would not be ECI. However, the
temporary regulations provide a special

rule for certain section 988 transactions of
a dollar QBU (including section 988
transactions denominated in the owner's
functional currency) that arise from the
conduct of a United States trade or busi-
ness.

The special rule applies to a CFC
owner of a dollar QBU that would have a
section 988 transaction that would give
rise to section 988 gain or loss that would
be treated as ECI under § 1.988-4(c) if the
item that would give rise to the section 988
transaction were treated as properly re-
flected on the books and records of the dol-
lar QBU. Under § 1.987-1T(b)(6)(ii)(B),
solely for purposes of determining the
amount of section 988 gain or loss of the
CFC that is ECI, any section 988 gain or
loss that would be determined under section
988 as a result of the acquisition or accrual
of any item and treated as ECI if the item
were treated as properly reflected on the
books and records of the dollar QBU is
determined by treating such item as properly
reflected on the books and records of the
dollar QBU and, consequently, is deter-
mined by reference to the U.S. dollar.

The application of § 1.987-1T(b)(6)(ii)
to a section 988 transaction that is denom-
inated in a third currency (that is, neither
the CFC's functional currency nor the
U.S. dollar) could result in the same sec-
tion 988 transaction generating ECI (de-
termined by reference to the U.S. dollar)
and generating subpart F income (deter-
mined by reference to the CFC owner's
functional currency), subject to any limi-
tation imposed by section 952(b). Under
section 952(b), if the amount determined
under § 1.987-1T(b)(6)(ii)(A) by refer-
ence to the owner's functional currency
and the amount of ECI determined under
§ 1.987-1T(b)(6)(ii)(B) were both gains,
only the excess, if any, of the gain deter-
mined by reference to the owner's func-
tional currency over the ECI gain would
be taken into account in determining sub-
part F income. If the amount determined
under § 1.987-1T(b)(6)(ii)(A) by refer-
ence to the owner's functional currency
and the amount of ECI determined under
§ 1.987-1T(b)(6)(ii)(B) were both losses,
the loss determined by reference to the
owner's functional currency would be
taken into account in determining subpart
F income only to the extent it exceeds the
ECI loss.

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The Treasury Department and the IRS
recognize the potential administrative bur-
den associated with applying the forego-
ing rules to a dollar QBU, which may give
rise to a large number of section 988
transactions. Accordingly, § 1.987-1T(b)
(6)(iii) provides an election for a CFC that
directly or indirectly owns a dollar QBU
to apply section 987 and the regulations
thereunder in lieu of applying section 988
pursuant to § 1.987-1T(b)(6)(ii). The
Treasury Department and the IRS have
determined that, when this election ap-
plies, the source of foreign currency gain
or loss that is determined under section
987 pursuant to the election should be
consistent with the source that would have
been determined under section 988 in the
absence of the election. Accordingly, con-
sistent with the source rule in section
988(a)(3), § 1.987-6T(b)(4) provides that
the source of section 987 gain or loss
determined with respect to a dollar QBU
for which the owner has elected to apply
section 987 is determined by reference to
the residence of the CFC owner. Thus,
such section 987 gain or loss will have a
foreign source.

As is the case for dollar QBUs of CFCs
that do not make the election under
§ 1.987-1T(b)(6)(iii) to apply section 987,
CFCs that make the election and that have
a dollar QBU that engages in a U.S. trade
or business must apply a special rule to
determine the amount of ECI that arises
from transactions that would give rise to
section 988 gain or loss if determined by
reference to the dollar QBU's U.S. dollar
functional currency. This special rule for
determining the amount of ECI applies
only to dollar QBUs that generate ECI
because, under § 1.985-1(b)(1)(v), a QBU
that produces income or loss that is, or is
treated as, ECI must use the dollar as its
functional currency. The special rule is
needed for dollar QBUs that elect to be
treated as section 987 QBUs because, un-
der the general rules of § 1.987-3T(b)(4)
(i) and (ii), which apply to all section 987
QBUs other than with respect to certain
short-term transactions described in
§ 1.987-3T(b)(4)(iii)(B) that are ac-
counted for under a mark-to-market
method of accounting, section 988 gain or
loss of a section 987 QBU with respect to
transactions denominated in a third cur-
rency is determined in, and by reference

to, the functional currency of the owner of
the section 987 QBU, and section 988
gain or loss generally is not determined
with respect to specified owner functional
currency transactions described in Part
4.B of this Explanation of Provisions.
Thus, in order to determine the appropri-
ate amount of ECI from transactions of a
dollar QBU for which an election to apply
section 987 is in effect, § 1.987-1T(b)
(6)(iii)(B) provides that, solely for pur-
poses of determining the amount of sec-
tion 988 gain or loss that is ECI, any
section 988 gain or loss that would be
determined under section 988 as a result
of the acquisition or accrual of any item
and treated as ECI under § 1.988-4(c) if
the item were treated as properly reflected
on the books and records of the dollar
QBU is determined by treating the item as
properly reflected on the books and re-
cords of the dollar QBU. Consequently,
solely for that purpose, such section 988
gain or loss is determined by reference to
the U.S. dollar. For purposes of determin-
ing the amount of section 988 gain or loss
for other purposes, including to determine
the earnings and profits of the CFC, the
rules in § 1.987-3T(b)(4)(i) and (ii) con-
tinue to apply. As is the case for a CFC
that has not made the election to apply
section 987 in lieu of section 988, a trans-
action to which the special rule applies
could generate both ECI and subpart F
income.

## 6. Combinations and Separations of QBUs

### A. Combinations and separations do not give rise to transfers

Under § 1.987-2(c), an asset or liabil-
ity is treated as transferred to a section
987 QBU from its owner if, as a result of
a disregarded transaction, the asset or lia-
bility is reflected on the books and records
of the section 987 QBU. Similarly, an
asset or liability is treated as transferred
from a section 987 QBU to its owner if, as
a result of a disregarded transaction, the
asset or liability is no longer reflected on
the books and records of the section 987
QBU. For this purpose, a disregarded
transaction generally means a transaction
that is not regarded for Federal income tax
purposes. Absent a special rule, the com-

bination of multiple section 987 QBUs
that have the same owner, or the separa-
tion of a section 987 QBU into two or
more section 987 QBUs that have the
same owner, would give rise to a transfer
between an owner and one or more sec-
tion 987 QBUs under the final regulations.

Consistent with the policy of deferring
section 987 gain or loss under § 1.987-
12T when assets of a section 987 QBU are
reflected on the books and records of an-
other section 987 QBU in the same con-
trolled group as a result of certain trans-
actions that result in deemed transfers, the
Treasury Department and the IRS have
determined that it would not be appropri-
ate for combinations or separations of sec-
tion 987 QBUs of the same owner to give
rise to transfers to or from the section 987
QBUs. Accordingly, under the temporary
regulations, section 987 gain or loss gen-
erally is not recognized when two or more
section 987 QBUs (combining QBUs)
with the same owner combine into a sin-
gle section 987 QBU (combined QBU) or
when a section 987 QBU (separating
QBU) separates into multiple section 987
QBUs (each, a separated QBU).

Specifically, notwithstanding the gen-
eral rule of the final regulations, § 1.987-
2T(c)(9)(i) provides that the combination
of two or more combining QBUs that
have the same owner into a combined
QBU does not give rise to a transfer of
any combining QBU's assets or liabilities
to the owner. In addition, § 1.987-
2T(c)(9)(i) provides that transactions be-
tween the combining QBUs occurring in
the taxable year of the combination, which
otherwise would give rise to transfers, do
not result in a transfer of the combining
QBUs' assets or liabilities to the owner
under § 1.987-2(c). For this purpose, a
combination occurs when the assets and
liabilities that are properly reflected on the
books and records of two or more com-
bining QBUs begin to be properly re-
flected on the books and records of a
combined QBU and the separate existence
of the combining QBUs ceases. A combi-
nation may result from any transaction or
series of transactions in which combining
QBUs become a combined QBU.

Similarly, § 1.987-2T(c)(9)(iii) pro-
vides that the separation of a separating
QBU into two or more separated QBUs
that have the same owner after the sepa-

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ration does not give rise to a transfer of
any of the separating QBU's assets or
liabilities to the owner. For this purpose, a
separation occurs when assets and liabili-
ties that are properly reflected on the
books and records of a separating QBU
begin to be properly reflected on the
books and records of two or more sepa-
rated QBUs. A separation may result from
any transaction or series of transactions in
which the separating QBU becomes two
or more separated QBUs.

#### B. Determination of net unrecognized section 987 gain or loss of combined QBUs and separated QBUs

The temporary regulations generally
require combining the aggregate net un-
recognized section 987 gain or loss of
combining QBUs for purposes of deter-
mining net unrecognized section 987 gain
or loss of the combined QBU and require
apportioning the net unrecognized section
987 gain or loss of a separating QBU
among separated QBUs in proportion to
their respective shares of the aggregate
adjusted basis of the separating QBU's
gross assets. Specifically, § 1.987-4T
(f)(1) provides that the net unrecognized
section 987 gain or loss of a combined
QBU for a taxable year is determined by
taking into account the net accumulated
unrecognized section 987 gain or loss of
each combining QBU for all prior taxable
years for which the final regulations apply
and treating the combining QBUs as hav-
ing combined immediately prior to the
beginning of the taxable year of combina-
tion. Additionally, § 1.987-4T(f)(2) pro-
vides that the net unrecognized section
987 gain or loss of a separated QBU for a
taxable year is determined by taking into
account the separated QBU's share of the
net accumulated unrecognized section 987
gain or loss of the separating QBU for all
prior taxable years for which the final
regulations apply and treating the separat-
ing QBU as having separated immediately
prior to the beginning of the taxable year
of separation. No transactions are deemed
to occur between the separating QBUs in
the taxable year of separation prior to the
completion of the separation. A separated
QBU's share of the separating QBU's net
accumulated unrecognized section 987
gain or loss for all prior taxable years is

determined by apportioning the separating
QBU's net accumulated unrecognized
section 987 gain or loss for all prior tax-
able years to each separated QBU in pro-
portion to the aggregate adjusted basis of
the gross assets properly reflected on the
books and records of each separated QBU
immediately after the separation.

The temporary regulations also clarify
at § 1.987-2T(c)(9)(ii) that, if a combin-
ing section 987 QBU has a different func-
tional currency than the combined QBU,
the combining section 987 QBU will be
deemed to have automatically changed its
functional currency to the functional cur-
rency of the combined section 987 QBU
immediately prior to the combination. A
combining section 987 QBU that is
deemed to change its functional currency
under this paragraph must make the ad-
justments described in § 1.985-5.

##### 7. Translation of Foreign Taxes Claimed as a Foreign Tax Credit and Related Income

Under the general rule of § 1.987-
3(c)(1), the owner of a section 987 QBU
uses the yearly average exchange rate (as
defined in § 1.987-1(c)(2)) to translate an
item of income, gain, deduction, or loss of
a section 987 QBU into the owner's func-
tional currency. Alternatively, the owner
of a section 987 QBU may elect to use the
spot rate (as defined in § 1.987-1(c)(1))
for the day each item is taken into ac-
count.

Under section 986(a)(1)(A), for pur-
poses of determining the amount of its
foreign tax credit, a taxpayer that takes
foreign income taxes into account when
accrued generally translates the amount of
any foreign income taxes (and any adjust-
ments thereto) into dollars using the aver-
age exchange rate for the taxable year
to which such taxes relate. However,
sections 986(a)(1)(B) and (C) contain ex-
ceptions to this general rule, including for
taxes that are not paid within two years of
the close of the taxable year to which the
taxes relate (two-year rule). In addition,
section 986(a)(1)(D) provides that a tax-
payer may elect to translate foreign in-
come taxes denominated in a functional
currency other than the taxpayer's func-
tional currency using a spot rate in lieu of
using the yearly average exchange rate.

Section 986(a)(2)(A) generally provides
that, for purposes of determining the
amount of the foreign tax credit with re-
spect to any foreign income taxes not sub-
ject to section 986(a)(1)(A) (or section
986(a)(1)(E), which provides a special
rule for regulated investment companies),
including by reason of the two-year rule
or an election under section 986(a)(1)(D),
the taxes are translated into dollars using
the spot rate on the date such taxes were
paid. Adjustments to such taxes are sub-
ject to the same rule, except that any re-
fund or credit is translated into dollars
using the exchange rate that applied to the
original payment of such foreign income
taxes.

Taking into account the translation
rules of § 1.987-3(c) and section 986(a), a
mismatch could arise between the owner
functional currency value of income used
to pay foreign income taxes and the owner
functional currency value of the foreign
income taxes claimed as a credit. In the
case of foreign income taxes deemed paid
under section 902, section 78 generally
prevents such a mismatch at the level of
the domestic shareholder claiming the
credit by requiring the domestic share-
holder to include in income an amount
equal to the taxes deemed paid, but where
a U.S. person claims a credit under section
901 that is not for taxes deemed paid
under section 902 or section 960, foreign
income taxes and the income used to pay
those taxes could be translated at different
translation rates. To address this potential
mismatch, Notice 89-74, 1989-1 C.B.
739, provides that when a U.S. taxpayer
with a foreign branch that has a functional
currency other than the dollar claims a
foreign tax credit with respect to a foreign
tax, the taxpayer is required to translate a
functional currency amount equal to the
foreign taxes paid on branch income using
the exchange rate at the time of payment
of such taxes.

Consistent with Notice 89-74, § 1.987-
3T(c)(2)(v) includes a special translation
rule providing that income in an amount
equal to the functional currency amount of
the section 987 QBU's foreign income
taxes claimed as a credit must be trans-
lated at the same rate used to translate the
taxes. This translation rule applies to the
owner of a section 987 QBU claiming a
credit under section 901 for foreign in-

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come taxes, other than income taxes
deemed paid under section 902 or section
960, that are properly reflected on the
books of the section 987 QBU. Mechani-
cally, this rule requires the owner to re-
duce the amount of section 987 taxable
income or loss that otherwise would be
determined under § 1.987-3 by an amount
equal to the creditable tax amount, trans-
lated into U.S. dollars at the yearly aver-
age exchange rate for the taxable year in
which the creditable tax is accrued, and
then to increase the resulting amount by
an amount equal to the creditable tax
amount translated into U.S. dollars at the
same exchange rate used to translate the
creditable taxes into U.S. dollars under
section 986(a). If the foreign taxes and the
income are both translated at the same rate
(that is, the same yearly average exchange
rate), no adjustment is necessary under
§ 1.987-3T(c)(2)(v).

##### 8. Determination of a Partner's Share of Assets and Liabilities of a Section 987 Aggregate Partnership

As discussed in the preamble to the
final regulations, the final regulations ap-
ply an aggregate approach with respect to
section 987 aggregate partnerships, which
are defined in § 1.987-1(b)(5) as partner-
ships for which all of the capital and prof-
its interests are owned, directly or indi-
rectly, by persons that are related within
the meaning of section 267(b) or section
707(b). This approach is consistent with
the aggregate approach to partnerships re-
flected in the 2006 proposed regulations,
but the 2006 proposed regulations would
have applied to all partnerships. Under the
aggregate approach, assets and liabilities
reflected on the books and records of an
eligible QBU of a partnership are allo-
cated to each partner, which is considered
an indirect owner of the eligible QBU. If
the eligible QBU has a different func-
tional currency than its indirect owner,
then the assets and liabilities of the eligi-
ble QBU that are allocated to the partner
are treated as a section 987 QBU of the
indirect owner.

The 2006 proposed regulations pro-
vided a rule for determining a partner's
share of the assets and liabilities of an
eligible QBU that is owned indirectly
through a section 987 aggregate partner-

ship. Specifically, proposed § 1.987-7(b)
provided that a partner's share of assets
and liabilities reflected on the books and
records of an eligible QBU owned
through a section 987 aggregate partner-
ship must be determined in a manner con-
sistent with how the partners have agreed
to share the economic benefits and bur-
dens 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 indi-
rectly owned section 987 QBU was am-
biguous and that the rules and principles
of subchapter K do not provide sufficient
guidance in this regard.

The Treasury Department and the IRS
acknowledge the ambiguity in the 2006
proposed regulations regarding the man-
ner in which assets and liabilities of a
partnership are allocated to a partner's
indirectly owned section 987 QBU under
the aggregate approach. Accordingly, the
temporary regulations provide more spe-
cific 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. Specifically,
§ 1.987-7T(b) provides that, in any tax-
able year, a partner's share of each asset
and liability of a section 987 aggregate
partnership is proportional to the partner's
liquidation value percentage with respect
to the aggregate partnership. A partner's
liquidation value percentage is defined as
the ratio of the liquidation value of the
partner's interest in the partnership to the
aggregate liquidation value of all the part-
ners' interests in the partnership. The liq-
uidation value of the partner's interest in
the partnership is the amount of cash the
partner would receive with respect to its
interest if, immediately following the ap-
plicable determination date, the partner-
ship sold all of its assets for cash equal to
the fair market value of such assets (tak-
ing into account section 7701(g)), satisfied
all of its liabilities (other than those de-
scribed in § 1.752-7), paid an unrelated
third party to assume all of its § 1.752-7
liabilities in a fully taxable transaction,
and then liquidated.

In general, the temporary regulations
provide that the determination date for de-
termining a partner's liquidation value per-

centage is the date of the most recent event
described in § 1.704-1(b)(2)(iv)(f)(5) or
§ 1.704-1(b)(2)(iv)(s)(1) (a revaluation
event), irrespective of whether the capital
accounts of the partners are adjusted under
§ 1.704-1(b)(2)(iv)(f), or, if there has
been no revaluation event, the date of the
formation of the partnership. However, if
a partnership agreement provides for the
allocation of any item of income, gain,
deduction, or loss from partnership prop-
erty to a partner other than in accordance
with the partner's liquidation value per-
centage in a particular taxable year, the
determination date is the last day of the
partner's taxable year, or, if the partner's
section 987 QBU owned indirectly
through a section 987 aggregate partner-
ship terminates during the partner's tax-
able year, the date such section 987 QBU
is terminated. Without this requirement to
redetermine liquidation value percentages
at year-end when such an allocation is in
effect, the allocation could result in sec-
tion 987 taxable income or loss, which
necessarily would reflect the allocation,
being taken into account in determining
section 987 gain or loss under § 1.987-4
even though the allocation was not taken
into account in computing the owner func-
tional currency value of the section 987
QBU, such that distortions would arise in
the computation of section 987 gain or loss.

The Treasury Department and the IRS
have determined that the liquidation value
percentage methodology reflected in
§ 1.987-7T(b) reflects an administrable
approach to allocating assets and liabili-
ties of a section 987 aggregate partnership
to eligible QBUs of its partners in a man-
ner consistent with the partners' economic
interests in the assets and liabilities of the
partnership. The Treasury Department and
the IRS request comments on the applica-
tion of the liquidation value percentage
approach reflected in the temporary regu-
lations, including whether any alternative
measure could better satisfy the criteria of
administrability and consistency with the
economics of the partners' arrangement.

9\. Deferral of Certain Section 988 Loss
Realized by a Debtor with Respect to a
Related-party Loan

Section 267(a)(1) provides that no de-
duction is allowed in respect of any loss

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from the sale or exchange of property,
directly or indirectly, between persons
who have a relationship described in sec-
tion 267(b). Section 267(f)(2) modifies the
general rule of section 267(a)(1) in the
case of a sale or exchange of property
between corporations that are members of
the same controlled group (as defined in
section 267(f)(1)), generally providing
that a loss realized upon such a sale or
exchange is deferred until the property is
transferred outside the group such that
there would be recognition of loss under
consolidated return principles. Section
267(f)(3)(C) provides that, to the extent
provided in regulations, section 267(a)(1)
does not apply to any loss sustained by a
member of a controlled group on the re-
payment of a loan made to another mem-
ber of such controlled group if such loan
is payable or denominated in a foreign
currency and attributable to a reduction in
the value of that foreign currency. Section
1.267(f)-1(e) provides that section 267(a)
generally does not apply to an exchange
loss realized with respect to a loan of
nonfunctional currency to another con-
trolled group member if the transaction
that causes the realization of the loss does
not have as a significant purpose the
avoidance of Federal income tax. Addi-
tionally, § 1.267(f)-1(h) provides that if a
transaction is engaged in with a principal
purpose to avoid the purposes of
§ 1.267(f)-1, including by distorting the
timing of losses, adjustments may be
made to carry out such purposes. Section
1.988-2(b)(16)(i) cross-references the
regulations under section 267 regarding
the coordination of sections 267 and 988
with respect to the treatment of a creditor
under a debt instrument, but § 1.988-
2(b)(16)(ii) is reserved with respect to the
treatment of a debtor. The temporary reg-
ulations correct the cross-reference in
§ 1.988-2(b)(16)(i) to refer to § 1.267(f)-
1(e) rather than § 1.267(f)-1(h).

The Treasury Department and the IRS
have determined that the policy consider-
ations underlying section 267(f)(3)(C) and
§ 1.267(f)-1(e) with respect to creditors
on loans to related persons also apply with
respect to debtors on such loans and that
there is no reason to distinguish between a
creditor and debtor with regard to the ap-
plication of an anti-avoidance rule to the
same transaction. Accordingly, pursuant

to the authority granted to the Secretary in
section 989(c)(5) to prescribe regulations
providing for the appropriate treatment of
related-party transactions, § 1.988-2T(b)
(16)(ii) provides that exchange loss of a
debtor with respect to a loan (original
loan) from a person with whom the debtor
has a relationship described in section
267(b) or section 707(b) is deferred if the
transaction resulting in realization of the
loss has a principal purpose of avoiding
Federal income tax. Such deferred loss
will be recognized at the end of the term
of the original loan.

## Special Analyses

Certain IRS regulations, including
these, are exempt from the requirements
of Executive Order 12866, as supple-
mented and reaffirmed by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. For applicability of
the Regulatory Flexibility Act (5 U.S.C.
chapter 6), please refer to the Special
Analyses section in the preamble to the
cross-referenced notice of proposed rule-
making in the Proposed Rules section
of this issue of the Bulletin. Pursuant to
section 7805(f) of the Internal Revenue
Code, these regulations have been submit-
ted to the Chief Counsel for Advocacy of
the Small Business Administration for
comment on their impact on small busi-
ness.

## Drafting Information

The principal author of these regula-
tions is Mark E. Erwin of the Office of
Associate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.

* * * * *

## Amendment to the Regulations

Accordingly, 26 CFR part 1 is
amended as follows:

PART 1-INCOME TAXES

Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 985, 987, 989(c)
and 7805 * *

Par. 2. Section 1.987-0 is amended by
adding entries for §§ 1.987-6(b)(4)and

1.987-12(a) through (h) to read as fol-
lows:

§ 1.987-0 Section 987; table of
contents.

* * * * *

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

* * * * *

(b) * * *
(4) [Reserved].

* * * * *

§ 1.987-12 Deferral of section 987 gain
or loss.

(a) through (h) [Reserved].

Par. 3. Section 1.987-1 is amended by
adding paragraphs (b)(1)(iii), (b)(6),
(c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f),
(g)(2)(i)(B) and (C), and (g)(3)(i)(E)
through (H) to read as follows:

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

* * * * *

(b) * * *

(1) * * *

(iii) [Reserved]. For further guidance,
see § 1.987-1T(b)(1)(iii).

** * * *

(b) * * *

(6) [Reserved]. For further guidance,
see § 1.987-1T(b)(6).

* * * * *

(c) * * *

(1) * * *

(ii) * * *

(B) [Reserved]. For further guidance,
see § 1.987-1T(c)(1)(ii)(B).

* * * * *

(c) * * *

(3) * * *

(i) * * *

(E) [Reserved]. For further guidance,
see § 1.987-1T(c)(3)(i)(E).

** * * *

(d) * * *

(3) [Reserved]. For further guidance,
see § 1.987-1T(d)(3).

* * * * *

(f) [Reserved]. For further guidance,
see § 1.987-1T(f).

* * * * *

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(g) * * *

(2) * * *

(i) * * *

(B) through (C) [Reserved]. For further
guidance, see § 1.987-1T(g)(2)(i)(B)
through (C).

* * * * *

(g) * * *

(3) * * *

(i) * * *

(E) through (H) [Reserved]. For further
guidance, see § 1.987-1T(g)(3)(i)(E)
through (H).

* * * * *

Par. 4. Section 1.987-1T is added to
read as follows:

§ 1.987-1T Scope, definitions, and
special rules (temporary).

(a) through (b)(1)(ii) [Reserved]. For
further guidance, see § 1.987-1(a) through
(b)(1)(ii).

(iii) Certain provisions applicable to
all taxpayers. Notwithstanding § 1.987-
1(b)(1)(ii), paragraphs (b)(6) and (g)(3)
(i)(E) of this section and § 1.987-6T(b)
(4) apply to any taxpayer that is an owner
of a dollar QBU (as defined in paragraph
(b)(6) of this section), and paragraphs
(g)(2)(i)(B) and (g)(3)(i)(H) of this sec-
tion and §§ 1.987-8T(d) and 1.987-12T
apply to any taxpayer that is an owner of
an eligible QBU (determined without re-
gard to § 1.987-1(b)(3)(ii)) that is subject
to section 987.

(b)(2) through (b)(5) [Reserved]. For
further guidance, see § 1.987-1(b)(2)
through (b)(5).

(6) Dollar QBUs-(i) In general. Ex-
cept as provided in paragraphs (b)(1)(iii)
and (b)(6)(iii) of this section, section 987
and the regulations thereunder do not ap-
ply with respect to an eligible QBU (de-
termined without regard to § 1.987-
1(b)(3)(ii)) that has the U.S. dollar as its
functional currency and that would be
subject to section 987 if it had a functional
currency other than the dollar (dollar
QBU). This paragraph (b)(6) applies to all
taxpayers, including entities described in
§ 1.987-1(b)(1)(ii).

(ii) Application of section 988 to a dol-
lar QBU-(A) In general. Except as pro-
vided in paragraphs (b)(6)(ii)(B) and
(b)(6)(iii) of this section, a controlled for-
eign corporation (as defined in section

957(a)) (CFC) that is the owner of a dollar
QBU applies section 988 with respect to
any item that is properly reflected on the
books and records of the dollar QBU and
that would give rise to a section 988 trans-
action if such item were acquired, ac-
crued, or entered into directly by the
owner of the dollar QBU. Except as pro-
vided in paragraph (b)(6)(ii)(B) of this
section, for purposes of determining the
amount of section 988 gain or loss of the
CFC, any item that is properly reflected on
the books and records of the dollar QBU
and that would give rise to a section 988
transaction if such item were acquired,
accrued, or entered into directly by the
owner of the dollar QBU is treated as
properly reflected on the books and re-
cords of the owner of the dollar QBU,
such that the amount of section 988 gain
or loss with respect to such item is deter-
mined by reference to the owner's func-
tional currency.

(B) Section 988 gain or loss character-
ized as effectively connected income.
Solely for the purpose of determining the
amount of section 988 gain or loss of a
CFC described in paragraph (b)(6)(ii)(A)
of this section that is effectively con-
nected with the conduct of a trade or busi-
ness within the United States (ECI), any
section 988 gain or loss that would be
determined under section 988 as a result
of the acquisition or accrual of any item
and treated as ECI under § 1.988-4(c) if
the item were treated as properly reflected
on the books and records of the dollar
QBU is determined by treating such item
as properly reflected on the books and
records of the dollar QBU. Consequently,
solely for that purpose, such section 988
gain or loss is determined by reference to
the U.S. dollar.

(iii) Election for a CFC to apply sec-
tion 987 to a dollar QBU-(A) In general.
A CFC that is the owner of a dollar QBU
may elect to apply section 987 and the
regulations thereunder with respect to the
dollar QBU in lieu of applying section
988 pursuant to paragraph (b)(6)(ii) of this
section. If the dollar QBU or CFC is de-
scribed in § 1.987-1(b)(1)(ii), however,
the CFC must apply section 987 to the
dollar QBU using the method it applied to
the dollar QBU immediately prior to the
effective date of this paragraph (b)(6) as
provided in paragraph (h) of this section,

provided such method was a reasonable
interpretation of section 987, or, if no such
method exists, a reasonable method.

(B) Section 988 gain or loss character-
ized as effectively connected income.
Solely for the purpose of determining the
amount of section 988 gain or loss of a
dollar QBU that is the subject of an elec-
tion described in paragraph (b)(6)(iii)(A)
of this section that is ECI, § 1.987-
3T(b)(4)(i) and (ii) do not apply, and any
section 988 gain or loss that would be
determined under section 988 as a result
of the acquisition or accrual of any item
and treated as ECI under § 1.988-4(c) if
the item were treated as properly reflected
on the books and records of the dollar
QBU is determined by treating such item
as properly reflected on the books and
records of the dollar QBU. Consequently,
solely for that purpose, such section 988
gain or loss is determined by reference to
the U.S. dollar. See § 1.987-6T(b)(4) for
rules regarding the source of section 987
gain or loss with respect to a dollar QBU
for which the CFC owner has made the
election described in this paragraph.

(b)(7) through (c)(1)(ii)(A) [Reserved].
For further guidance, see § 1.987-1(b)(7)
through (c)(1)(ii)(A).

(B) Election inapplicable with respect
to certain amounts. Except as provided in
this paragraph (c)(1)(ii)(B), the election
provided in § 1.987-1(c)(1)(ii)(A) does
not apply for purposes of determining sec-
tion 987 taxable income or loss (as de-
fined in § 1.987-3(a)) with respect to a
historic item (as defined in § 1.987-1(e))
if acquiring, accruing, or entering into
such item gives rise to a section 988 trans-
action or specified owner functional cur-
rency transaction. However, the election
provided in § 1.987-1(c)(1)(ii)(A) does
apply for purposes of determining section
987 taxable income or loss with respect to
a payable or receivable described in
§ 1.988-1(d)(3) under the circumstances
described in § 1.988-1(d)(3).

(c)(2) through (c)(3)(i)(D) [Reserved].
For further guidance, see § 1.987-1(c)(2)
through (c)(3)(i)(D).

(E) Section 988 transactions and spec-
ified owner functional currency transac-
tions. If acquiring, accruing, or entering
into a historic item gives rise to a section
988 transaction of a section 987 QBU or a
specified owner functional currency trans-

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action described in § 1.987-3T(b)(4)(ii),
the historic rate is the spot rate (as defined
in paragraph (c)(1) of this section) on the
date such item is acquired, accrued, or
entered into. For this purpose, use of a
spot rate convention under § 1.987-
1(c)(1)(ii) is permitted only with respect
to a payable or receivable described in
§ 1.988-1(d)(3) and only to the extent
provided therein.

(c)(3)(ii) through (d)(2) [Reserved].
For further guidance, see § 1.987-
1(c)(3)(ii) through (d)(2).

(3) Gives rise to a qualified short-term
section 988 transaction (as defined in
§ 1.987-3T(b)(4)(iii)(B)) of the section
987 QBU, whether denominated in the
functional currency of the owner or other
nonfunctional currency with respect to the
section 987 QBU, for which section 988
gain or loss is determined under § 1.987-
3T(b)(4)(iii)(A) in, and by reference to,
the functional currency of the section 987
QBU.

(e) [Reserved]. For further guidance,
see § 1.987-1(e).

(f) Examples. The following examples
illustrate the application of § 1.987-1(d)
and (e).

Example 1. U.S. Corp is a domestic corporation
with the U.S. dollar as its functional currency and is
the owner of Business A, a section 987 QBU that has
the pound as its functional currency. Assume all
transactions of Business A are entered into in the
ordinary course of its business. U.S. Corp has not
made an election under § 1.987-3T(b)(4)(iii)(C) to
adopt a foreign currency mark-to-market method of
accounting for qualified short-term section 988
transactions. Items reflected on Business A's balance
sheet include £10,000, $1,000, a building with a
basis of £100,000, a light general purpose truck with
a basis of £30,000, a computer with a basis of
£1,000, a 60-day receivable for ¥15,000, an account
payable of £5,000, and a foreign currency contract
within the meaning of section 1256(g)(2) that re-
quires Business A to exchange £100 for $125 in 90
days. Under paragraph (d) of this section, the
£10,000, the £5,000 account payable and the £/$
section 1256 foreign currency contract are marked
items. The other items are historic items under this
paragraph (e) of this section.

Example 2. The facts are the same as Example 1
except that U.S. Corp has elected under § 1.987-
3T(b)(4)(iii)(C) to adopt the foreign currency mark-
to-market method of accounting for qualified short-
term section 988 transactions of Business A. Under
paragraphs (d) and (e) of this section, the £10,000,
the $1,000, the ¥15,000 receivable, the £5,000 ac-
count payable, and the £/$ section 1256 foreign
currency contract are marked items.

(g)(1) through (g)(2)(i)(A) [Reserved].
For further guidance, see § 1.987-1(g)(1)
through (g)(2)(i)(A).

(B) Annual deemed termination elec-
tion-(1) In general. Except as provided
in paragraph (g)(2)(i)(B)(2) of this sec-
tion, an election under § 1.987-8T(d) (an-
nual deemed termination election) applies
to all section 987 QBUs owned by the
taxpayer, as well as to all section 987
QBUs owned by any person that has a
relationship to the taxpayer described in
section 267(b) or section 707(b) (substitut-
ing "and the profits interest" for "or the
profits interest" in section 707(b)(1)(A) and
substituting "and profits interests" for "or
profits interests" in section 707(b)(1)(B))
on the last day of the first taxable year for
which the election applies (a related per-
son). If a taxpayer makes the election un-
der § 1.987-8T(d), the first taxable year
of a related person for which the election
applies is the first taxable year that ends
with or within a taxable year of the tax-
payer for which the taxpayer's election
applies. An election under § 1.987-8T(d)
may not be revoked.

(i) Fresh start taxpayers. A taxpayer to
which § 1.987-10 applies that is required
under § 1.987-10(a) to apply the fresh
start transition method described in
§ 1.987-10(b) (fresh start taxpayer) may
make the election under § 1.987-8T(d)
only if the first taxable year for which the
election would apply to the taxpayer is
either the first taxable year beginning on
or after the transition date (as defined in
§ 1.987-11(c)) in which the election is
relevant or a subsequent taxable year in
which the taxpayer's controlled group ag-
gregate section 987 loss, if any, does not
exceed $5 million. For purposes of this
paragraph (g)(2)(i)(B), a taxpayer's con-
trolled group aggregate section 987 loss
means the aggregate net amount of section
987 loss that would be recognized pursu-
ant to the election by the taxpayer and all
other persons to whom the taxpayer's
election would apply in the first taxable
year of each person for which the election
would apply.

(ii) Other taxpayers. Other taxpayers, in-
cluding taxpayers described in § 1.987-
1(b)(1)(ii) and taxpayers described in § 1.987-
10(c), must follow the election rules
provided in paragraph (g)(2)(i)(B)(1)(i)of
this section if any related party is a fresh

start taxpayer. If no related party is a fresh
start taxpayer, the election under § 1.987-
8T(d) may be made only if the first tax-
able year for which the election would
apply to the taxpayer is either the first
taxable year beginning on or after Decem-
ber 7, 2016, in which the election is rele-
vant or a subsequent taxable year in which
the taxpayer's controlled group aggregate
section 987 loss, if any, does not exceed
$5 million.

(2) QBU-by-QBU elections in certain
circumstances. Notwithstanding para-
graph (g)(2)(i)(B)(1) of this section, a tax-
payer may make a separate election under
§ 1.987-8T(d) with respect to any section
987 QBU owned by the taxpayer if the
first taxable year for which the election
would apply to the taxpayer with respect
to the section 987 QBU is a taxable year
in which there is a section 987 gain rec-
ognized with respect to the section 987
QBU pursuant to the election, or is a tax-
able year in which there is a section 987
loss of $1 million or less that would be
recognized with respect to the section 987
QBU pursuant to the election

(C) Election to translate all items at
the yearly average exchange rate. An
election under § 1.987-3T(d) (election to
translate all items at the yearly average
exchange rate) may be made with respect
to a section 987 QBU only if the first
taxable year for which the election would
apply is the first taxable year for which an
election under § 1.987-8T(d) (annual
deemed termination election) applies with
respect to the section 987 QBU.

(g)(2)(ii) through (g)(3)(i)(D) [Re-
served]. For further guidance, see § 1.987-
1(g)(2)(ii) through (g)(3)(i)(D).

(E) Election for a CFC to apply section
987 to a dollar QBU. An election under
§ 1.987-1T(b)(6)(iii) for a CFC to apply
section 987 to a dollar QBU must be titled
"Section 987 Election for a CFC to Apply
Section 987 to a Dollar QBU Under
§ 1.987-1T(b)(6)(iii)" and must provide
the name and address of each QBU for
which the election is being made.

(F) Election to apply the foreign cur-
rency mark-to-market method of account-
ing for qualified short-term section 988
transactions. An election under § 1.987-
3T(b)(4)(iii)(C) to apply the foreign cur-
rency mark-to-market method of account-
ing for qualified short-term section 988

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transactions must be titled "Section 987
Election to Use Foreign Currency Mark-
to-Market Method of Accounting for
Qualified Short-Term Section 988 Trans-
actions Under § 1.987-3(b)T(4)(iii)(C)"
and must provide the name and address of
each section 987 QBU for which the elec-
tion is being made.

(G) Election to translate all items at
the yearly average exchange rate. An
election under § 1.987-3T(d) to translate
all items at the yearly average exchange
rate must be titled "Section 987 Election
to Translate All Items at the Yearly Av-
erage Exchange Rate Under § 1.987-
3T(d)" and must provide the name and
address of each section 987 QBU for
which the election is being made.

(H) Annual deemed termination elec-
tion. An election under § 1.987-8T(d) for
an owner to deem all of its section 987
QBUs to terminate on the last day of each
taxable year must be titled "Section 987
Annual Deemed Termination Election
Under § 1.987-8T(d)" and must provide
the name and address of each section 987
QBU to which the election applies, in-
cluding a section 987 QBU owned by a
related person (within the meaning of
paragraph (g)(2)(i)(B)(1) of this section).

(g)(4) through (6) [Reserved]. For fur-
ther guidance, see § 1.987-1(g)(4)
through (6).

(h) Effective/applicability date. Para-
graphs (g)(2)(i)(B) and (g)(3)(i)(H) of this
section apply to the first taxable year be-
ginning on or after December 7, 2016.
Paragraphs (b)(1)(iii), (b)(6), (c)(1)(ii)(B),
(c)(3)(i)(E), (d)(3), (f), (g)(2)(i)(C), and
(g)(3)(i)(E) through (G) of this section
apply to taxable years beginning one year
after the first day of the first taxable year
following December 7, 2016. Notwith-
standing the preceding sentence, if a tax-
payer makes an election under § 1.987-
11(b), then paragraphs (b)(1)(iii), (b)(6),
(c)(1)(ii)(B), (c)(3)(i)(E), (d)(3), (f),
(g)(2)(i)(C), and (g)(3)(i)(E) through (G)
of this section apply to taxable years to
which §§ 1.987-1 through 1.987-10 apply
as a result of such election.

(i) Expiration date. The applicability of
this section expires on December 6, 2019.

Par. 5. Section 1.987-2 is amended by
adding paragraph (c)(9) to read as fol-
lows:

§ 1.987-2 Attribution of items to eligi-
ble QBUs; definition of a transfer and
related rules.

* * * * *

(c) * * *

(9) [Reserved]. For further guidance,
see § 1.987-2T(c)(9).

* * * * *

Par. 6. Section 1.987-2T is added to
read as follows:

§ 1.987-2T Attribution of items to
eligible QBUs; definition of a transfer
and related rules (temporary).

(a) through (c)(8) [Reserved]. For fur-
ther guidance, see § 1.987-2(a) through
(c)(8).

(9) Certain disregarded transactions
not treated as transfers-(i) Combina-
tions of section 987 QBUs. The combina-
tion of two or more separate section 987
QBUs (combining QBUs) that are directly
owned by the same owner, or that are
indirectly owned by the same partner
through a single section 987 aggregate
partnership, into one section 987 QBU
(combined QBU) does not give rise to a
transfer of any combining QBU's assets
or liabilities to the owner under § 1.987-
2(c). In addition, transactions between the
combining QBUs occurring in the taxable
year of the combination do not result in a
transfer of the combining QBUs' assets or
liabilities to the owner under § 1.987-
2(c). For this purpose, a combination oc-
curs when the assets and liabilities that are
properly reflected on the books and re-
cords of two or more combining QBUs
begin to be properly reflected on the
books and records of a combined QBU
and the separate existence of the combin-
ing QBUs ceases. A combination may re-
sult from any transaction or series of
transactions in which the combining
QBUs become a combined QBU. For
rules regarding the determination of net
unrecognized section 987 gain or loss of a
combined QBU, see § 1.987-4T(f)(1).

(ii) Change in functional currency
from a combination. If, following a com-
bination of section 987 QBUs described in
paragraph (c)(9)(i) of this section, the
combined section 987 QBU has a differ-
ent functional currency than one or more
of the combining section 987 QBUs, any
such combining section 987 QBU is

treated as changing its functional currency
and the owner of the combined section
987 QBU must comply with the regula-
tions under section 985 regarding the
change in functional currency. See
§§ 1.985-1(c)(6) and 1.985-5.

(iii) Separation of section 987 QBUs.
The separation of a section 987 QBU
(separating QBU) into two or more sec-
tion 987 QBUs (separated QBUs) that,
after the separation, are directly owned by
the same owner, or that are indirectly
owned by the same partner through a sin-
gle section 987 aggregate partnership,
does not give rise to a transfer of the
separating QBU's assets or liabilities to
the owner under § 1.987-2(c). Addition-
ally, transactions that occurred between
the separating QBUs in the taxable year of
the separation prior to the completion
of the separation do not give rise to trans-
fers for purposes of section 987. For this
purpose, a separation occurs when the as-
sets and liabilities that are properly re-
flected on the books and records of a
separating QBU begin to be properly re-
flected on the books and records of two or
more separated QBUs. A separation may
result from any transaction or series of
transactions in which a separating QBU
becomes two or more separated QBUs. A
separation may also result when a section
987 QBU that is subject to a grouping
election under § 1.987-1(b)(2)(ii)(A)
changes its functional currency. For rules
regarding the determination of net unrec-
ognized section 987 gain or loss of a sep-
arated QBU, see § 1.987-4T(f)(2).

(c)(10) through (d) [Reserved]. For fur-
ther guidance see § 1.987-2(c)(10)
through (d).

(e) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(f) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 7. Section 1.987-3 is amended by
adding paragraphs (b)(2)(ii), (b)(4), (c)(2)
(ii) and (v), and (d), and Example 9

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through Example 14 at the end of para-
graph (e) to read as follows:

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

* * * * *

(b) * * *

(2) * * *

(ii) [Reserved]. For further guidance,
see § 1.987-3T(b)(2)(ii).

* * * * *

(b) * * *

(4) [Reserved]. For further guidance,
see § 1.987-3T(b)(4).

* * * * *

(c) * * *

(2) * * *

(ii) [Reserved]. For further guidance,
see § 1.987-3T(c)(2)(ii).

* * * * *

(c) * * *

(2) * * *

(v) through (d) [Reserved]. For further
guidance, see § 1.987-3T(c)(2)(v)
through (d).

(e) Examples. * * *

Example 9 through Example 14 [Re-
served]. For further guidance, see
§ 1.987-3T(e), Example 9 through Exam-
ple 14.

Par. 8. Section 1.987-3T is added to
read as follows:

§ 1.987-3T Determination of section
987 taxable income or loss of an owner
of a section 987 QBU (temporary).

(a) through (b)(2)(i) [Reserved]. For
further guidance, see § 1.987-3(a)
through (b)(2)(i).

(ii) No translation of basis or amount
realized with respect to a specified owner
functional currency transaction treated as
a historic asset. If the acquisition of a
historic asset gives rise to a specified
owner functional currency transaction de-
scribed in paragraph (b)(4)(ii) of this sec-
tion, the basis of the historic asset, and
any amount realized on a disposition of
the historic asset, is not translated if the
amount is denominated in the owner's
functional currency.

(3) [Reserved]. For further guidance,
see § 1.987-3(b)(3).

(4) Special rule for section 988 trans-
actions-(i) In general. Section 988 and

the regulations thereunder apply to section
988 transactions of a section 987 QBU.
For this purpose, whether a transaction is
a section 988 transaction is determined by
reference to the functional currency of the
section 987 QBU. (But see paragraph
(b)(4)(ii) of this section, providing that
specified owner functional currency trans-
actions are not treated as section 988
transactions.) However, except as pro-
vided in paragraph (b)(4)(iii)(A) of this
section, section 988 gain or loss is deter-
mined in, and by reference to, the func-
tional currency of the owner of the section
987 QBU rather than the functional cur-
rency of the section 987 QBU. Accord-
ingly, in determining section 988 gain or
loss of a section 987 QBU with respect to
a section 988 transaction of the section
987 QBU, the amounts required under
section 988 and the regulations thereunder
to be translated on the applicable booking
date or payment date with respect to the
section 988 transaction are translated into
the owner's functional currency at the rate
required under section 988 and the regu-
lations thereunder.

(ii) Specified owner functional cur-
rency transactions not treated as section
988 transactions. Transactions of a sec-
tion 987 QBU described in sections
988(c)(1)(B)(i), 988(c)(1)(B)(ii), and 988
(c)(1)(C) (including the acquisition of
nonfunctional currency as described in
§ 1.988-1(a)(1)), other than transactions
described in paragraph (b)(4)(iii)(A) of
this section, that are denominated in (or
determined by reference to) the owner's
functional currency (specified owner
functional currency transactions) are not
treated as section 988 transactions. Thus,
no currency gain or loss is recognized by
a section 987 QBU under section 988 with
respect to such transactions.

(iii) Determination of section 988 gain
or loss for qualified short-term section
988 transactions-(A) Determination by
reference to the section 987 QBU's func-
tional currency for certain transactions
subject to a mark-to-market method of
accounting. Section 988 gain or loss with
respect to section 988 transactions de-
scribed in paragraph (b)(4)(iii)(B) of this
section that are accounted for under a
mark-to-market method of accounting for
Federal income tax purposes or under the
foreign currency mark-to-market method

of accounting described in paragraph
(b)(4)(iii)(C) of this section, and any
hedges entered into to manage risk with
respect to such transactions within the
meaning of § 1.1221-2(c)(4) (related
hedges), must be determined in, and by
reference to, the functional currency of the
section 987 QBU (rather than the func-
tional currency of its owner).

(B) Qualified short-term section 988
transaction. A qualified short-term sec-
tion 988 transaction is a section 988 trans-
action that occurs in the ordinary course
of a section 987 QBU's business and has
an original term of one year or less on the
date the transaction is entered into by the
section 987 QBU. The holding of cur-
rency that is nonfunctional currency
(within the meaning of section 988(c)
(1)(C)(ii)) to the section 987 QBU in the
ordinary course of a section 987 QBU's
trade or business also is treated as a qual-
ified short-term section 988 transaction.
Any transaction that is denominated in, or
determined by reference to, a hyperinfla-
tionary currency, including the holding of
hyperinflationary currency, is not consid-
ered a qualified short-term section 988
transaction. See §§ 1.988-2(b)(15),
1.988-2(d)(5), and 1.988-2(e)(7) for
rules relating to transactions denominated
in, or determined by reference to, a hyper-
inflationary currency.

(C) Election to use a foreign currency
mark-to-market method of accounting. A
taxpayer may elect under this paragraph
(b)(4)(iii)(C) to apply the foreign currency
mark-to-market method of accounting de-
scribed in this paragraph for all qualified
short-term section 988 transactions de-
scribed in paragraph (b)(4)(iii)(B) of this
section, and any related hedges, that are
properly attributable to a section 987
QBU on or after the effective date of the
election and that are not otherwise ac-
counted for under a mark-to-market
method of accounting under section 475
or section 1256. Under the foreign cur-
rency mark-to-market method of account-
ing, the timing of section 988 gain or loss
on section 988 transactions is determined
under the principles of section 1256(a)(1).
Thus, only section 988 gain or loss is
taken into account under the foreign cur-
rency mark-to-market method of account-
ing. Appropriate adjustments must be
made to prevent the section 988 gain or

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loss from being taken into account again
under section 988 or another provision of
the Code or regulations. A section 988
transaction subject to this election is not
subject to the "netting rule" of section
988(b) and § 1.988-2(b)(8), under which
exchange gain or loss is limited to overall
gain or loss realized in a transaction, in
taxable years prior to the taxable year in
which section 988 gain or loss would be
recognized with respect to such section
988 transaction but for this election.

(iv) Examples. Examples 10 through
13 of paragraph (e) of this section illus-
trate the application of this paragraph
(b)(4).

(c)(1) through (c)(2)(i) [Reserved]. For
further guidance, see § 1.987-3(c)(1)
through (c)(2)(i).

(ii) Amount realized with respect to
historic assets that are section 988 trans-
actions. If the acquisition of a historic
asset gave rise to a section 988 transaction
described in paragraph (b)(4)(i) of this
section, then in computing the total gain
or loss on a disposition of the historic
asset (some or all of which total gain or
loss may be section 988 gain or loss de-
scribed in section 988(b) and paragraph
(b)(4)(i) of this section), the amount real-
ized (determined, if necessary, under
§ 1.987-3(b)(2)(i)) is translated into the
owner's functional currency using the
spot rate on the date such item is properly
taken into account, subject to the limita-
tion under § 1.987-1T(c)(1)(ii)(B) regard-
ing the use of a spot rate convention.

(iii) through (iv) [Reserved]. For fur-
ther guidance, see § 1.987-3(c)(2)(iii)
through (iv).

(v) Translation of income to account
for certain foreign income tax claimed as
a credit. The owner of a section 987 QBU
claiming a credit under section 901 for
foreign income taxes, other than foreign
income taxes deemed paid under section
902 or section 960, that are properly re-
flected on the books and records of the
section 987 QBU (the creditable tax
amount) must determine section 987 tax-
able income or loss attributable to the
section 987 QBU by reducing the amount
of section 987 taxable income or loss that
otherwise would be determined under this
section by an amount equal to the credit-
able tax amount, translated into U.S. dol-
lars using the yearly average exchange

rate for the taxable year in which the
creditable tax is accrued, and by increas-
ing the resulting amount by an amount
equal to the creditable tax amount, trans-
lated using the same exchange rate that is
used to translate the creditable taxes into
U.S. dollars under section 986(a). See Ex-
ample 14 of paragraph (e) of this section,
, for an illustration of this rule.

(d) Election to translate all items at the
yearly average exchange rate. Notwith-
standing § 1.987-3(c), a taxpayer that has
made the annual deemed termination elec-
tion described in § 1.987-8T(d) may elect
under this paragraph (d) to translate all
items of income, gain, deduction, and loss
with respect to a section 987 QBU deter-
mined under § 1.987-3(b) in the func-
tional currency of the section 987 QBU
into the owner's functional currency, if
necessary, at the yearly average exchange
rate for the taxable year. Example 9 of
paragraph (e) of this section illustrates the
application of this election.

(e) Example 1 through Example 8
[Reserved]. For further guidance, see
§ 1.987-3(e), Example 1 through Example
8.

Example 9. The facts are the same as in Example
7, except that U.S. Corp properly elects under para-
graph (d) of this section to translate all items of
income, gain, deduction, and loss with respect to
Business A at the yearly average exchange rate.
Accordingly, Business A's €2,000 gain on the sale of
the land is translated at the yearly average exchange
rate for 2021 of €1 = $1.05, and the amount of gain
reported by U.S. Corp on the sale of the land is
$2,100.

Example 10. Business A acquires £100 on Au-
gust 27, 2021, for €120 and sells the pounds on
November 17, 2021, for €125. The dollar-pound spot
rate (without the use of a spot rate convention) is £1
= $1 on August 27, 2021, and £1 = $1.10 on
November 17, 2021. The disposition of the pounds is
a section 988 transaction of Business A under para-
graph (b)(4)(i) of this section, and the pounds are a
historic asset under § 1.987-1(e). Section 988 gain
or loss with respect to the disposition of the pounds
is determined under paragraph (b)(4)(i) of this sec-
tion and § 1.988-2(a)(2) by reference to the dollar
functional currency of Business A's owner. The dol-
lar amount realized for the pounds is determined
under paragraph (c)(2)(ii) of this section by translat-
ing £100 into $110 using the dollar-pound spot rate
on November 17, 2021, without the use of a spot rate
convention. The dollar basis in the pounds is deter-
mined under § 1.987-3(c)(2)(i) by translating £100
into $100 using the historic rate described in
§ 1.987-1T(c)(3)(i)(E), which is the dollar-pound
spot rate on August 27, 2021, without the use of a
spot rate convention. Thus, U.S. Corp takes into
account $10 of section 988 gain with respect to
Business A's disposition of £100.

Example 11. (i) Business A purchases a £100
2-year note for €75 on October 1, 2021, and receives
a £100 repayment of principal with respect to the
note on December 31, 2021. At the spot rates on
October 1, 2021 (as defined in § 1.987-1(c)(1)),
without the use of a spot rate convention, Business
A's €75 purchase price translates into £80 and $95.
At the spot rates on December 31, 2021, without the
use of a spot rate convention, the £100 principal
amount on the note translates into €90 and $130, and
£80 translates into $104.

(ii) The acquisition of the note is a section 988
transaction of Business A under paragraph (b)(4)(i)
of this section, and the note is a historic asset under
§ 1.987-1(e). To determine its section 987 taxable
income or loss with respect to Business A, U.S. Corp
must determine Business A's total gain or loss on the
disposition of the note in U.S. Corp's dollar func-
tional currency. Consistent with § 1.988-2(b)(8),
U.S. Corp also must determine whether some or all
of that gain or loss constitutes section 987 gain or
loss described in section 988(b).

(iii) To determine Business A's total gain or loss
on the disposition of the note, Business A's basis and
amount realized on the note must be determined in
euros under § 1.987-3(b), if necessary, and trans-
lated into dollars under § 1.987-3(c). Business A has
a €75 basis in the note that is translated into $95
under § 1.987-3(c)(2)(i) at the historic rate described
in § 1.987-1T(c)(3)(i)(E), which is the spot rate on
the date the note was acquired without the use of a
spot rate convention. Business A's £100 amount
realized on the note is translated into €90 under
§ 1.987-3(b)(2)(i) using the spot rate on December
31, 2021, without the use of a spot rate convention.
That €90 amount realized is then translated into $130
under paragraph (c)(2)(ii) of this section using the
spot rate on December 31, 2021, without the use of
a spot rate convention. Accordingly, the total gain
with respect to the disposition of the note that is
included in section 987 taxable income is $35 ($130
less $95).

(iv) U.S. Corp must determine whether some or
all of the $35 total gain with respect to the note
constitutes section 988 gain. The amount of section
988 gain realized with respect to the note is deter-
mined under § 1.988-2(b)(5), which requires a com-
parison of the functional currency value of the prin-
cipal amount of the note on the booking date and
payment date spot rates, respectively, and defines the
principal amount of the note as Business A's pur-
chase price in units of nonfunctional currency, which
is £80. Under paragraph (b)(4)(i) of this section,
section 988 gain or loss with respect to the note is
determined by reference to U.S. Corp's dollar func-
tional currency, such that the amounts required under
section 988 to be translated on the booking date and
payment date are translated into the dollars at the
booking date and payment date spot rates. Accord-
ingly, Business A's £80 principal amount with re-
spect to the note is translated at the booking date and
payment date spots rates into $95 and $104, respec-
tively. Thus, $9 ($104 less $95) of the $35 total gain
taken into account by U.S. Corp as section 987
taxable income with respect to the note is section
988 gain. The remaining $26 of gain, which may be
attributable to credit risk or another factor unrelated

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to currency fluctuations, is sourced and characterized
without regard to section 988.

Example 12. The facts are the same as in Exam-
ple 11, except that Business A is owned by a foreign
corporation with a pound functional currency. Under
paragraph (b)(4)(ii) of this section, the acquisition of
the £100 2-year note is a specified owner functional
currency transaction that is not treated as a section
988 transaction of Business A. Because the note is a
historic asset under § 1.987-1(e), Business A's €75
basis in the note translates into £80 at the historic
rate described in § 1.987-1T(c)(3)(i)(E), which pro-
vides that the historic rate is the spot rate for the date
the note was acquired without the use of a spot rate
convention. (If, instead, Business A had purchased
the 5-year note for £80 rather than €75, then pursuant
to paragraph (b)(2)(ii) of this section, Business A's
basis in the note would have been determined with-
out translating the £80 purchase price because it is
denominated in the owner's functional currency.)
Under paragraph (b)(2)(ii) of this section, the £100
amount realized with respect to the note is not trans-
lated because it is denominated in the owner's func-
tional currency. Thus, the owner takes into account
£20 (£100 less £80) of section 987 taxable income in
2021 with respect to the note.

Example 13. (i) Business A receives and accrues
$100 of income from the provision of services on
January 1, 2021. Business A continues to hold the
$100 as a U.S. dollar-denominated demand deposit
at a bank on December 31, 2021. U.S. Corp has
elected under paragraph (b)(4)(iii)(C) of this section
to use the foreign currency mark-to-market method
of accounting for qualified short-term section 988
transactions entered into by Business A. The euro-

dollar spot rate without the use of a spot rate con-
vention is €1 = $1 on January 1, 2021, and €1 = $2
on December 31, 2021, and the yearly average ex-
change rate for 2021 is €1 = $1.50.

(ii) Under § 1.987-3(b)(2)(i), the $100 earned by
Business A is translated into €100 at the spot rate on
January 1, 2021, as defined in § 1.987-1(c)(1) with-
out the use of a spot rate convention. In determining
U.S. Corp's taxable income, the €100 of service
income is translated into $150 at the yearly average
exchange rate for 2021, as provided in § 1.987-
3(c)(1).

(iii) The $100 demand deposit constitutes a qual-
ified short-term section 988 transaction under para-
graph (b)(4)(iii)(B) of this section because the de-
mand deposit is treated as nonfunctional currency
within the meaning of section 988(c)(1)(C)(ii). Be-
cause Business A uses the foreign currency mark-to-
market method of accounting for qualified short-
term section 988 transactions, under paragraph
(b)(4)(iii)(A) of this section, section 988 gain or loss
for such transactions is determined in, and by refer-
ence to, euros, the functional currency of Business
A. Accordingly, section 988 gain or loss must be
determined on Business A's holding of the $100
demand deposit in, and by reference to, the euro.
Under § 1.988-2(a)(2), Business A is treated as
having an amount realized of €50 when the $100 is
marked to market at the end of 2021 under paragraph
(b)(4)(iii)(C) of this section. Marking the dollars to
market gives rise to a section 988 loss of €50 (€50
amount realized, less Business A's €100 basis in the
$100). In determining U.S. Corp's taxable income,
that €50 loss is translated into a $75 loss at the yearly

average exchange rate for 2021, as provided in
§ 1.987-3(c)(1).

Example 14. (i) Facts. Business A earns €100 of
revenue from the provision of services and incurs
€30 of general expenses and €10 of depreciation
expense during 2021. Except as otherwise provided,
U.S. Corp uses the yearly average exchange rate
described in § 1.987-1(c)(2) to translate items of
income, gain, deduction, and loss of Business A.
Business A is subject to income tax in Country X at
a 25 percent rate. U.S. Corp claims a credit with
respect to Business A's foreign income taxes and
elects under section 986(a)(1)(D) to translate the
foreign income taxes at the spot rate on the date the
taxes were paid. The yearly average exchange rate
for 2021 is €1 = $1.50. The historic rate used to
translate the depreciation expense is €1 = $1.00. The
spot rate on the date that Business A paid its foreign
income taxes was €1 = $1.60.

(ii) Analysis. Because U.S. Corp has elected to
translate foreign income taxes at the spot rate on the
date such taxes were paid rather than at the yearly
average exchange rate, U.S. Corp must make the
adjustments described in paragraph (c)(2)(v) of this
section. Accordingly, U.S. Corp determines its sec-
tion 987 taxable income by reducing the section 987
taxable income or loss that otherwise would be de-
termined under this section by €15, translated into
U.S. dollars at the yearly average exchange rate
(€1 = $1.50), and increasing the resulting amount by
€15, translated using the same exchange rate that is
used to translate the creditable taxes into U.S. dollars
under section 986(a) (€1 = $1.60). Following these
adjustments, Business A's section 987 taxable in-
come for 2021 is $96.50, computed as follows:

Amount in €

Translation Rate

Amount in $

Revenue

€100

€1 = $1.50

$150.00

General Expenses

(30)

€1 = $1.50

(45.00)

Depreciation

(10)

€1 = $1.00

(10.00)

Tentative section 987 taxable income

€60

$95.00

Adjustments under paragraph (c)(2)(v) of this section:

Decrease by €15 tax translated at yearly average exchange rate (€1 = $1.50)

($22.50)

Increase by €15 tax translated at spot rate on payment date (€1 = $1.60)

24.00

Section 987 taxable income

$96.50

(f) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(g) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 9. Section 1.987-4 is amended by
adding paragraphs (c)(2) and (f) to read as
follows:

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

* * * * *

(c) * * *

(2) [Reserved]. For further guidance,
see § 1.987-4T(c)(2).

* * * * *

(f) [Reserved]. For further guidance,
see § 1.987-4T(f).

* * * * *

Par. 10. Section 1.987-4T is added to
read as follows:

§ 1.987-4T Determination of net
unrecognized section 987 gain or loss of
a section 987 QBU (temporary).

(a) through (c)(1) [Reserved]. For fur-
ther guidance, see § 1.987-4(a) through
(c)(1).

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(2) Coordination with § 1.987-12T.
For purposes of paragraph (c)(1) of this
section, amounts taken into account under
§ 1.987-5 are determined without regard
to § 1.987-12T.

(d) through (e) [Reserved]. For further
guidance, see § 1.987-4(d) through (e).

(f) Combinations and separations-(1)
Combinations. The net unrecognized sec-
tion 987 gain or loss of a combined QBU
(as defined in § 1.987-2T(c)(9)(i)) for a
taxable year is determined under § 1.987-
4(b) by taking into account the net accu-
mulated unrecognized section 987 gain or
loss of each combining QBU (as defined
in § 1.987-2T(c)(9)(i)) for all prior tax-
able years to which the regulations under
section 987 apply, as determined under
§ 1.987-4(c), and by treating the combin-
ing QBUs as having combined immedi-
ately prior to the beginning of the taxable
year of combination.

(2) Separations. The net unrecognized
section 987 gain or loss of a separated
QBU (as defined in § 1.987-2T(c)(9)(iii))
for a taxable year is determined under
§ 1.987-4(b) by taking into account the
separated QBU's share of the net accumu-
lated unrecognized section 987 gain or
loss of the separating QBU (as defined in
§ 1.987-2T(c)(9)(iii)) for all prior taxable
years to which the regulations under sec-
tion 987 apply, as determined under
§ 1.987-4(c), and by treating the separat-
ing QBU as having separated immediately
prior to the beginning of the taxable year
of separation. A separated QBU's share of
the separating QBU's net accumulated un-
recognized section 987 gain or loss for all
such prior taxable years is determined by
apportioning the separating QBU's net ac-
cumulated unrecognized section 987 gain
or loss for all such prior taxable years to
each separated QBU in proportion to the
aggregate adjusted basis of the gross as-
sets properly reflected on the books and
records of each separated QBU immedi-
ately after the separation. For purposes of
determining the owner functional cur-
rency net value of the separated QBUs on
the last day of the taxable year preceding
the taxable year of separation under
§ 1.987-5(d)(1)(B) and (e), the balance
sheets of the separated QBUs on that day
will be deemed to reflect the assets and
liabilities reflected on the balance sheet of
the separating QBU on that day, appor-

tioned between the separated QBUs in a
reasonable manner that takes into account
the assets and liabilities reflected on the
balance sheets of the separated QBUs im-
mediately after the separation.

(3) Examples. The following examples
illustrate the rules of paragraphs (f)(1) and
(2) of this section.

Example 1. Combination of two section 987
QBUs that have the same owner. (i) Facts. DC1, a
domestic corporation, owns Entity A, a DE. Entity A
conducts a business in France that constitutes a sec-
tion 987 QBU (French QBU) that has the euro as its
functional currency. French QBU has a net accumu-
lated unrecognized section 987 loss from all prior
taxable years to which the regulations under section
987 apply of $100. DC1 also owns Entity B, a DE.
Entity B conducts a business in Germany that con-
stitutes a section 987 QBU (German QBU) that has
the euro as its functional currency. German QBU has
a net accumulated unrecognized section 987 gain
from all prior taxable years to which the regulations
under section 987 apply of $110. During the taxable
year, Entity A and Entity B merge under local law.
As a result, the books and records of French QBU
and German QBU are combined into a new single set
of books and records. The combined entity has the
euro as its functional currency.

(ii) Analysis. Pursuant to § 1.987-2T(c)(9)(i),
French QBU and German QBU are combining
QBUs, and their combination does not give rise to a
transfer that is taken into account in determining the
amount of a remittance (as defined in § 1.987-5(c)).
For purposes of computing net unrecognized section
987 gain or loss under § 1.987-4 for the year of the
combination, the combination is deemed to have
occurred on the last day of the owner's prior taxable
year, such that the owner functional currency net
value of the combined section 987 QBU at the end of
that taxable year described under § 1.987-4(d)(1)(B)
takes into account items reflected on the balance
sheets of both French QBU and German QBU at that
time. Additionally, any transactions between French
QBU and German QBU occurring during the year of
the merger will not result in transfers to or from a
section 987 QBU. Pursuant to paragraph (f)(1) of
this section, the combined QBU will have a net
accumulated unrecognized section 987 gain from all
prior taxable years of $10 (the $100 loss from French
QBU plus the $110 gain from German QBU).

Example 2. Separation of two section 987 QBUs
that have the same owner. (i) Facts. DC1, a domestic
corporation, owns Entity A, a DE. Entity A conducts
a business in the Netherlands that constitutes a sec-
tion 987 QBU (Dutch QBU) that has the euro as its
functional currency. The business of Dutch QBU
consists of manufacturing and selling bicycles and
scooters and is recorded on a single set of books and
records. On the last day of Year 1, the adjusted basis
of the gross assets of Dutch QBU is €1,000. In Year
2, the net accumulated unrecognized section 987 loss
of Dutch QBU from all prior taxable years is $200.
During Year 2, Entity A separates the bicycle and
scooter business such that each business begins to
have its own books and records and to meet the
definition of a section 987 QBU under § 1.987-
1(b)(2) (hereafter, "bicycle QBU" and "scooter

QBU"). There are no transfers between DC1 and
Dutch QBU before the separation. After the separa-
tion, the aggregate adjusted basis of bicycle QBU's
assets is €600 and the aggregate adjusted basis of
scooter QBU's assets is €400. Each section 987
QBU continues to have the euro as its functional
currency.

(ii) Analysis. Pursuant to § 1.987-2T(c)(9)(iii),
bicycle QBU and scooter QBU are separated QBUs,
and the separation of Dutch QBU, a separating QBU,
does not give rise to a transfer taken into account in
determining the amount of a remittance (as defined
in § 1.987-5(c)). For purposes of computing net
unrecognized section 987 gain or loss under
§ 1.987-4 for Year 2, the separation will be deemed
to have occurred on the last day of the owner's prior
taxable year, Year 1. Pursuant to paragraph (f)(2) of
this section, bicycle QBU will have a net accumu-
lated unrecognized section 987 loss of $120 (€600/
€1,000 x $200), and scooter QBU will have a net
accumulated unrecognized section 987 loss of $80
(€400/€1,000 x $200).

(g) [Reserved]. For further guidance,
see § 1.987-4(g).

(h) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(i) Expiration date. The applicability of
this section expires on December 6, 2019.

Par. 11. Section 1.987-6 is amended
by adding paragraph (b)(4) to read as fol-
lows:

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

** * * *

(b) * * *

(4) [Reserved]. For further guidance,
see § 1.987-6T(b)(4).

* * * * *

Par. 12. Section 1.987-6T is added to
read as follows:

§ 1.987-6T Character and source of
section 987 gain or loss (temporary)

(a) through (b)(3) [Reserved]. For fur-
ther guidance, see § 1.987-6(a) through
(b)(3).

(4) Source of section 987 gain or loss
with respect to a dollar QBU. The source
of section 987 gain or loss with respect to
a dollar QBU (as defined in § 1.987-

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1T(b)(6)(i)) for which the CFC owner has
elected under § 1.987-1T(b)(6)(iii) to ap-
ply section 987 is determined by reference
to the residence of the CFC owner. This
paragraph (b)(4) applies to any CFC that
has made the election under § 1.987-
1T(b)(6)(iii), including a CFC described
in § 1.987-1(b)(1)(ii).

(c) [Reserved]. For further guidance,
see § 1.987-6(c).

(d) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(e) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 13. Section 1.987-7 is amended by
adding paragraph (b) to read as follows:

§ 1.987-7 Section 987 aggregate
partnerships.

* * * * *

(b) [Reserved]. For further guidance,
see § 1.987-7T(b).

* * * * *

Par. 14. Section 1.987-7T is added to
read as follows:

§ 1.987-7T Section 987 aggregate
partnerships (temporary).

(a) [Reserved]. For further guidance,
see § 1.987-7(a).

(b) Liquidation value percentage meth-
odology-(1) In general. In any taxable
year, a partner's share of each asset, in-
cluding its basis in each asset, and the
amount of each liability reflected under
§ 1.987-2(b) on the books and records of
an eligible QBU owned indirectly through
a section 987 aggregate partnership is pro-
portional to the partner's liquidation value
percentage with respect to the aggregate
partnership for that taxable year, as deter-
mined under paragraph (b)(2) of this sec-
tion.

(2) Liquidation value percentage-(i)
In general. For purposes of this paragraph
(b), a partner's liquidation value percent-

age is the ratio (expressed as a percentage)
of the liquidation value of the partner's
interest in the partnership to the aggregate
liquidation value of all of the partners'
interests in the partnership. The liquida-
tion value of a partner's interest in a part-
nership is the amount of cash the partner
would receive with respect to the interest
if, immediately following the applicable
determination date, the partnership sold
all of its assets for cash equal to the fair
market value of such assets (taking into
account section 7701(g)), satisfied all of
its liabilities (other than those described in
§ 1.752-7), paid an unrelated third party
to assume all of its § 1.752-7 liabilities in
a fully taxable transaction, and then liqui-
dated.

(ii) Determination date .- (A) In gen-
eral. Except as provided in paragraph
(b)(2)(ii)(B) of this section, the determi-
nation date is the date of the most recent
event described in § 1.704-1(b)(2)
(iv)(f)(5) or § 1.704-1(b)(2)(iv)(s)(1) (a
revaluation event), irrespective of whether
the capital accounts of the partners are
adjusted under § 1.704-1(b)(2)(iv)(f), or,
if there has been no revaluation event, the
date of the formation of the partnership.

(B) Allocations not in accordance with
liquidation value percentage. If a partner-
ship agreement provides for the allocation
of any item of income, gain, deduction, or
loss from partnership property to a partner
other than in accordance with the part-
ner's liquidation value percentage, the de-
termination date is the last day of the
partner's taxable year, or, if the partner's
section 987 QBU owned indirectly
through a section 987 aggregate partner-
ship terminates during the partner's tax-
able year, the date such section 987 QBU
is terminated.

(3) Example. The following example
illustrates the rule of this paragraph (b).

Example. (i) Facts. DC, a domestic corporation,
owns all of the stock of FS, a controlled foreign
corporation (as defined in section 957(a)) with the
U.S. dollar as its functional currency. FS owns a
capital and profits interest in FPRS, a foreign part-
nership. The remaining capital and profits interest in
FPRS is owned by DC. FPRS is a section 987
aggregate partnership with the euro as its functional
currency. The balance sheet of FPRS reflects one
asset (Asset A) with a basis of €60x and a fair market
value of €100x, another asset (Asset B) with a basis
of €100x and a fair market value of €200x, and a
liability (Liability) of €50x. At the end of year 1, the
liquidation value percentage, as determined under

paragraph (b)(2) of this section, of DC with respect
to FPRS is 75 percent, and the liquidation value
percentage of FS with respect to FPRS is 25 percent.

(ii) Result. Under § 1.987-1(b)(4), DC and FS
are each treated as indirectly owning an eligible
QBU with a balance sheet that reflects their respec-
tive shares of any assets and liabilities of FPRS.
Under paragraph (b)(1) of this section, DC and FS's
shares of FPRS's assets and liabilities are deter-
mined in accordance with DC and FS's respective
liquidation value percentages. Accordingly, because
DC has a liquidation value percentage of 75 percent
with respect to FPRS, €75x of Asset A (with a €45x
basis), €150x of Asset B (with a €75x basis), and
€37.50x of Liability will be attributed to the DC-
FPRS QBU. Additionally, because FS has a liquida-
tion value percentage of 25 percent with respect to
FPRS, €25x of Asset A (with a €15x basis), €50x of
Asset B (with a €25x basis), and €12.50x of Liability
will be attributed to the FS-FPRS QBU.

(c) [Reserved]. For further guidance,
see § 1.987-7(c).

(d) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(e) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 15. Section 1.987-8 is amended
by adding paragraph (d) to read as fol-
lows:

§ 1.987-8 Termination of a section 987
QBU.

* * * * *

(d) [Reserved]. For further guidance,
see § 1.987-8T(d).
* * * * *

Par. 16. Section 1.987-8T is added to
read as follows

§ 1.987-8T Termination of a section
987 QBU (temporary).

(a) through (c) [Reserved]. For further
guidance, see § 1.987-8(a) through (c).

(d) Annual deemed termination elec-
tion. A taxpayer, including a taxpayer de-
scribed in § 1.987-1(b)(1)(ii) to which
§§ 1.987-1 through 1.987-11 generally
do not apply, may elect under this para-
graph (d) to deem all of the section 987
QBUs of which it is an owner to terminate

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on the last day of each taxable year for
which the election is in effect. See
§ 1.987-8(e) regarding the effect of such
a deemed termination. The owner of a
section 987 QBU that is deemed to termi-
nate under this paragraph is treated as
having transferred all of the assets and
liabilities attributable to such section 987
QBU to a new section 987 QBU on the
first day of the following taxable year.

(e) through (f) [Reserved]. For further
guidance, see § 1.987-8(e) through (f).

(g) Effective/applicability date. This
section applies to taxable years beginning
on or after December 7, 2016.

(h) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 17. Section 1.987-12 is added to
read as follows:

§ 1.987-12 Deferral of section 987 gain
or loss.

(a) through (h) [Reserved]. For further
guidance, see § 1.987-12T(a) through (h).

Par. 18. Section 1.987-12T is added to
read as follows:

### § 1.987-12T Deferral of section 987 gain or loss (temporary).

(a) In general-(1) Overview. This
section provides rules that defer the rec-
ognition of section 987 gain or loss that,
but for this section, would be recognized
in connection with certain QBU termina-
tions and certain other transactions in-
volving partnerships. This paragraph (a)
provides an overview of this section and
describes the section's scope of applica-
tion, including with respect to QBUs sub-
ject to section 987 but to which
§§ 1.987-1 through 1.987-11 generally
do not apply. Paragraph (b) of this section
describes the extent to which section 987
gain or loss is recognized under § 1.987-5
or similar principles in the taxable year of
a deferral event (as defined in paragraph
(b)(2) of this section) with respect to a
QBU. Paragraph (c) of this section de-
scribes the extent to which section 987
gain or loss that, as a result of paragraph
(b), is not recognized under § 1.987-5 or
similar principles is recognized upon the
occurrence of subsequent events. Para-
graph (d) of this section describes the ex-

tent to which section 987 loss is recog-
nized under § 1.987-5 or similar
principles in the taxable year of an out-
bound loss event (as defined in paragraph
(d)(2) of this section) with respect to a
QBU. Paragraph (e) of this section pro-
vides rules for determining the source and
character of gains and losses that, as a
result of this section, are not recognized
under § 1.987-5 or similar principles in
the taxable year of a deferral event or
outbound loss event. Paragraph (f) of this
section defines controlled group and qual-
ified successor for purposes of this sec-
tion. Paragraph (g) of this section provides
an anti-abuse rule. Paragraph (h) of this
section provides examples illustrating the
rules described in this section.

(2) Scope. This section applies to any
foreign currency gain or loss realized un-
der section 987(3), including foreign cur-
rency gain or loss of an entity described in
§ 1.987-1(b)(1)(ii). References in this
section to section 987 gain or loss refer to
any foreign currency gain or loss realized
under section 987(3), references to a sec-
tion 987 QBU refer to any eligible QBU
(as defined in § 1.987-1(b)(3)(i), but with-
out regard to § 1.987-1(b)(3)(ii)) that is
subject to section 987, and references to a
section 987 aggregate partnership refer to
any partnership for which the acquisition
or disposition of a partnership interest
could give rise to foreign currency gain or
loss realized under section 987(3). Addi-
tionally, references to recognition of sec-
tion 987 gain or loss under § 1.987-5
encompass any determination and recog-
nition of gain or loss under section 987(3)
that would occur but for this section. Ac-
cordingly, the principles of this section
apply to a QBU subject to section 987
regardless of whether the QBU otherwise
is subject to §§ 1.987-1 through 1.987-
11. An owner of a QBU that is not subject
to § 1.987-5 must adapt the rules set forth
in this section as necessary to recognize
section 987 gains or losses that are subject
to this section consistent with the princi-
ples of this section.

(3) Exceptions-(i) Annual deemed
termination elections. This section does
not apply to section 987 gain or loss of a
section 987 QBU with respect to which
the annual deemed termination election
described in § 1.987-8T(d) is in effect.

(ii) De minimis exception. This section
does not apply to a section 987 QBU for a
taxable year if the net unrecognized sec-
tion 987 gain or loss of the section 987
QBU that, as a result of this section,
would not be recognized under § 1.987-5
in the taxable year does not exceed $5
million.

(b) Gain and loss recognition in con-
nection with a deferral event-(1) In gen-
eral. Notwithstanding § 1.987-5, the
owner of a section 987 QBU with respect
to which a deferral event occurs (a defer-
ral QBU) includes in taxable income sec-
tion 987 gain or loss in connection with
the deferral event only to the extent pro-
vided in paragraphs (b)(3) and (c) of this
section. However, if the deferral event
also constitutes an outbound loss event
described in paragraph (d) of this section,
the amount of loss recognized by the
owner may be further limited under that
paragraph.

(2) Deferral event-(i) In general. A
deferral event with respect to a section
987 QBU means any transaction or series
of transactions that satisfy the conditions
described in paragraphs (b)(2)(ii) and
(b)(2)(iii) of this section.

(ii) Transactions. The transaction or
series of transactions include either:

(A) A termination of the section 987
QBU other than any of the following ter-
minations: a termination described in
§ 1.987-8(b)(3), a termination described
in § 1.987-8(c), or a termination de-
scribed solely in § 1.987-8(b)(1); or

(B) A disposition of part of an interest
in a section 987 aggregate partnership or
DE through which the section 987 QBU is
owned or any contribution by another per-
son to such a partnership or DE of assets
that, immediately after the contribution,
are not considered to be included on the
books and records of an eligible QBU,
provided that the contribution gives rise to
a deemed transfer from the section 987
QBU to the owner.

(iii) Assets on books of successor QBU.
Immediately after the transaction or series
of transactions, assets of the section 987
QBU are reflected on the books and re-
cords of a successor QBU (as defined in
paragraph (b)(4) of this section).

(3) Gain or loss recognized under
§ 1.987-5 in the taxable year of a deferral
event. In the taxable year of a deferral

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event with respect to a deferral QBU, the
owner of the deferral QBU recognizes
section 987 gain or loss as determined
under § 1.987-5, except that, solely for
purposes of applying § 1.987-5, all assets
and liabilities of the deferral QBU that,
immediately after the deferral event, are
reflected on the books and records of a
successor QBU are treated as not having
been transferred and therefore as remain-
ing on the books and records of the defer-
ral QBU notwithstanding the deferral
event.

(4) Successor QBU. For purposes of
this section, a section 987 QBU (potential
successor QBU) is a successor QBU with
respect to a section 987 QBU referred to
in paragraph (b)(2)(ii) of this section if,
immediately after the transaction or series
of transactions described in that para-
graph, the potential successor QBU satis-
fies all of the conditions described in para-
graphs (b)(4)(i) through (b)(4)(iii) of this
section.

(i) The books and records of the poten-
tial successor QBU reflect assets that, im-
mediately before the transaction or series
of transactions described in paragraph
(b)(2)(ii) of this section, were reflected on
the books and records of the section 987
QBU referred to in that paragraph.

(ii) The owner of the potential succes-
sor QBU and the owner of the section 987
QBU referred to in paragraph (b)(2)(ii) of
this section immediately before the trans-
action or series of transactions described
in that paragraph are members of the same
controlled group.

(iii) In the case of a section 987 QBU
referred to in paragraph (b)(2)(ii)(A) of
this section, if the owner of the section
987 QBU immediately before the transac-
tion or series of transactions described in
that paragraph was a U.S. person, the po-
tential successor QBU is owned by a U.S.
person.

(c) Recognition of deferred section 987
gain or loss in the taxable year of a de-
ferral event and in subsequent taxable
years-(1) In general-(i) Deferred sec-
tion 987 gain or loss. A deferral QBU
owner (as defined in paragraph (c)(1)(ii)
of this section) recognizes section 987
gain or loss attributable to the deferral
QBU that, as a result of paragraph (b) of
this section, is not recognized in the tax-
able year of the deferral event under

§ 1.987-5 (deferred section 987 gain or
loss) in the taxable year of the deferral
event and in subsequent taxable years as
provided in paragraphs (c)(2) through (4)
of this section.

(ii) Deferral QBU owner. For purposes
of this paragraph (c), a deferral QBU
owner means, with respect to a deferral
QBU, the owner of the deferral QBU im-
mediately before the deferral event, or the
owner's qualified successor.

(2) Recognition upon a subsequent re-
mittance-(i) In general. Except as pro-
vided in paragraph (c)(3) of this section, a
deferral QBU owner recognizes deferred
section 987 gain or loss in the taxable year
of the deferral event and in subsequent
taxable years upon a remittance from a
successor QBU to the owner of the suc-
cessor QBU (successor QBU owner) in
the amount described in paragraph
(c)(2)(ii) of this section.

(ii) Amount. The amount of deferred
section 987 gain or loss that is recognized
pursuant to this paragraph (c)(2) in a tax-
able year of the deferral QBU owner is the
outstanding deferred section 987 gain or
loss (that is, the amount of deferred sec-
tion 987 gain or loss not previously rec-
ognized) multiplied by the remittance pro-
portion of the successor QBU owner with
respect to the successor QBU for the tax-
able year ending with or within the tax-
able year of the deferral QBU owner, as
determined under § 1.987-5(b) (and, to
the extent relevant, paragraphs (b) and
(c)(2)(iii) of this section) without regard
to any election under § 1.987-8T(d). For
purposes of computing this remittance
proportion, multiple successor QBUs of
the same deferral QBU are treated as a
single successor QBU.

(iii) Deemed remittance when a suc-
cessor QBU ceases to be owned by a
member of the deferral QBU owner's con-
trolled group. For purposes of this para-
graph (c)(2), in a taxable year of the de-
ferral QBU owner in which a successor
QBU ceases to be owned by a member of
a controlled group that includes the defer-
ral QBU owner, the successor QBU owner
is treated as having a remittance propor-
tion of 1. Accordingly, if there is only one
successor QBU with respect to a deferral
QBU and that successor QBU ceases to be
owned by a member of the controlled
group that includes the deferral QBU

owner, all outstanding deferred section
987 gain or loss with respect to that de-
ferral QBU will be recognized. This para-
graph (c)(2)(iii) does not affect the appli-
cation of §§ 1.987-1 through 1.987-11 to
the successor QBU owner with respect to
its ownership of the successor QBU.

(3) Recognition of deferred section 987
loss in certain outbound successor QBU
terminations. Notwithstanding paragraph
(c)(2) of this section, if assets of the suc-
cessor QBU (transferred assets) are trans-
ferred (or deemed transferred) in a trans-
action that would constitute an outbound
loss event if the successor QBU had a net
accumulated section 987 loss at the time
of the exchange, then the deferral QBU
owner recognizes outstanding deferred
section 987 loss, if any, to the extent it
would recognize loss under paragraph
(d)(1) of this section if (i) the deferral
QBU owner owned the successor QBU,
(ii) the deferral QBU owner had net un-
recognized section 987 loss with respect
to the successor QBU equal to its out-
standing deferred section 987 loss with
respect to the deferral QBU, and (iii) the
transferred assets were transferred (or
deemed transferred) in an outbound loss
event. Any outstanding deferred section
987 loss with respect to the deferral QBU
that is not recognized as a result of the
preceding sentence is recognized by the
deferral QBU owner in the first taxable
year in which the deferral QBU owner
(including any qualified successor) ceases
to be a member of a controlled group that
includes the acquirer of the transferred
assets or any qualified successor of such
acquirer.

(4) Special rules regarding successor
QBUs-(i) Successor QBU with respect
to a deferral QBU that is a successor
QBU. If a section 987 QBU is a successor
QBU with respect to a deferral QBU that
is a successor QBU with respect to an-
other deferral QBU, the first-mentioned
section 987 QBU is considered a succes-
sor QBU with respect to the second-
mentioned deferral QBU. For example, if
QBU A is a successor QBU with respect
to QBU B, and QBU B is a successor
QBU with respect to QBU C, then QBU A
is a successor QBU with respect to QBU C.

(ii) Separation of a successor QBU. If
a successor QBU with respect to a deferral
QBU separates into two or more separated

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QBUs (as defined in § 1.987-2T(c)(9)
(iii)), each separated QBU is considered a
successor QBU with respect to the defer-
ral QBU.

(iii) Combination of a successor QBU.
If a successor QBU with respect to a de-
ferral QBU combines with another section
987 QBU of the same owner, resulting in
a combined QBU (as defined in § 1.987-
2T(c)(9)(i)), the combined QBU is consid-
ered a successor QBU with respect to the
deferral QBU.

(d) Loss recognition upon an outbound
loss event-(1) In general. Notwithstand-
ing § 1.987-5, the owner of a section 987
QBU with respect to which an outbound
loss event occurs (an outbound loss QBU)
includes in taxable income in the taxable
year of an outbound loss event section 987
loss with respect to that section 987 QBU
only to the extent provided in paragraph
(d)(3) of this section.

(2) Outbound loss event. An outbound
loss event means, with respect to a section
987 QBU:

(i) Any termination of the section 987
QBU in connection with a transfer by a
U.S. person of assets of the section 987
QBU to a foreign person that is a member
of the same controlled group as the U.S.
transferor immediately before the transac-
tion or, if the transferee did not exist im-
mediately before the transaction, immedi-
ately after the transaction (related foreign
person), provided that the termination
would result in the recognition of section
987 loss with respect to the section 987
QBU under § 1.987-5 and paragraph (b)
of this section but for this paragraph (d);

(ii) Any transfer by a U.S. person of
part of an interest in a section 987 aggre-
gate partnership or DE through which the
U.S. person owns the section 987 QBU to
a related foreign person that has the same
functional currency as the section 987
QBU, or any contribution by such a re-
lated foreign person to such a partnership
or DE of assets that, immediately after the
contribution, are not considered to be in-
cluded on the books and records of an
eligible QBU, provided that the transfer
would result in the recognition of section
987 loss with respect to the section 987
QBU under § 1.987-5 and paragraph (b)
of this section but for this paragraph (d).

(3) Loss recognized upon an outbound
loss event. In the taxable year of an out-

bound loss event with respect to an out-
bound loss QBU, the owner of the out-
bound loss QBU recognizes section 987
loss as determined under § 1.987-5 and
paragraphs (b) and (c) of this section, ex-
cept that, solely for purposes of applying
§ 1.987-5, the following assets and liabil-
ities of the outbound loss QBU are treated
as not having been transferred and there-
fore as remaining on the books and re-
cords of the outbound loss QBU notwith-
standing the outbound loss event:

(i) In the case of an outbound loss
event described in paragraph (d)(2)(i) of
this section, assets and liabilities that, im-
mediately after the outbound loss event,
are reflected on the books and records of
the related foreign person described in
that paragraph or of a section 987 QBU
owned by such related foreign person; and

(ii) In the case of an outbound loss
event described in paragraph (d)(2)(ii) of
this section, assets and liabilities that, im-
mediately after the outbound loss event,
are reflected on the books and records of
the eligible QBU from which the assets
and liabilities of the outbound loss QBU
are allocated and not on the books and
records of a section 987 QBU.

(4) Adjustment of basis of stock re-
ceived in certain nonrecognition transac-
tions. If an outbound loss event results
from the transfer of assets of the outbound
loss QBU in a transaction described in
section 351 or section 361, the basis of the
stock that is received in the transaction is
increased by an amount equal to the sec-
tion 987 loss that, as a result of this para-
graph (d), is not recognized with respect
to the outbound loss QBU in the taxable
year of the outbound loss event (outbound
section 987 loss).

(5) Recognition of outbound section
987 loss that is not converted into stock
basis. Outbound section 987 loss attribut-
able to an outbound loss event that is not
described in paragraph (d)(4) of this sec-
tion is recognized by the owner of the
outbound loss QBU in the first taxable
year in which the owner or any qualified
successor of the owner ceases to be a
member of a controlled group that in-
cludes the related foreign person referred
to in paragraph (d)(2)(i) or (ii) of this
section, or any qualified successor of such
person.

(e) Source and character-(1) De-
ferred section 987 gain or loss and certain
outbound section 987 loss. The source and
character of deferred section 987 gain or
loss recognized pursuant to paragraph (c)
of this section, and of outbound section
987 loss recognized pursuant to paragraph
(d)(5) of this section, is determined under
§ 1.987-6 as if such deferred section 987
gain or loss were recognized pursuant to
§ 1.987-5 without regard to this section
on the date of the related deferral event or
outbound loss event.

(2) Outbound section 987 loss reflected
in stock basis. If loss is recognized on the
sale or exchange of stock described in
paragraph (d)(4) of this section within two
years of the outbound loss event described
in that paragraph, then, to the extent of the
outbound section 987 loss, the source and
character of the loss recognized on the
sale or exchange is determined under
§ 1.987-6 as if such loss were section 987
loss recognized pursuant to § 1.987-5
without regard to this section on the date
of the outbound loss event.

(f) Definitions-(1) Controlled group.
For purposes of this section, a controlled
group means all persons with the relation-
ships to each other specified in sections
267(b) or 707(b).

(2) Qualified successor. For purposes
of this section, a qualified successor with
respect to a corporation (transferor corpo-
ration) means another corporation (acquir-
ing corporation) that acquires the assets of
the transferor corporation in a transaction
described in section 381(a), but only if (A)
the acquiring corporation is a domestic
corporation and the transferor corporation
was a domestic corporation, or (B) the
acquiring corporation is a controlled for-
eign corporation (as defined in section
957(a)) (CFC) and the transferor corpora-
tion was a CFC. A qualified successor of
a corporation includes the qualified suc-
cessor of a qualified successor of the cor-
poration.

(g) Anti-abuse. No section 987 loss is
recognized under § 1.987-5 or this section
in connection with a transaction or series
of transactions that are undertaken with a
principal purpose of avoiding the pur-
poses of this section.

(h) Examples. The following examples
illustrate the application of this section.
For purposes of the examples, DC1 is a

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domestic corporation that owns all of the
stock of DC2, which is also a domestic
corporation, and CFC1 and CFC2 are
CFCs. In addition, DC1, DC2, CFC1, and
CFC2 are members of a controlled group
as defined in paragraph (f)(1) of this sec-
tion, and the de minimis rule of paragraph
(a)(3)(ii) of this section is not applicable.
Finally, except as otherwise provided,
Business A is a section 987 QBU with the
euro as its functional currency, there are
no transfers between Business A and its
owner, and Business A's assets are not
depreciable or amortizable.

Example 1. Contribution of a section 987 QBU to
a member of the controlled group. (i) Facts. DC1
owns all of the interests in Business A. The balance
sheet of Business A reflects assets with an aggregate
adjusted basis of €1,000x and no liabilities. DC1
contributes €900x of Business A's assets to DC2 in
an exchange to which section 351 applies. Immedi-
ately after the contribution, the remaining €100x of
Business A's assets are no longer reflected on the
books and records of a section 987 QBU. DC2,
which has the U.S. dollar as its functional currency,
uses the former Business A assets in a business
(Business B) that constitutes a section 987 QBU. At
the time of the contribution, Business A has net
accumulated unrecognized section 987 gain of
$100x.

(ii) Analysis. (A) Under § 1.987-2(c)(2)(ii),
DC1's contribution of €900x of Business A's assets
to DC2 is treated as a transfer of all of the assets of
Business A to DC1, immediately followed by DC1's
contribution of €900x of Business A's assets to DC2.
The contribution of Business A's assets is a deferral
event within the meaning of paragraph (b)(2) of this
section because: (1) the transfer from Business A to
DC1 is a transfer of substantially all of Business A's
assets to DC1, resulting in a termination of Business
A under § 1.987-8(b)(2); and (2) immediately after
the transaction, assets of Business A are reflected on
the books and records of Business B, a section 987
QBU owned by a member of DC1's controlled group
and a successor QBU within the meaning of para-
graph (b)(4) of this section. Accordingly, Business A
is a deferral QBU within the meaning of paragraph
(b)(1) of this section, and DC1 is a deferral QBU
owner of Business A within the meaning of para-
graph (c)(1)(ii) of this section.

(B) Under paragraph (b)(3) of this section,
DC1's taxable income in the taxable year of the
deferral event includes DC1's section 987 gain or
loss determined with respect to Business A under
§ 1.987-5, except that, for purposes of applying
§ 1.987-5, all assets and liabilities of Business A that
are reflected on the books and records of Business B
immediately after Business A's termination are
treated as not having been transferred and therefore
as though they remained on Business A's books and
records (notwithstanding the deemed transfer of
those assets under § 1.987-8(e)). Accordingly, in the
taxable year of the deferral event, DC1 is treated as
making a remittance of €100x, corresponding to the
assets of Business A that are no longer reflected on
the books and records of a section 987 QBU, and is

treated as having a remittance proportion with re-
spect to Business A of 0.1, determined by dividing
the €100x remittance by the sum of the remittance
and the €900x aggregate adjusted basis of the gross
assets deemed to remain on Business A's books at
the end of the year. Thus, DC1 recognizes $10x of
section 987 gain in the taxable year of the deferral
event. DC1's deferred section 987 gain equals $90x,
which is the amount of section 987 gain that, but for
the application of paragraph (b) of this section, DC1
would have recognized under § 1.987-5 ($100x),
less the amount of section 987 gain recognized by
DC1 under § 1.987-5 and this section ($10x).

Example 2. Election to be classified as a corpo-
ration. (i) Facts. DC1 owns all of the interests in
Entity A, a DE. Entity A conducts Business A, which
has net accumulated unrecognized section 987 gain
of $500x. Entity A elects to be classified as a cor-
poration under § 301.7701-3(a). As a result of the
election and pursuant to § 301.7701-3(g)(1)(iv),
DC1 is treated as contributing all of the assets and
liabilities of Business A to newly-formed CFC1,
which has the euro as its functional currency. Imme-
diately after the contribution, the assets and liabili-
ties of Business A are reflected on CFC1's balance
sheet.

(ii) Analysis. Under § 1.987-2(c)(2)(ii), DC1's
contribution of all of the assets and liabilities of
Business A to CFC1 is treated as a transfer of all of
the assets and liabilities of Business A to DC1,
followed immediately by DC1's contribution of
those assets and liabilities to CFC1. Because the
deemed transfer from Business A to DC1 is a trans-
fer of substantially all of Business A's assets to DC1,
the Business A QBU terminates under § 1.987-
8(b)(2). The contribution of Business A's assets is
not a deferral event within the meaning of paragraph
(b)(2) of this section because, immediately after the
transaction, no assets of Business A are reflected on
the books and records of a successor QBU within the
meaning of paragraph (b)(4) of this section due to
the fact that the assets of Business A are not reflected
on a section 987 QBU immediately after the termi-
nation as well as the fact that the requirement of
paragraph (b)(4)(iii) of this section is not met. Ac-
cordingly, DC1 recognizes section 987 gain with
respect to Business A under § 1.987-5 without re-
gard to this section. Because the requirement of
paragraph (b)(4)(iii) of this section is not met, the
result would be the same even if the assets of Busi-
ness A were transferred in a section 351 exchange to
an existing foreign corporation that had a different
functional currency than Business A.

Example 3. Outbound loss event. (i) Facts. The
facts are the same as in Example 2, except that
Business A has net accumulated unrecognized sec-
tion 987 loss of $500x rather than net accumulated
unrecognized section 987 gain of $500x.

(ii) Analysis. (A) The analysis of the transactions
under §§ 1.987-2(c)(2)(ii), 1.987-8(b)(2), and para-
graph (b) of this section is the same as in Example 2.
However, the termination of Business A as a result
of the transfer of the assets of Business A by a U.S.
person (DC1) to a foreign person (CFC1) that is a
member of DC1's controlled group is an outbound
loss event described in paragraph (d)(2) of this sec-
tion.

(B) Under paragraphs (d)(1) and (d)(3) of this
section, in the taxable year of the outbound loss
event, DC1 includes in taxable income section 987
loss recognized with respect to Business A as deter-
mined under § 1.987-5, except that, for purposes of
applying § 1.987-5, all assets and liabilities of Busi-
ness A that are reflected on the books and records of
CFC1, a related foreign person described in para-
graph (d)(2) of this section, are treated as not having
been transferred. Accordingly, DC1's remittance
proportion with respect to Business A is 0, and DC1
recognizes no section 987 loss with respect to Busi-
ness A. DC1's outbound section 987 loss is $500x,
which is the amount of section 987 loss that DC1
would have recognized under § 1.987-5 ($500x)
without regard to paragraph (d) of this section, less
the amount of section 987 loss recognized by DC1
under paragraph (d)(3) of this section ($0). Under
paragraph (d)(4) of this section, DC1 must increase
its basis in its CFC1 shares by the amount of the
outbound section 987 loss ($500x).

Example 4. Conversion of a DE to a partnership.
(i) Facts. DC1 owns all of the interests in Entity A,
a DE that conducts Business A. On the last day of
Year 1, DC1 sells 50 percent of its interest in Entity
A to DC2 (the Entity A sale).

(ii) Analysis. (A) For Federal income tax pur-
poses, Entity A is converted to a partnership when
DC2 purchases the 50 percent interest in Entity A.
DC2's purchase is treated as the purchase of 50
percent of the assets of Entity A (that is, the assets of
Business A), which, prior to the purchase, were
treated as held directly by DC1 for Federal income
tax purposes. Immediately after DC2's deemed pur-
chase of 50 percent of Business A assets, DC1 and
DC2 are treated as contributing their respective in-
terests in Business A assets to a partnership. See
Rev. Rul. 99-5 (1999-1 CB 434) (situation 1).
These deemed transactions are not taken into ac-
count for purposes of this section, but the Entity A
sale and resulting existence of a partnership have
consequences under section 987 and this section, as
described in paragraphs (ii)(B) through (D) of this
Example 4.

(B) Immediately after the Entity A sale, Entity A
is a section 987 aggregate partnership within the
meaning of § 1.987-1(b)(5) because DC1 and DC2
own all the interests in partnership capital and prof-
its, DC1 and DC2 are related within the meaning of
section 267(b), and the partnership has an eligible
QBU (Business A) that would be a section 987 QBU
with respect to a partner if owned by the partner
directly. As a result of the Entity A sale, 50 percent
of the assets and liabilities of Business A ceased to
be reflected on the books and records of DC1's
Business A section 987 QBU. As a result, such
assets and liabilities are treated as if they were trans-
ferred from DC1's Business A section 987 QBU to
DC1. Additionally, following DC2's acquisition of
50 percent of the interest in Entity A, DC2 is allo-
cated 50 percent of the assets and liabilities of Busi-
ness A under §§ 1.987-2(b), 1.987-7(a), and 1.987-
7T(b). Because DC2 and Business A have different
functional currencies, DC2's portion of the Business
A assets and liabilities constitutes a section 987
QBU. Accordingly, 50 percent of the assets and
liabilities of Business A are treated as transferred by
DC2 to DC2's Business A section 987 QBU.

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(C) The Entity A sale is a deferral event de-
scribed in paragraph (b)(2) of this section because:
(1) the sale constitutes the disposition of part of an
interest in a DE; and (2) immediately after the trans-
action, assets of DC1's Business A section 987 QBU
are reflected on the books and records of DC1's
Business A section 987 QBU and DC2's Business A
section 987 QBU, each of which is a successor QBU
with respect to DC1's Business A section 987 QBU
within the meaning of paragraph (b)(4) of this sec-
tion. Accordingly, DC1's Business A section 987
QBU is a deferral QBU within the meaning of para-
graph (b)(1) of this section, and DC1 is a deferral
QBU owner within the meaning of paragraph
(c)(1)(ii) of this section. Under paragraph (b)(1) of
this section, DC1 includes in taxable income section
987 gain or loss with respect to Business A in
connection with the deferral event to the extent pro-
vided in paragraphs (b)(3) and (c) of this section.

(D) Under paragraph (b) of this section, in the
taxable year of the Entity A sale, DC1 includes
in taxable income section 987 gain or loss with
respect to Business A as determined under
§ 1.987-5, except that, for purposes of applying
§ 1.987-5, all assets and liabilities of Business A
that, immediately after the Entity A sale, are re-
flected on the books and records of successor QBUs
are treated as though they were not transferred and
therefore as remaining on the books and records of
DC1's Business A section 987 QBU notwithstanding
the Entity A sale. Accordingly, DC1's remittance
amount under § 1.987-5 is $0, and DC1 recognizes
no section 987 gain or loss with respect to Business
A.

Example 5. Partial recognition of deferred gain
or loss. (i) Facts. DC1 owns all of the interests in
Entity A, a DE that conducts Business A in Country
X. During Year 1, DC1 contributes all of its interests
in Entity A to DC2 in an exchange to which section
351 applies. At the time of the contribution, Business
A has net accumulated unrecognized section 987
gain of $100x. After the contribution, Entity A con-
tinues to conduct business in Country X (Business
B). In Year 3, as a result of a net transfer of property
from Business B to DC2, DC2's remittance propor-
tion with respect to Business B, as determined under
§ 1.987-5, is 0.25.

(ii) Analysis. (A) For the reasons described in
Example 1, the contribution of Entity A by DC1 to
DC2 results in a termination of Business A and a
deferral event with respect to Business A, a deferral
QBU; DC1 is a deferral QBU owner within the
meaning of paragraph (c)(1)(ii) of this section; Busi-
ness B is a successor QBU with respect to Business
A; DC2 is a successor QBU owner; and the $100x of
net accumulated unrecognized section 987 gain with
respect to Business A becomes deferred section 987
gain as a result of the deferral event.

(B) Under paragraph (c)(1) of this section, DC1
recognizes deferred section 987 gain with respect to
Business A in accordance with paragraphs (c)(2)
through (4) of this section. Under paragraph (c)(2)(i)
of this section, DC1 recognizes deferred section 987
gain in Year 3 as a result of the remittance from
Business B to DC2. Under paragraph (c)(2)(ii) of
this section, the amount of deferred section 987 gain
that DC1 recognizes is $25x, which is DC1's out-
standing deferred section 987 gain or loss ($100x)

with respect to Business A multiplied by the remit-
tance proportion (0.25) of DC2 with respect to Busi-
ness B for the taxable year as determined under
§ 1.987-5(b).

(i) Coordination with fresh start tran-
sition method-(1) In general. If a tax-
payer is a deferral QBU owner, or is or
was the owner of an outbound loss QBU,
and the taxpayer is required under
§ 1.987-10(a) to apply the fresh start tran-
sition method described in § 1.987-10(b)
to the deferral QBU or outbound loss
QBU, or would have been so required if
the taxpayer had owned the deferral QBU
or outbound loss QBU on the transition
date (as defined in § 1.987-11(c)), the
adjustments described in paragraphs (i)(2)
and (i)(3) of this section, as applicable,
must be made on the transition date.

(2) Adjustment to deferred section 987
gain or loss. The amount of any outstand-
ing deferred section 987 gain or loss of a
deferral QBU owner with respect to a
deferral QBU described in paragraph
(i)(1) of this section must be adjusted to
equal the amount of outstanding deferred
section 987 gain or loss that the deferral
QBU owner would have had with respect
to the deferral QBU on the transition date
if, immediately before the deferral event,
the deferral QBU had transitioned to the
method prescribed by §§ 1.987-1 through
1.987-10 pursuant to the fresh start tran-
sition method.

(3) Adjustments in the case of an out-
bound loss event. The basis of any stock
described in paragraph (d)(4) of this sec-
tion that was received in connection with
the transfer (or deemed transfer) of assets
of an outbound loss QBU described in
paragraph (i)(1) of this section and that is
held on the transition date must be ad-
justed to equal the basis that such stock
would have had on the transition date if,
immediately prior to the outbound loss
event, the outbound loss QBU had transi-
tioned to the method prescribed by
§§ 1.987-1 through 1.987-10 pursuant to
the fresh start transition method. If no
such stock was received, the amount of
any outbound section 987 loss with re-
spect to the outbound loss QBU that may
be recognized on or after the transition
date pursuant to paragraph (d)(5) of this
section must be adjusted to equal the
amount of such loss that would be out-
standing and that may be recognized pur-
suant to that paragraph if, immediately

before the outbound loss event, the out-
bound loss QBU had transitioned to the
method prescribed by §§ 1.987-1 through
1.987-10 pursuant to the fresh start tran-
sition method.

(j) Effective/applicability date-(1) In
general. Except as described in paragraph
(j)(2) of this section, this section applies to
any deferral event or outbound loss event
that occurs on or after January 6, 2017.

(2) Exception. This section applies to
any deferral event or outbound loss event
that occurs on or after December 7, 2016,
if such deferral event or outbound loss
event is undertaken with a principal pur-
pose of recognizing section 987 loss.

(k) Expiration date. The applicability
of this section expires December 6, 2019.

Par. 19. Section 1.988-0 is amended
by revising the entry for § 1.988-2(b)(16)
and adding an entry for § 1.988-2(i) to
read as follows:

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

* * * * *

§ 1.988-2 Recognition and computation of exchange
gain or loss.

* * * * *

(b) * * *
(16) [Reserved].

* * * * *

(i) [Reserved].

Par. 20. Section 1.988-1 is amended
by adding paragraph (a)(3) to read as fol-
lows:

§ 1.988-1 Certain definitions and special rules.
* * * * *

(a) * * *

(3) [Reserved]. For further guidance,
see § 1.988-1T(a)(3).

* * * * *

Par. 21. Section 1.988-1T is added to
read as follows:

§ 1.988-1T Certain definitions and special rules
(temporary).
(a)(1) through (a)(2) [Reserved]. For
further guidance, see § 1.988-1(a)(1)
through (2).

(3) Specified owner functional cur-
rency transactions of a section 987 QBU
not treated as section 988 transactions.
Specified owner functional currency
transactions, as defined in § 1.987-
3T(b)(4)(ii), held by a section 987 QBU
are not treated as section 988 transactions.
Thus, no currency gain or loss shall be
recognized by a section 987 QBU under

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section 988 with respect to such transac-
tions.

(4) through (i) [Reserved]. For further
guidance, see § 1.988-1(a)(4) through (i).

(j) Effective/applicability date. This
section applies to taxable years beginning
on or after one year after the first day of
the first taxable year following December
7, 2016. Notwithstanding the preceding
sentence, if a taxpayer makes an election
under § 1.987-11(b), then this section ap-
plies to taxable years to which §§ 1.987-1
through 1.987-10 apply as a result of such
election.

(k) Expiration date. The applicability
of this section expires on December 6,
2019.

Par. 22. Section 1.988-2 is amended
by revising paragraph (b)(16) and adding
paragraph (i) to read as follows:

§ 1.988-2 Recognition and computation of exchange
gain or loss.

* * * * *

(b) * * *

(16) [Reserved]. For further guidance,
see § 1.988-2T(b)(16).

* * * * *

(i) [Reserved]. For further guidance,
see § 1.988-2T(i).

Par. 23. Section 1.988-2T is added to
read as follows:

§ 1.988-2T Recognition and computation of ex-
change gain or loss (temporary).

(a) through (b)(15) [Reserved]. For fur-
ther guidance, see § 1.988-2(a) through
(b)(15).

(16) Deferral of loss on certain related-
party debt instruments .- (i) Treatment of
creditor. For rules applicable to a corpora-
tion included in a controlled group that is a
creditor under a debt instrument see
§ 1.267(f)-1(e).

(ii) Treatment of debtor-(A) In gen-
eral. Exchange loss realized under
§ 1.988-2(b)(4) or (b)(6) is deferred if-

(1) The loss is realized by a debtor with
respect to a loan from a person that has a
relationship to the debtor described in sec-
tion 267(b) or section 707(b); and

(2) The transaction resulting in the re-
alization of exchange loss has as a princi-
pal purpose the avoidance of Federal in-
come tax.

(B) Recognition of deferred loss. Any
exchange loss that is deferred under para-
graph (b)(16)(ii)(A) of this section is de-
ferred until the end of the term of the loan,

determined immediately prior to the trans-
action.

(17) through (h) [Reserved]. For fur-
ther guidance, see § 1.988-2(b)(17)
through (h).

(i) Special rules for section 988 trans-
actions of a section 987 QBU. For rules
regarding section 988 transactions of a
section 987 QBU, see § 1.987-3T(b)(4)
for section 987 QBUs in general and
§ 1.987-1T(b)(6) for dollar QBUs.

(j) Effective/applicability date. Para-
graph (b)(16) of this section applies to any
exchange loss realized on or after Decem-
ber 7, 2016. Paragraph (i) of this section
applies to taxable years beginning on or
after one year after the first day of the first
taxable year following December 7, 2016.
Notwithstanding the preceding sentence,
if a taxpayer makes an election under
§ 1.987-11(b), then paragraph (i) of this
section applies to taxable years to which
§§ 1.987-1 through 1.987-10 apply as a
result of such election.

(k) Expiration date. The applicability
of this section expires on December 6,
2019.

John Dalrymple,
Deputy Commissioner for Services and
Enforcement.
Approved November 14, 2016,

Mark J. Mazur,
Assistant Secretary of the Treasury (Tax
Policy).

(Filed by the Office of the Federal Register on December 7,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 8, 2016, 81 F.R. 88854)

## T.D. 9801

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

### Issue Price Definition for Tax- Exempt Bonds

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-
nal regulations on the definition of issue
price for purposes of the arbitrage invest-
ment restrictions that apply to tax-exempt
bonds and other tax-advantaged bonds.
These final regulations affect State and
local governments that issue tax-exempt
bonds and other tax-advantaged bonds.

DATES: Effective date: These regulations
are effective on December 9, 2016.

Applicability date: For the date of ap-
plicability, see § 1.148-11(m).

FOR FURTHER INFORMATION CON-
TACT:
Lewis Bell at (202) 317-6980 (not a toll-
free number).

SUPPLEMENTARY INFORMATION:

## Paperwork Reduction Act

The collection of information con-
tained 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 1545-1347. The collection of in-
formation in these final regulations is in
§ 1.148-1(f)(2)(ii), which requires the un-
derwriter to provide to the issuer a certi-
fication and reasonable supporting docu-
mentation for use of the initial offering
price to the public, § 1.148-1(f)(2)(iii),
which requires the issuer to obtain a cer-
tification from the underwriter for com-
petitive sales, and § 1.148-1(f)(2)(iv),
which requires the issuer to identify in its
books and records the rule used to deter-
mine the issue price of the bonds. The
respondents are issuers of tax-exempt
bonds that want to apply the special rules
in § 1.148-1(f)(2) to determine the issue
price of the bonds.

An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally tax returns and tax
return information are confidential, as re-
quired by section 6103.

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### Background

This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) on the arbitrage investment restric-
tions under section 148 of the Internal
Revenue Code (Code). On June 18, 1993,
the Department of the Treasury (Treasury
Department) and the IRS published com-
prehensive final regulations in the Fed-
eral Register (TD 8476, 58 FR 33510) on
the arbitrage investment restrictions and
related provisions for tax-exempt bonds
under sections 103, 148, 149, and 150.
Since that time, those final regulations
have been amended in various limited re-
spects, including most recently in final
regulations published in the Federal Reg-
ister (TD 9777, 81 FR 46582) on July 18,
2016 (the regulations issued in 1993 and
the various amendments thereto are col-
lectively referred to as the Existing Reg-
ulations).

A notice of proposed rulemaking was
published in the Federal Register (78 FR
56842; REG-148659-07) on September
16, 2013 (the 2013 Proposed Regula-
tions), which, among other things, pro-
posed to amend the definition of "issue
price." Subsequently, the Treasury De-
partment and the IRS withdrew § 1.148-
1(f) of the 2013 Proposed Regulations re-
garding the definition of issue price and
published another notice of proposed rule-
making in the Federal Register (80 FR
36301; REG-138526-14) on June 24,
2015, which re-proposed a definition of
issue price (the 2015 Proposed Regula-
tions). Comments were received and a
public hearing was held on October 28,
2015. After consideration of all of the
public comments, the Treasury Depart-
ment and the IRS adopt the 2015 Pro-
posed Regulations, with revisions, by this
Treasury decision (the Final Regulations).

## Summary of Comments and Explanation of Provisions

This section discusses the comments
received from the public regarding the
2015 Proposed Regulations. The com-
ments are available for public inspection
at www.regulations.gov. This section also

explains revisions made in the Final Reg-
ulations.

### 1. Introduction.

Under section 103, interest received by
investors on eligible State and local bonds
is exempt from Federal income tax. As a
result, tax-exempt bonds tend to have
lower interest rates than taxable obliga-
tions. Section 148 generally limits invest-
ment of proceeds of tax-exempt bonds to
investment yields that are not materially
higher than the yield on the bond issue.
Section 148 also generally requires that
excess investment earnings be paid to the
Federal Government at periodic intervals.
For purposes of these arbitrage investment
restrictions, section 148(h) provides that
yield on an issue is to be determined on
the basis of the issue price (within the
meaning of sections 1273 and 1274). The
reason for using issue price (rather than
sales proceeds less the costs of issuance)
to determine yield for purposes of section
148(h) is to ensure that issuers bear the
costs of issuance, rather than recover these
costs through arbitrage profits. See H.
Rep. No. 99-426, at 517 (1985). The
report of the Committee on Ways and
Means states that the Committee believed
that this requirement would encourage is-
suers to scrutinize costs of issuance more
closely and would encourage better target-
ing of the federal subsidy associated with
tax-exempt bonds. Id., at 517-518. In gen-
eral, the lower the issue price for bonds
bearing a stated interest rate, the higher
the yield. An issuer has an economic in-
centive to receive the highest price for
bonds and to pay the lowest yield. This
aligns with the purpose of the arbitrage
restrictions, which is to minimize arbi-
trage investment benefits and remove in-
centives to issue more tax-exempt bonds,
and thus to limit the federal revenue cost
of the tax subsidy for tax-exempt bonds.

The issue price definition under the
Existing Regulations generally follows
the issue price definition used for comput-
ing original issue discount on debt instru-
ments under sections 1273 and 1274, with
certain modifications. The definition of is-
sue price under the Existing Regulations

provides generally that the issue price of
bonds that are publicly offered is the first
price at which a substantial amount of the
bonds is sold to the public. The Existing
Regulations define a substantial amount to
mean ten percent. Further, the Existing
Regulations include a special rule that ap-
plies a reasonable expectations standard
(rather than a standard based on actual
sales) to determine, as of the sale date,12
the issue price for bonds for which a bona
fide public offering is made, based on
reasonable expectations regarding the ini-
tial offering price. The issue prices of
bonds with different payment and credit
terms are determined separately. Tax-
exempt bond issues often include bonds
with different payment and credit terms
that generally sell at different prices.

The special rule in the Existing Regu-
lations that provides for the determination
of issue price as of the sale date based on
reasonable expectations about the initial
public offering price aims, in part, to pro-
vide certainty that the bonds will qualify
as tax-exempt bonds and meet State or
local requirements for debt issuance. Gen-
erally, the sale date is the date when the
syndicate or sole underwriter in contrac-
tual privity with the issuer signs the agree-
ment to buy the bonds from the issuer and
when the terms of the bond issue are set.
In the municipal bond market, due largely
to the serial maturity structure and, in
many cases, an inability to sell a substan-
tial amount of each of the different matur-
ities of the bonds with different terms (for
which issue price must be determined sep-
arately) by the sale date, issuers may have
difficulties in establishing the issue price
of all of the bonds included within an
issue by the sale date, unless a special rule
is available.

#### 2. General Rule: Actual Sale of a Substantial Amount of Bonds.

Consistent with section 148(h), the
2015 Proposed Regulations proposed to
retain the rule that issue price generally
will be determined under the rules of sec-
tions 1273 and 1274. The 2015 Proposed
Regulations also proposed a general rule
similar to that in the regulations under

12Under § 1.150-1(c)(6), the sale date of a bond is the first day on which there is a binding contract in writing for the sale or exchange of the bond. By comparison, under § 1.150-1(b),
the issue date for a bond is the date on which the issuer receives the purchase price in exchange for that bond, commonly referred to as the closing date or settlement date.

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section 1273 that the issue price of bonds
issued for money is the first price at which
a substantial amount of the bonds is sold
to the public. The 2015 Proposed Regula-
tions proposed to retain the rule in the
Existing Regulations that ten percent is
the measure of a substantial amount. The
2015 Proposed Regulations also proposed
to retain the rule that the issue prices of
bonds with different payment and credit
terms are determined separately.

Commenters recommended adding an
express rule to address the treatment of
private placements (for example, bank
loans), which in the municipal bond in-
dustry typically do not involve underwrit-
ers. Commenters also recommended clar-
ifying that an issuer may use the general
rule to determine issue price even if the
issuer had sought to use the special rule
based on the initial offering price to the
public discussed in section 3 of this pre-
amble. The Treasury Department and the
IRS agree with these recommendations.

The Final Regulations retain the rules
in the Existing Regulations and the gen-
eral rule of the 2015 Proposed Regula-
tions that, for bonds issued for money, the
issue price is the first price at which a
substantial amount of the bonds is sold to
the public, and a substantial amount is ten
percent. In addition, in response to com-
ments, the Final Regulations expressly
provide that, for a bond issued for money
in a private placement to a single buyer
that is not an underwriter or a related party
(as defined in § 1.150-1(b)) to an under-
writer, the issue price of the bond is the
price paid by that buyer. Further, the Final
Regulations clarify that for bonds for
which more than one rule for determining
issue price is available, for example, the
general rule and one of the special rules
discussed in sections 3 and 4 of this pre-
amble, an issuer may select the rule it will
use to determine the issue price for the
bonds at any time on or before the issue
date of the bonds. On or before the issue
date of the bonds, the issuer must identify
the rule selected in its books and records
maintained for the bonds.

A commenter suggested that a specific
time on the sale date should be established
as the proper time for determining issue
price. The Treasury Department and the
IRS understand that it has been a long-
standing practice to determine issue price

on the sale date without regard to a spe-
cific time and that it is unlikely for bonds
to be sold to the public at different prices
on that date. Thus, the imposition of a
specific time deadline for such determina-
tion seems unnecessary and would add to
the administrative burden. The Final Reg-
ulations do not adopt this comment.

##### 3. Special Rule for Use of the Initial Offering Price to the Public.

The 2015 Proposed Regulations pro-
posed a special rule that would allow an
issuer to treat the initial offering price to
the public as the issue price as of the sale
date, provided certain requirements were
met. That proposed special rule (referred
to as the "alternative method" in the 2015
Proposed Regulations) proposed to re-
quire that the lead underwriter (or sole
underwriter, if applicable) certify certain
matters, including that no underwriter
would sell bonds after the sale date and
before the issue date at a price higher than
the initial offering price except if the
higher price was the result of a market
change for the bonds after the sale date
(for example, due to a change in market
interest rates), and that the lead under-
writer provide the issuer with supporting
documentation for the matters covered by
the certifications, including a justification
for any higher price based on a market
change. (This proposed requirement for
underwriters generally to hold the price at
no higher than the initial offering price to
the public until the issue date is some-
times referred to herein as the "hold-the-
offering-price" requirement.)

Commenters favored a special rule to
allow use of the initial offering price to
the public to set the issue price as of the
sale date. Numerous commenters, how-
ever, expressed concerns about various as-
pects of the eligibility requirements for
this proposed special rule. One concern
expressed by underwriters was that the
requirement for the lead underwriter to
provide certification as to the actions of
the entire underwriting syndicate or sell-
ing group was overly broad. Instead, un-
derwriters recommended allowing mem-
bers of an underwriting syndicate or a
selling group to agree individually to act
in accordance with the specific matters
required under the special rule. The Final

Regulations adopt the comment that each
underwriter is individually or severally re-
sponsible for its agreement (rather than
jointly responsible with other underwrit-
ers).

Several commenters suggested that the
hold-the-offering-price requirement would
result in lower offering prices and should
not be included in the special rule. One
concern expressed related to the differing
time periods between the sale date and the
issue date for various issuers. One com-
menter recommended limiting the time
period for holding the price to six business
days after the sale date. Further, notwith-
standing the potential flexibility in pricing
afforded by the proposed market change
exception to the hold-the-offering-price
requirement, commenters overwhelm-
ingly objected to this exception as un-
workable because of the absence of mean-
ingful benchmarks for municipal bond
prices. Commenters also expressed con-
cern that use of this exception could lead
to audit disputes over appropriate docu-
mentation to support such price changes.

Accordingly, the Final Regulations
adopt a modified hold-the-offering-price
requirement that requires underwriters to
hold the price for offering and selling un-
sold bonds at a price that is no greater than
the initial offering price to the public for a
shorter time period that ends on the earlier
of (1) the close of the date that is the fifth
(5th) business day after the sale date or (2)
the date on which the underwriters have
sold a substantial amount of the bonds to
the public. Further, in response to the
overwhelming negative comments about
the proposed market change exception to
the proposed hold-the-offering-price re-
quirement, the Final Regulations omit the
market change exception.

The modified hold-the-offering-price
requirement in the Final Regulations pro-
vides a standardized time period for ap-
plication of the requirement to bonds re-
gardless of the differing time periods
among issuers between sales and closings
of municipal bond issues. Further, the
shorter time period for this requirement
should reduce potential associated risks to
underwriters and thereby limit the effects
of this requirement on initial pricing to
issuers and, at the same time, ensure that
market pricing behavior is consistent with

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the initial offering price used for issue
price determinations.

Two commenters suggested confirm-
ing that, for purposes of the hold-the-
offering-price requirement, an under-
writer may sell bonds to anyone at a price
that is lower (rather than higher) than the
initial offering price to the public under
this special rule. This special rule ex-
pressly provides for this result under the
Final Regulations. One commenter sought
clarification that underwriters may sell
bonds to other underwriters at prices that
are higher than the initial offering price to
the public under this special rule. Sales to
underwriters at such higher prices are in-
consistent with a purpose of this special
rule to use the initial offering price to the
public as a proxy for the issuer's agree-
ment with the underwriters about the max-
imum amount of underwriters' compensa-
tion that is reflected in setting the issue
price. Thus, the Final Regulations clarify
that underwriters may not sell the bonds at
a price that is higher than the initial offer-
ing price to the public.

Several commenters recommended a
different special rule that would base de-
terminations of issue price on sales of an
aggregate percentage of all of the bonds
included within an issue, as distinguished
from the bond-by-bond method required
to determine issue price for bonds with
different interest rates, maturities, credits,
or payment terms under the Existing Reg-
ulations and the 2015 Proposed Regula-
tions. Commenters recommended differ-
ent percentages of sales of aggregate
principal amounts of bonds within an is-
sue to determine issue price, including 25
percent, 50 percent, and 65 percent.

Although a rule that would focus on
actual sales of greater percentages of the
aggregate principal amounts of bonds in-
cluded within an issue to determine issue
price has potential utility, the Treasury
Department and the IRS have concerns
about the comparability of the terms of
unsold bonds with the terms of sold
bonds, which would serve as a proxy for
setting the issue price of the unsold bonds,
and about the attendant potential com-
plexity to ensure appropriate comparabil-
ity. Further, the Treasury Department and
the IRS have concerns about selection of
an appropriate percentage of aggregate
sales for such a rule and whether issuers

would be able to sell the required percent-
age of the aggregate principal amount of
bonds within the issue. The public com-
ments did not reflect any consensus on an
appropriate percentage of aggregate sales
for such a rule. In addition, several of the
comments in favor of such a rule focused
particularly on the need for a more work-
able rule for competitive sales. In re-
sponse to this concern, the Final Regula-
tions provide a simplified special rule for
competitive sales, as described in section
4 of this preamble. Accordingly, the Final
Regulations do not adopt a rule that would
focus on actual sales of greater percent-
ages of the aggregate principal amounts of
bonds included within an issue.

In summary, the Final Regulations pro-
vide a special rule under which an issuer
may treat the initial offering price to the
public as the issue price of the bonds as of
the sale date if: (1) The underwriters of-
fered the bonds to the public at a specified
initial offering price on or before the sale
date, and the lead underwriter in the un-
derwriting syndicate or selling group (or,
if applicable, the sole underwriter) pro-
vides, on or before the issue date, a
certification to that effect to the issuer,
together with reasonable supporting doc-
umentation for that certification, such as a
copy of the pricing wire or equivalent
communication; and (2) each underwriter
agrees in writing that it will neither offer
nor sell the bonds to any person at a price
that is higher than the initial offering price
during the period starting on the sale date
and ending on the earlier of the close of
the fifth (5th) business day after the sale
date, or the date on which the underwriters
have sold a substantial amount of the
bonds to the public at a price that is no
higher than the initial offering price to the
public.

### 4. Special Rule for Competitive Sales.

Numerous commenters, including four
States, strongly urged a streamlined spe-
cial rule for competitive sales to allow the
reasonably expected initial offering price
to the public reflected in the winning bid
in a competitive sale to establish the issue
price without a hold-the-offering-price re-
quirement or other restrictions. Comment-
ers suggested that the public bidding pro-
cess for pricing municipal bonds in

competitive sales itself provides a suffi-
cient basis to achieve the best pricing for
issuers. The Treasury Department and the
IRS recognize that competitive sales favor
competition and price transparency that
may result in better pricing for issuers.
The Final Regulations adopt these com-
ments and provide that, for bonds issued
for money pursuant to an eligible compet-
itive sale, an issuer may treat the reason-
ably expected initial offering price to the
public of the bonds as the issue price of
the bonds as of the sale date if the issuer
obtains a certification from the winning
bidder regarding the reasonably expected
initial offering price to the public of the
bonds upon which the price in the winning
bid is based.

For purposes of this special rule, the
Final Regulations define competitive sale
to mean a sale of bonds by an issuer to an
underwriter that is the winning bidder in a
bidding process in which the issuer offers
the bonds for sale to underwriters at spec-
ified written terms and that meets the fol-
lowing requirements: (1) The issuer dis-
seminates the notice of sale to potential
underwriters in a manner reasonably de-
signed to reach potential underwriters; (2)
all bidders have an equal opportunity to
bid; (3) the issuer receives bids from at
least three underwriters of municipal
bonds who have established industry rep-
utations for underwriting new issuances of
municipal bonds; and (4) the issuer
awards the sale to the bidder who offers
the highest price (or lowest interest cost).

### 5. Definitions

The 2015 Proposed Regulations pro-
posed to define the term "public" for pur-
poses of determining the issue price of
tax-exempt bonds to mean any person
other than an underwriter or a related
party to an underwriter. Several comment-
ers recommended expanding the defini-
tion of public to include related parties to
underwriters. This recommended change
would allow various affiliates of under-
writers, such as entities involved in pro-
prietary trading, to qualify as members of
the public for purposes of determining
issue price. The Final Regulations do not
adopt this comment. The Final Regula-
tions retain this related party restriction on

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the definition of the public as a safeguard
to protect against potential abuse.

The 2015 Proposed Regulations pro-
posed to define "underwriter" to include:
(1) Any person that contractually agrees
to participate in the initial sale of the
bonds to the public by entering into a
contract with the issuer or into a contract
with a lead underwriter to form an under-
writing syndicate and (2) any person that,
on or before the sale date, directly or
indirectly enters into a contract or other
arrangement with any of the foregoing to
sell the bonds. Numerous commenters ex-
pressed significant concern that the phrase
"other arrangement" in the definition of
underwriter was vague and unworkable.
One commenter asked if distribution ar-
rangements (for example, a retail distribu-
tion contract between a member of an
underwriting syndicate or selling group
and another dealer that is not in the syn-
dicate or selling group) were included.
Another commenter suggested changes to
clarify that a contract to sell the bonds be
limited to a contract with respect to the
initial sale of the bonds to the public. In
response to these comments, the Final
Regulations omit the phrase "or other ar-
rangement" from the definition of under-
writer. The Final Regulations also clarify
that covered agreements must relate to the
initial sale of the bonds to the public and
that these agreements include retail distri-
bution agreements.

6\. Standard for Reliance on
Certifications and Consequences of
Violations.

The 2015 Proposed Regulations pro-
posed a standard that would limit an issu-
er's ability to rely on certifications from
underwriters to circumstances in which an
issuer did not know or have reason to
know, after exercising due diligence, that
the certifications were false. Several com-
menters expressed concerns about this
proposed standard for reliance on certifi-
cations. One commenter expressed partic-
ular concern that the proposed standard
appeared to be higher than or different
from the general due diligence standard
for determining reasonable expectations
that bonds are not arbitrage bonds under
§ 1.148-2(b) of the Existing Regulations.
The existing definition of reasonable ex-

pectations, found in § 1.148-1(b) of the
Existing Regulations, treats an issuer's ex-
pectations or actions as reasonable only if
a prudent person in the same circum-
stances as the issuer would have those
same expectations or take those same ac-
tions, based on all the objective facts and
circumstances. One commenter also
sought confirmation that issuers could rely
on certifications from underwriters with-
out independent verification.

In response to the comments, the Final
Regulations omit the proposed special
standard for reliance on underwriters' cer-
tifications. Instead, the existing due dili-
gence standard under the Existing Regu-
lations for reasonable expectations or
reasonableness will apply to any certifica-
tion under the Final Regulations. For ex-
ample, this existing due diligence standard
will apply under the special rule on com-
petitive sales to an issuer's reliance on a
certification from the winning bidder re-
garding the reasonably expected initial of-
fering price to the public of the bonds
upon which the price in the winning bid is
based.

Several commenters urged providing
conclusive legal certainty for issue price
determinations as of the sale date based on
receipt of required underwriter certifica-
tions without regard to whether such cer-
tifications subsequently proved to be false.
Although the Final Regulations generally
will allow issuers to establish the issue
price as of the sale date, the Final Regu-
lations do not adopt this comment. Ac-
cordingly, a failure to meet a specific
eligibility requirement of a rule for deter-
mining issue price, such as an underwrit-
er's breach of its hold-the-offering-price
agreement under the special rule for use of
initial offering price, will result in a fail-
ure to establish issue price under that rule
and a redetermination of issue price under
a different rule. The potential invalidation
of an issue price determination is impor-
tant to ensure compliance with the arbi-
trage restrictions and the legal availability
of penalties against underwriters for false
statements. A false statement by an under-
writer in a certification or in the agree-
ment among underwriters under one of
these special rules may result in a penalty
against the underwriter under section
6700, depending on the facts and circum-
stances.

In accordance with section 6001, the
issuer must maintain reasonable docu-
mentation in its books and records to sup-
port its issue price determinations. In ad-
dition, the Final Regulations require that
the issuer obtain from the underwriter cer-
tain certifications and other reasonable
supporting documentation such as a pric-
ing wire to establish its issue price deter-
mination under a specific rule in the Final
Regulations. A certification from the un-
derwriter of the first price at which ten
percent of the bonds were sold to the
public is an example of reasonable sup-
porting documentation to establish the is-
sue price of the bonds under the general
rule in the Final Regulations.

### 7. Other Comments

A commenter requested a special rule
under section 148 to determine issue price
in a debt-for-debt exchange, including an
exchange resulting from a significant
modification under § 1.1001-3. Under the
special rule, an issuer would have the op-
tion to use a tax-exempt bond's stated
principal amount as the issue price rather
than the issue price that otherwise would
apply under section 1273 or 1274. The
commenter requested the rule because, in
the commenter's experience, the stated in-
terest rate on a tax-exempt bond issued in
a debt-for-debt exchange was generally
less than the adjusted applicable Federal
rate (AAFR) used under section 1288 to
determine whether the bond has adequate
stated interest for purposes of section
1274. In this situation, the issue price of
the bond would be less than the bond's
stated principal amount, resulting in an
arbitrage yield that is higher than it other-
wise would be if the bond were treated as
issued for an amount equal to the bond's
stated principal amount. The Final Regu-
lations do not include such a rule because,
since the date of the commenter's request,
the method to determine the AAFR has
been modified in TD 9763, 81 FR 24482
(April 26, 2016). As a result of this mod-
ification, it is more likely that the issue
price of a tax-exempt bond issued in a
debt-for-debt exchange will be the bond's
stated principal amount under section
1273 or 1274 (for example, because the
AAFR will not be greater than the corre-
sponding applicable Federal rate for tax-

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able bonds, as it was in certain years be-
fore the modification).

In addition, some commenters recom-
mended allowing the use of issue price as
defined for arbitrage purposes in applying
various limitations for other tax-exempt
bond purposes, such as those based on
principal amounts, face amounts, and sale
proceeds. The Final Regulations do not
adopt this recommendation because it
raises issues that are beyond the scope of
the 2015 Proposed Regulations, and the
recommended extension of the application
of the definition of issue price beyond
arbitrage purposes appropriately warrants
a separate opportunity for public com-
ment. The Treasury Department and the
IRS, however, expect to consider this rec-
ommendation in connection with future
guidance.

## Applicability Date

The Final Regulations apply to bonds
that are sold on or after June 7, 2017.

Special Analyses

Certain IRS regulations, including
these Final Regulations, are exempt from
the requirements of Executive Order
12866, as supplemented by Executive Or-
der 13563. Therefore, a regulatory impact
assessment is not required.

It is hereby certified that these Final
Regulations will not have a significant
economic impact on a substantial number
of small entities. This certification is
based generally on the fact that any effect
on small entities by these rules generally
flows from section 148 of the Code. Sec-
tion 148(h) of the Code requires the yield
on an issue of bonds to be determined on
the basis of issue price (within the mean-
ing of sections 1273 and 1274). Under
section 1273(b), the issue price is the first
price at which a substantial amount of the
bonds is sold to the public. Section 1.148-
1(f)(2) of the Final Regulations gives ef-
fect to the statute by requiring the issuer to
(1) obtain certain documentation from the
underwriter, which is the party that sells
the bonds to the public, to support the
issuer's determination of issue price and
(2) indicate in its books and records the
rule used by the issuer to determine issue
price. This information will be used to
support the issue price of the bonds for

audit and other purposes. Any economic
impact of obtaining this information is
minimal because most of the information
already is provided to issuers by the un-
derwriters under existing industry prac-
tices. Accordingly, these changes do not
add to the impact on small entities im-
posed by the statutory provision. There-
fore, a Regulatory Flexibility Analysis un-
der the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required.

Pursuant to section 7805(f) of the
Code, the 2015 Proposed Regulations pre-
ceding these Final Regulations were sub-
mitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business,
and no comments were received.

### Drafting Information

The principal authors of these regula-
tions are Johanna Som de Cerff and Lewis
Bell, Office of Associate Chief Counsel
(Financial Institutions and Products), IRS.
However, other personnel from the Trea-
sury Department and the IRS participated
in their development.

* * * * *

### Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is
amended as follows:

PART 1-INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.148-0(c) is amended
by adding entries for §§ 1.148-1(f) and
1.148-11(m) to read as follows:

§ 1.148-0 Scope and table of contents.

* * * * *

(c) * * *

§ 1.148-1 Definitions and elections.

* * * * *

(f) Definition of issue price.

(1) In general.

(2) Bonds issued for money.

(3) Definitions.

(4) Other special rules.

* * * * *

§ 1.148-11 Effective/applicability dates.

* * * * *

(m) Definition of issue price.

Par. 3. Section 1.148-1 is amended by
revising the definition of issue price in
paragraph (b) and adding paragraph (f) to
read as follows:

§ 1.148-1 Definitions and elections.

* * * * *

(b) * * *

Issue price means issue price as de-
fined in paragraph (f) of this section.
* * * * *

(f) Definition of issue price-(1) In
general. Except as otherwise provided in
this paragraph (f), "issue price" is defined
in sections 1273 and 1274 and the regu-
lations under those sections.

(2) Bonds issued for money-(i) Gen-
eral rule. Except as otherwise provided in
this paragraph (f)(2), the issue price of
bonds issued for money is the first price at
which a substantial amount of the bonds is
sold to the public. If a bond is issued for
money in a private placement to a single
buyer that is not an underwriter or a re-
lated party (as defined in § 1.150-1(b)) to
an underwriter, the issue price of the bond
is the price paid by that buyer. Issue price
is not reduced by any issuance costs (as
defined in § 1.150-1(b)).

(ii) Special rule for use of initial offer-
ing price to the public. The issuer may
treat the initial offering price to the public
as of the sale date as the issue price of the
bonds if the requirements of paragraphs
(f)(2)(ii)(A) and (B) of this section are
met.

(A) The underwriters offered the bonds
to the public for purchase at a specified
initial offering price on or before the sale
date, and the lead underwriter in the un-
derwriting syndicate or selling group (or,
if applicable, the sole underwriter) pro-
vides, on or before the issue date, a
certification to that effect to the issuer,
together with reasonable supporting doc-
umentation for that certification, such as a
copy of the pricing wire or equivalent
communication.

(B) Each underwriter agrees in writing
that it will neither offer nor sell the bonds
to any person at a price that is higher than
the initial offering price to the public dur-

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ing the period starting on the sale date and
ending on the earlier of the following:

(1) The close of the fifth (5th) business
day after the sale date; or

(2) The date on which the underwriters
have sold a substantial amount of the
bonds to the public at a price that is no
higher than the initial offering price to the
public.

(iii) Special rule for competitive sales.
For bonds issued for money in a compet-
itive sale, an issuer may treat the reason-
ably expected initial offering price to the
public as of the sale date as the issue price
of the bonds if the issuer obtains from
the winning bidder a certification of the
bonds' reasonably expected initial offer-
ing price to the public as of the sale date
upon which the price in the winning bid is
based.

(iv) Choice of rule for determining is-
sue price. If more than one rule for deter-
mining the issue price of the bonds is
available under this paragraph (f)(2), at
any time on or before the issue date, the
issuer may select the rule it will use to
determine the issue price of the bonds. On
or before the issue date of the bonds, the
issuer must identify the rule selected in its
books and records maintained for the
bonds.

(3) Definitions. For purposes of this
paragraph (f), the following definitions
apply:

(i) Competitive sale means a sale of
bonds by an issuer to an underwriter that
is the winning bidder in a bidding process
in which the issuer offers the bonds for
sale to underwriters at specified written
terms, if that process meets the following
requirements:

(A) The issuer disseminates the notice
of sale to potential underwriters in a man-
ner that is reasonably designed to reach
potential underwriters (for example, through
electronic communication that is widely
circulated to potential underwriters by a
recognized publisher of municipal bond
offering documents or by posting on an
Internet-based Web site or other elec-
tronic medium that is regularly used for
such purpose and is widely available to
potential underwriters);

(B) All bidders have an equal opportu-
nity to bid (within the meaning of
§ 1.148-5(d)(6)(iii)(A)(6));

(C) The issuer receives bids from at
least three underwriters of municipal
bonds who have established industry rep-
utations for underwriting new issuances of
municipal bonds; and

(D) The issuer awards the sale to the
bidder who submits a firm offer to pur-
chase the bonds at the highest price (or
lowest interest cost).

(ii) Public means any person (as de-
fined in section 7701(a)(1)) other than an
underwriter or a related party (as defined
in § 1.150-1(b)) to an underwriter.

(iii) Underwriter means:

(A) Any person (as defined in section
7701(a)(1)) that agrees pursuant to a writ-
ten contract with the issuer (or with the
lead underwriter to form an underwriting
syndicate) to participate in the initial sale
of the bonds to the public; and

(B) Any person that agrees pursuant to
a written contract directly or indirectly
with a person described in paragraph
(f)(3)(iii)(A) of this section to participate
in the initial sale of the bonds to the public
(for example, a retail distribution agree-
ment between a national lead underwriter
and a regional firm under which the re-
gional firm participates in the initial sale
of the bonds to the public).

(4) Other special rules. For purposes of
this paragraph (f), the following special
rules apply:

(i) Separate determinations. The issue
price of bonds in an issue that do not have
the same credit and payment terms is de-
termined separately. The issuer need not
apply the same rule to determine issue
price for all of the bonds in the issue.

(ii) Substantial amount. Ten percent is
a substantial amount.

(iii) Bonds issued for property. If a
bond is issued for property, the adjusted
applicable Federal rate, as determined un-
der section 1288 and § 1.1288-1, is used
in lieu of the applicable Federal rate to
determine the bond's issue price under
section 1274.

Par. 4. Section 1.148-11 is amended
by adding paragraph (m) to read as fol-
lows:

§ 1.148-11 Effective/applicability dates.

* * * * *

(m) Definition of issue price. The def-
inition of issue price in § 1.148-1(b) and

(f) applies to bonds that are sold on or
after June 7, 2017.

John Dalrymple,
Deputy Commissioner for Services and
Enforcement.
Approved November 22, 2016,

Mark J. Mazur,
Assistant Secretary of the Treasury for
Tax Policy.

(Filed by the Office of the Federal Register on December 8,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 9, 2016, 81 F.R. 88999)

## Section 301 .- Distributions of property

26 CFR 301.6103(j)(1)-1T: Disclosures of return
information reflected on returns to officers and em-
ployees of the Department of Commerce for Certain
Statistical

T.D. 9802

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 301

Disclosures of Return Information
Reflected on Returns to Officers and
Employees of the Department of
Commerce for Certain Statistical
Purposes and Related Activities

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains
temporary regulations that authorize the
disclosure of certain items of return infor-
mation to the Bureau of the Census
(Bureau) in conformance with section
6103(j)(1) of the Internal Revenue Code
(Code). These temporary regulations are
made pursuant to a request from the Sec-
retary of Commerce. These temporary
regulations also provide clarifying lan-
guage for an item of return information
and remove duplicative paragraphs con-
tained in the existing regulations. These
temporary regulations require no action
by taxpayers and have no effect on their

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tax liabilities. Thus, no taxpayers are
likely to be affected by the disclosures
authorized by this guidance. The text of
the temporary regulations also serves as
the text of the proposed regulations set
forth in the Proposed Rules section in this
issue of the Bulletin.

DATES: Effective Date: These temporary
regulations are effective on December 9,
2016.

Applicability Date: For dates of appli-
cability, see § 301.6103(j)(1)-1T(e).

FOR FURTHER INFORMATION CON-
TACT: William Rowe, (202) 317-6834
(not a toll-free call).

### SUPPLEMENTARY INFORMATION:

#### Background and Explanation of Provisions

This document contains amendments
to 26 CFR part 301. Section 6103(j)(1)(A)
of the Internal Revenue Code authorizes
the Secretary of the Treasury (Secretary)
to furnish, upon written request by the
Secretary of Commerce, such returns or
return information as the Secretary may
prescribe by regulation to officers and em-
ployees of the Bureau for the purpose of,
but only to the extent necessary in, the
structuring of censuses and national eco-
nomic accounts and conducting related
statistical activities authorized by law.
Section 301.6103(j)(1)-1 of the existing
regulations further defines such purposes
by reference to 13 U.S.C. chapter 5 and
provides an itemized description of the
return information authorized to be dis-
closed for such purposes.

By letter dated August 2, 2016, the
Secretary of Commerce requested amend-
ments to § 301.6103(j)(1)-1 to allow dis-
closure of several additional items of re-
turn information to the Bureau for
purposes of its economic statistics pro-
gram, structuring the censuses, and related
program evaluations. The Secretary of
Commerce's letter lists the additional
items of return information requested
based on the Bureau's specific need for
each item of information.

The Secretary of Commerce's letter re-
quested additional expense items from
business tax returns in order to improve
the expense data that is collected by the
Bureau. Specifically, the Secretary of

Commerce requested disclosure of the fol-
lowing enumerated components of total
expenses or total deductions from busi-
ness tax returns (Forms 1065, Forms in
the 1120 series, and Form 1040, Schedule
C, E or C/EZ): (1) repairs (and mainte-
nance) expense; (2) rents (or lease) ex-
pense; (3) taxes and licenses expense; (4)
interest expense, including mortgage or
other interest; (5) depreciation expense;
(6) depletion expense; (7) advertising ex-
pense; (8) pension and profit-sharing
plans (retirement plans) expense; (9) em-
ployee benefit programs expense; (10)
utilities expense; (11) supplies expense;
(12) contract labor expense; and (13)
management (and investment advisory)
fees. The Secretary of Commerce has also
requested purchases from Form 1125-A
and the following additional items from
Form 1040, Schedule C: (1) materials and
supplies; and (2) purchases less cost of
items withdrawn for personal use. The
Secretary of Commerce determined that
these additional items are needed to eval-
uate the quality of expense data collected
from surveys and to improve the Bureau's
imputation models as the Bureau faces a
trend of rising non-response rates in its
surveys.

The Secretary of Commerce's letter
also requested additional items of return
information from business tax returns for
the purpose of directing a high proportion
of research and development surveys to-
wards businesses with known research ac-
tivities. Specifically, the Secretary of
Commerce requested the following addi-
tional items of return information from
Forms 6765 (when filed with corporation
income tax returns): (1) cycle posted; and
(2) the research tax credit amount to be
carried over to a business return, schedule,
or form. The Secretary of Commerce de-
termined that the amount of research tax
credit is needed to improve the coverage
and reliability of surveys that collect re-
search and development data, and deter-
mined that the cycle posted is needed in
order to align the research tax credit with
the appropriate survey year for sampling
purposes.

The Secretary of Commerce's letter
also requested additional items of return
information for purposes of maintaining a
centralized, continuous Business Register
that comprehensively lists and character-

izes United States business establishments
and their domestic parent enterprises. The
Business Register provides the central
business list necessary to support the Bu-
reau's economic census and survey activ-
ities. Specifically, the Secretary of Com-
merce requested the following additional
items of return information from employ-
ment tax returns: (1) if a business has
closed or stopped paying wages; (2) final
date a business paid wages; and (3) if a
business is a seasonal employer and does
not have to file a return for every quarter
of the year. The Secretary of Commerce
has determined that these items of return
information are vital to reducing or elim-
inating costly mailings to businesses that
have closed or are seasonal in nature. The
Secretary of Commerce also requested the
electronic system filing indicator from
business tax returns and the cycle from the
IRS's Business Master Files. The Secre-
tary of Commerce determined that the
electronic system filing indicator is
needed to help establish the ideal survey
mode for a particular entity (electronic or
paper reporting forms).

The Secretary of Commerce's letter
also requested additional items of return
information for purposes of modeling firm
survival for production of statistics on
business dynamics. Specifically, the Sec-
retary of Commerce has requested the fol-
lowing additional items of return informa-
tion from business tax returns: (1)
dividends, including ordinary and quali-
fied; and (2) type of REIT (from Form
1120-REIT). The Secretary of Commerce
has determined that these items are
needed to estimate models of firm survival
and to estimate an owner's percentage of
capital.

The Secretary of Commerce's letter
also requested additional items of return
information for purposes of the Survey of
Business Owners. Specifically, the Secre-
tary of Commerce has requested the fol-
lowing additional items of return informa-
tion from Form 1065, Schedule K-1: (1)
publicly-traded partnership indicator; (2)
partner's share of nonrecourse, qualified
nonrecourse, and recourse liabilities; and
(3) ordinary business income (loss). The
Secretary of Commerce has also requested
ordinary business income (loss) from
Forms 1120S, Schedule K-1. The Secre-
tary of Commerce has determined that the

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ordinary business income (loss) and part-
ner's share of liabilities items are needed
in order to ascertain which owner's demo-
graphic information to use for the entity
and as a proxy for ownership share of the
partner. The publicly-traded partnership
indicator is needed to save the cost of
mailing surveys to publicly-traded part-
nerships since it is unlikely that publicly-
traded partnerships could accurately pro-
vide demographic information about their
owners.

Finally, the Secretary of Commerce's
letter also requested additional items of
return information for purposes of devel-
oping and preparing the Quarterly Finan-
cial Report. Specifically, the Secretary of
Commerce requested the following addi-
tional items of return information from
Forms 1120-REIT: (1) type of Real Es-
tate Investment Trust ("REIT"); and (2)
gross rents from real property. The Secre-
tary of Commerce also requested the cor-
poration's method of accounting from
Form 1120F and the total amount reported
from Form 1096. The Secretary of Com-
merce determined that gross rents from
real property is needed to design and se-
lect the annual Quarterly Financial Report
sample, and that the type of REIT is
needed for editing and imputation pur-
poses in the event that there are charac-
teristic differences between the types of
REITs. The Secretary of Commerce deter-
mined that the corporation's method of
accounting is needed to understand how
businesses with different accounting
methods might report differently in the
Quarterly Financial Report surveys. The
Secretary of Commerce has determined
that the total amounts reported from Form
1096 are needed to measure labor inputs
for productivity since it would provide
information on labor costs not covered by
administrative records or survey reports of
payroll.

The Secretary of Commerce asserted
that good cause exists to amend
§ 301.6103(j)(1)-1 of the regulations to
add these additional items to the list of
items of return information that may be
disclosed to the Bureau. The Treasury De-
partment and the IRS agree that amending
existing regulations to permit disclosure
of these items to the Bureau is appropriate
to meet the needs of the Bureau. These
temporary regulations amend the existing

regulations to allow disclosure of the
items requested by the Secretary of Com-
merce.

This temporary regulation also amends
language in the existing regulations to
clarify that the T.D. 9500, which was pub-
lished in the Federal Register (75 F.R.
52458), authorized disclosure only of cat-
egorical information for total qualified re-
search expenses from Forms 6765. In ac-
cordance with the preamble to T.D. 9500,
the existing regulations do not authorize
the disclosure of the exact amount of total
research expenses as reported on Form
6765. By letter dated February 6, 2006,
the Secretary of Commerce requested dis-
closure of categorical information on total
qualified research expenses in three rang-
es: greater than zero, but less than $1
million; greater than or equal to $1 mil-
lion, but less than $3 million; and, greater
than or equal to $3 million. These tempo-
rary regulations amend the existing regu-
lations to more clearly reflect the categor-
ical nature of the disclosure of total
research expenses from Form 6765.

Lastly, this temporary regulation also
removes duplicate paragraphs contained
in the existing regulations. Under the ex-
isting regulations, each of the following
items of return information from business-
related returns was authorized for disclo-
sure by two identical paragraphs: Social
Security tip income; total Social Security
taxable earnings; and gross distributions
from employer-sponsored and individual
retirement plans from Form 1099-R. Be-
cause there is no need for duplicate para-
graphs that authorize disclosure of the
same items of return information for the
same purpose, the duplicate paragraphs
are removed.

The text of the temporary regulations
also serves as the text of the proposed
regulations set forth in the notice of pro-
posed rulemaking on this subject in the
Proposed Rules section of this issue of the
Bulletin.

#### Special Analyses

Certain IRS regulations, including this
one, 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 eco-

nomic impact on a substantial number of
small entities because the regulations do not
impose a collection of information on small
entities. Accordingly, a regulatory flexibility
analysis is not required under the Regula-
tory Flexibility Act (5 U.S.C. chapter 6).
Pursuant to section 7805(f) of the Internal
Revenue Code, this regulation has been sub-
mitted to the Chief Counsel for Advocacy of
the Small Business Administration for com-
ment on its impact on small businesses.

#### Drafting Information

The principal author of these tempo-
rary regulations is William Rowe, Office
of the Associate Chief Counsel (Proce-
dure & Administration).
* * * * *

#### Amendments to the Regulations

Accordingly, 26 CFR part 301 is
amended as follows:

PART 301 -- PROCEDURE AND
ADMINISTRATION

Paragraph 1. The authority citation for
part 301 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805

Par. 2. Section 301.6103(j)(1)-1T is
added to read as follows:

§ 301.6103(j)(1)-1T Disclosures of
return information reflected on returns
to officers and employees of the
Department of Commerce, for certain
statistical purposes and related activities
(Temporary).

(a) through (b)(2)(iii)(H) [Reserved]. For
further guidance see § 301.6103(j)(1)-1(a)
through (b)(2)(iii)(H).

(I) Total taxable wages paid for pur-
poses of chapter 21;

(J) [Reserved]. For further guidance
see § 301.6103(j)(1)-1(b)(2)(iii)(J).

(K) If a business has closed or stopped
paying wages;

(L) Final date a business paid wages;
and

(M) If a business is a seasonal em-
ployer and does not have to file a return
for every quarter of the year;

(b)(2)(iv) through (b)(3)(iv) [Reserved].
For further guidance see § 301.6103(j)(1)-
1(b)(2)(iv) through (b)(3)(iv).

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(v) Total expenses or deductions, in-
cluding totals of the following compo-
nents thereof:

(A) Repairs (and maintenance) expense;

(B) Rents (or lease) expense;

(C) Taxes and licenses expense;

(D) Interest expense, including mort-
gage or other interest;

(E) Depreciation expense;

(F) Depletion expense;

(G) Advertising expense;

(H) Pension and profit-sharing plans
(retirement plans) expense;

(I) Employee benefit programs ex-
pense;

(J) Utilities expense;

(K) Supplies expense;

(L) Contract labor expense; and

(M) Management (and investment ad-
visory) fees.

(b)(3)(vi) through (b)(3)(xxiv) [Reserved].
For further guidance see § 301.6103(j)(1)-
1(b)(3)(vi) through (b)(3)(xxiv).

(xxv) From Form 6765 (when filed
with corporation income tax returns)-

(A) Indicator that total qualified re-
search expenses is greater than zero, but
less than $1 million; greater than or equal
to $1 million, but less than $3 million; or,
greater than or equal to $3 million;

(B) Cycle posted; and

(C) Research tax credit amount to be
carried over to a business return, schedule,
or form.

(xxvi) Total number of documents re-
ported on Form 1096 transmitting Forms
1099-MISC.

(xxvii) Total amount reported on Form
1096 transmitting Forms 1099-MISC.

(xxviii) Type of REIT.

(xxix) From Form 1125-A-purchases.

(xxx) From Form 1040, Schedule C-
(A) Purchases less cost of items with-
drawn for personal use; and

(B) Materials and supplies.

(xxxi) Electronic filing system indicator.

(xxxii) Posting cycle date relative to
filing.

(xxxiii) Dividends, including ordinary
or qualified.

(xxxiv) From Form 1120S, Schedule
K-1-ordinary business income (loss).
(xxxv) From Form 1065, Schedule
K-1-

(A) Publicly-traded partnership indicator;

(B) Partner's share of nonrecourse,
qualified nonrecourse, and recourse liabil-
ities; and

(C) Ordinary business income (loss).

(b)(4) through (b)(6)(i)(B) [Reserved].
For further guidance see § 301.6103(j)(1)-
1(b)(4) through (b)(6)(i)(B).

(C) From Form 1120-REIT-

(1) Type of REIT; and

(2) Gross rents from real property;

(D) From Form 1120F-corporation's
method of accounting.

(E) From Form 1096-total amount
reported.

(b)(6)(ii) through (d)(3)(ii) [Reserved].
For further guidance see § 301.6103(j)(1)-
1(b)(6)(ii) through (d)(3)(ii).

(e) Applicability date. This section ap-
plies to disclosures to the Bureau of the
Census made on or after December 9, 2016.

(f) Expiration date. The applicability
of this section expires on or before De-
cember 9, 2019.

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.
Approved November 23, 2016.

Mark J. Mazur,
Assistant Secretary of the Treasury (Tax
Policy).

(Filed by the Office of the Federal Register on December 8,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 9, 2016, 81 F.R. 89004)

Section 1274 .-
Determination of Issue
Price in the Case of
Certain Debt Instruments
Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 1288, 7520, 7872.)

## Rev. Rul. 2017-02

This revenue ruling provides various pre-
scribed rates for federal income tax pur-
poses for January 2017 (the current month).
Table 1 contains the short-term, mid-term,
and long-term applicable federal rates
(AFR) for the current month for purposes of
section 1274(d) of the Internal Revenue
Code. Table 2 contains the short-term, mid-
term, and long-term adjusted applicable fed-
eral rates (adjusted AFR) for the current
month for purposes of section 1288(b). Ta-
ble 3 sets forth the adjusted federal long-
term rate and the long-term tax-exempt rate
described in section 382(f). Table 4 contains
the appropriate percentages for determining
the low-income housing credit described in
section 42(b)(1) for buildings placed in ser-
vice during the current month. However,
under section 42(b)(2), the applicable per-
centage for non-federally subsidized new
buildings placed in service after July 30,
2008, shall not be less than 9%. Table 5
contains the federal rate for determining the
present value of an annuity, an interest for
life or for a term of years, or a remainder or
a reversionary interest for purposes of sec-
tion 7520. Finally, Table 6 contains the
deemed rate of return for transfers made
during calendar year 2017 to pooled income
funds described in section 642(c)(5) that
have been in existence for less than 3 tax-
able years immediately preceding the tax-
able year in which the transfer was made.

REV. RUL. 2017-02 TABLE 1 Applicable Federal Rates (AFR) for January 2017

Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-term

AFR

.96%

.96%

.96%

.96%

110% AFR

1.06%

1.06%

1.06%

1.06%

120% AFR

1.15%

1.15%

1.15%

1.15%

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# REV. RUL. 2017-02 TABLE 1 Applicable Federal Rates (AFR) for January 2017 Period for Compounding

Annual

Semiannual

Quarterly

Monthly

130% AFR

1.25%

1.25% Mid-term

1.25%

1.25%

AFR

1.97%

1.96%

1.96%

1.95%

110% AFR

2.17%

2.16%

2.15%

2.15%

120% AFR

2.36%

2.35%

2.34%

2.34%

130% AFR

2.57%

2.55%

2.54%

2.54%

150% AFR

2.96%

2.94%

2.93%

2.92%

175% AFR

3.46%

3.43%

3.42%

3.41%

Long-term

AFR

2.75%

2.73%

2.72%

2.71%

110% AFR

3.02%

3.00%

2.99%

2.98%

120% AFR

3.31%

3.28%

3.27%

3.26%

130% AFR

3.58%

3.55%

3.53%

3.52%

REV. RUL. 2017-02 TABLE 3 Rates Under Section 382 for January 2017

REV. RUL. 2017-02 TABLE 2 Adjusted AFR for January 2017 Period for Compounding

Annual

Semiannual

Quarterly

Monthly

Short-term adjusted AFR

.71%

.71%

.71%

.71%

Mid-term adjusted AFR

1.47%

1.46%

1.46%

1.46%

Long-term adjusted AFR

2.04%

2.03%

2.02%

2.02%

Adjusted federal long-term rate for the current month

2.04%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted
federal long-term rates for the current month and the prior two months.)

2.04%

# REV. RUL. 2017-02 TABLE 4 Appropriate Percentages Under Section 42(b)(1) for January 2017

Note: Under section 42(b)(2), the applicable percentage for non-federally subsidized new buildings placed in service after
July 30, 2008, shall not be less than 9%.

Appropriate percentage for the 70% present value low-income housing credit

7.54%

Appropriate percentage for the 30% present value low-income housing credit

3.23%

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Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years,
or a remainder or reversionary interest

2.4%

# REV. RUL. 2017-02 TABLE 6 Deemed Rate for Transfers to New Pooled Income Funds During 2017

Deemed rate of return for transfers during 2017 to pooled income funds that have been in existence for less
than 3 taxable years

1.2%

## Section 42 .- Low-Income Housing Credit

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 280G .- Golden Parachute Payments

Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2017. See
Rev. Rul. 2017-2, page 364.

## Section 382 .- Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is
set forth for the month of January 2017. See Rev.
Rul. 2017-2, page 364.

## Section 412 .- Minimum Funding Standards

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 467 .- Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 468 .- Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 482 .- Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2017. See
Rev. Rul. 2017-2, page 364.

## Section 483 .- Interest on Certain Deferred Payments

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 642 .- Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2017. See
Rev. Rul. 2017-2, page 364.

## Section 1288 .- Treatment of Original Issue Discount on Tax-Exempt Obligations

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 7520 .- Valuation Tables

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

## Section 7872 .- Treatment of Loans With Below- Market Interest Rates

The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of January 2017. See Rev. Rul. 2017-2, page 364.

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# Part III. Administrative, Procedural, and Miscellaneous

Eligibility for Exemption
from User Fee
Requirement for Employee
Plans Determination Letter
Applications Filed On or
After January 1, 2017

Notice 2017-01

## I. Purpose

Section 7528(b)(2)(B) of the Internal
Revenue Code provides an exemption
from the requirement to pay a user fee for
certain requests to the Internal Revenue
Service (IRS) for determination letters
with respect to the qualified status of pen-
sion, profit-sharing, stock bonus, annuity,
and employee stock ownership (ESOP)
plans maintained by small employers. Un-
der § 7528(b)(2)(B), the exemption from
the user fee does not apply to any request
made after the later of (i) the fifth plan
year of the plan's existence or (ii) the end
of any remedial amendment period with
respect to the plan beginning within the
first five plan years (a "qualifying open
remedial amendment period"). Section
7528(b)(2)(A) also permits the Secretary
of the Treasury to provide exemptions
from the user fee requirement. This notice
describes the circumstances under which,
in light of changes to the remedial amend-
ment period rules set forth in Rev. Proc.
2016-37, 2016-29 I.R.B. 136, the IRS
will treat an application for a determina-
tion letter as being filed within a qualify-
ing open remedial amendment period (one
of the requirements for the user fee ex-
emption). Specifically, this notice pro-
vides that the IRS will treat an application
for a determination letter as being filed
within a qualifying open remedial amend-
ment period if the plan was first in exis-
tence no earlier than January 1 of the tenth
calendar year preceding the year in which
the application is filed ("the ten-year
rule").

This notice also provides that an appli-
cation that satisfies the requirements for
the user fee exemption in § 7528(b)(2)(B),
but that does not meet the requirements
for the ten-year rule described in the pre-
ceding paragraph, may be filed without a

user fee. However, the application must
include a statement describing how the
application satisfies the exemption under
§ 7528(b)(2)(B).

II. Background

Section 7528(a)(1) provides the gen-
eral rule that the Secretary of the Treasury
is to establish a program requiring the
payment of user fees for requests to the
IRS for determination letters. The IRS
user fee program procedures for requests
involving employee plans and exempt or-
ganizations are published as part of the
annual revenue procedures issued by the
IRS. See, for example, Rev. Proc. 2016-
8, 2016-1 I.R.B. 243.

Section 7528(b)(2)(A) provides that
the Secretary shall provide for such ex-
emptions from the user fee requirement
(and reduced fees) as the Secretary deter-
mines to be appropriate.

Section 7528(b)(2)(B) provides that, in
general, a request for a determination let-
ter with respect to the qualified status of a
pension benefit plan or any trust that is
part of the plan shall be exempt from the
user fee requirement if the plan is main-
tained solely by one or more eligible
employers. Under § 7528(b)(2)(C)(i), a
pension benefit plan means a pension,
profit-sharing, stock bonus, annuity, or
ESOP plan. Under § 7528(b)(2)(C)(ii), an
eligible employer means an employer that
has no more than 100 employees who
received at least $5,000 of compensation
from the employer for the preceding year,
and that has at least one employee who is
not a highly compensated employee (as
defined in § 414(q)) and is participating in
the plan. However, the § 7528(b)(2)(B)
user fee exemption does not apply if the
request is made after the later of (1) the
last day of the fifth plan year the plan is in
existence, or (2) the end of any qualifying
open remedial amendment period. The
§ 7528(b)(2)(B) user fee exemption also
does not apply to any request made by the
sponsor of any prototype or similar plan
that the sponsor intends to market to par-
ticipating employers.

Rev. Proc. 2007-44, 2007-2 C.B. 54,
provides for a system of cyclical remedial
amendment periods and staggered sub-

mission periods for determination letter
applications for individually designed plans
and pre-approved plans. Under Rev. Proc.
2007-44, the remedial amendment cycle
for individually designed plans is five
years and the remedial amendment cycle
for pre-approved plans is six years.

Rev. Proc. 2016-37 eliminates the re-
medial amendment cycle system for indi-
vidually designed plans set forth in Rev.
Proc. 2007-44, as of January 1, 2017. The
revenue procedure provides that sponsors
of Cycle A plans may continue to file
under the remedial amendment cycle sys-
tem until January 31, 2017. In addition,
the revenue procedure makes clarifying
changes to the ongoing six-year remedial
amendment cycle system for pre-approved
qualified plans. It also provides that the
deadline for certain employers to adopt a
newly approved pre-approved defined
contribution plan that was based on the
2010 Cumulative List, and to apply for a
determination letter, is extended from
April 30, 2016, to April 30, 2017, for any
newly approved pre-approved defined
contribution plan adopted on or after Jan-
uary 1, 2016.

Notice 2002-1, 2002-1 C.B. 283, as
amplified by Notice 2003-49, 2003-2
C.B. 294, provides guidance with respect
to the requirements for the § 7528(b)(2)
(B) user fee exemption, including an ex-
planation of when a plan is "in existence"
for that purpose (see Q&A-4 of Notice
2002-1). In addition, Notice 2011-86,
2011-45 I.R.B. 698, amplifies Notice
2002-1 by providing rules for determin-
ing, under the remedial amendment cycle
system, if an application for a determina-
tion letter has been filed within a qualify-
ing open remedial amendment period.

## III. Applications Treated as Being Filed Within a Qualifying Open Remedial Amendment Period

An application for a determination
letter with respect to a pension, profit-
sharing, stock bonus, annuity, or ESOP
plan maintained by an eligible employer
that is filed with the IRS by the later of (1)
the last day of the fifth plan year the plan
is in existence, or (2) the end of any qual-
ifying open remedial amendment period,
will be eligible for the user fee exemption

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under § 7528(b)(2)(B), provided that the
application satisfies all other applicable
requirements for the exemption.

In order to simplify the process for
establishing whether the user fee exemp-
tion under § 7528(b)(2) is available and,
thus, whether a user fee is required to be
paid with a determination letter applica-
tion for a plan, the IRS will, pursuant to
the authority under § 7528(b)(2)(A), treat
an application as being filed within a qual-
ifying open remedial amendment period
(one of the requirements for the user fee
exemption) if the plan was first in exis-
tence no earlier than January 1 of the tenth
calendar year preceding the year in which
the application is filed. For example, if an
application for a determination letter for a
plan that was first in existence during
2007 is filed on December 1, 2017, then
the IRS will treat the application as having
been filed within a qualifying open reme-
dial amendment period for purposes of
§ 7528(b)(2). In contrast, if the plan in this
example had first been in existence during
2006, then the IRS would not treat the
application as being filed within a quali-
fying open remedial amendment period.

If an application does not satisfy the
requirements of the ten-year rule de-
scribed in the preceding paragraph (and,
accordingly, is not treated under that rule
as being filed within a qualifying open
remedial amendment period), but the ap-
plication nevertheless satisfies the require-
ments for the user fee exemption under
§ 7528(b)(2)(B) (for example, in a case in
which a qualifying open remedial amend-
ment period ends more than ten years after
the year in which the plan is first in exis-
tence), then no user fee is required. In
such a case, in lieu of including a user fee
with the application, the applicant should
explain in a cover letter how the applica-
tion satisfies the requirements for the ex-
emption under § 7528(b)(2)(B). If the IRS
determines that the application does not
meet the requirements for the user fee

exemption under § 7528(b)(2)(B), the ap-
plicant will be asked to submit the re-
quired user fee.

## IV. Effect on Other Documents

Notice 2002-1 is amplified.
Notice 2011-86 is obsoleted.

## V. Effective Date

This notice generally applies to all ap-
plications for determination letters that are
filed on or after January 1, 2017. How-
ever, the rules under Notice 2011-86 con-
tinue to apply to (1) an application for a
determination letter that is filed on or be-
fore January 31, 2017, under Cycle A with
respect to an individually designed plan;
and (2) an application for a determination
letter that is filed on or before April 30,
2017, with respect to a newly approved
pre-approved defined contribution plan
that is based on the 2010 Cumulative List
and adopted on or after January 1, 2016.

## VI. DRAFTING INFORMATION

The principal author of this notice is
Patrick T. Gutierrez of the Office of As-
sociate Chief Counsel (Tax Exempt and
Government Entities). For further infor-
mation regarding this notice contact Mr.
Gutierrez at (202) 317-4148 (not a toll-
free number).

Maximum Vehicle Values
for 2017 for Use With
Vehicle Cents-Per-Mile and
Fleet-Average Valuation
Rules

Notice 2017-03
PURPOSE

This notice provides the maximum ve-
hicle values for 2017 that taxpayers need
to determine the value of personal use of

employer-provided vehicles under the
special valuation rules provided under
section 1.61-21 (d) and (e) of the Income
Tax Regulations.

## MAXIMUM VEHICLE VALUES

The maximum value of employer-
provided vehicles first made available to
employees for personal use in calendar
year 2017 for which the vehicle cents-per-
mile valuation rule provided under Regu-
lation section 1.61-21(e) may be applica-
ble is $15,900 for a passenger automobile
and $17,800 for a truck or van.

The maximum value of employer-
provided vehicles first made available to
employees for personal use in calendar
year 2017 for which the fleet-average val-
uation rule provided under Regulation
section 1.61-21(d) may be applicable is
$21,100 for a passenger automobile and
$23,300 for a truck or van.

## EFFECTIVE DATE

This notice applies to employer-provided
passenger automobiles first made available
to employees for personal use in calendar
year 2017.

## DRAFTING INFORMATION

The principal author of this notice is
Kathleen Edmondson of the Office of As-
sociate Chief Counsel (Tax Exempt &
Government Entities). For further infor-
mation on this notice contact Ms. Ed-
mondson on (202) 317-6798 (not a toll-
free number).

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## Part IV. Items of General Interest

Recognition and Deferral of
Section 987 Gain or Loss

REG-128276-12

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed rulemaking
by cross-reference to temporary regulations.

SUMMARY: Published elsewhere in this
issue of the Bulletin, the Treasury Depart-
ment and the IRS are issuing temporary
regulations under section 987 of the Code
relating to the recognition and deferral of
foreign currency gain or loss under sec-
tion 987 with respect to a qualified busi-
ness unit (QBU) in connection with cer-
tain QBU terminations and certain other
transactions involving partnerships. The
temporary regulations also contain rules
providing: an annual deemed termination
election for a section 987 QBU; an elec-
tive method, available to taxpayers that
make the annual deemed termination elec-
tion, for translating all items of income or
loss with respect to a section 987 QBU at
the yearly average exchange rate; rules
regarding the treatment of section 988
transactions of a section 987 QBU; rules
regarding QBUs with the U.S. dollar as
their functional currency; rules regarding
combinations and separations of section
987 QBUs; rules regarding the translation
of income used to pay creditable foreign
income taxes; and rules regarding the al-
location of assets and liabilities of certain
partnerships for purposes of section 987.
Finally, the temporary regulations contain
rules under section 988 requiring the de-
ferral of certain section 988 loss that
arises with respect to related-party loans.
The text of the temporary regulations
serves as the text of these proposed
regulations.

DATES: Written or electronic comments
and requests for a public hearing must be
received by March 8, 2017.

ADDRESSES: Send submissions to: CC:
PA:LPD:PR (REG-128276-12), room
5203, Internal Revenue Service, P.O. Box
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand-

delivered Monday through Friday be-
tween the hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG-128276-12), Cou-
rier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW, Washington, DC,
or sent electronically via the Federal eRule-
making Portal at http://www.regulations.
gov (IRS REG-128276-12).

FOR FURTHER INFORMATION CON-
TACT:Concerning the proposed regula-
tions, Steven D. Jensen at (202) 317-6938;
concerning submissions of comments or
requests for a public hearing, Regina
Johnson, (202) 317-6901 (not toll-free
numbers).

## SUPPLEMENTARY INFORMATION:

### Paperwork Reduction Act

The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in
accordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)). Com-
ments on the collection of information
should be sent to the Office of Manage-
ment and Budget, Attn: Desk Officer for
the Department of the Treasury, Office
of Information and Regulatory Affairs,
Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Re-
ports Clearance Officer, SE:CAR:MP:T:
T:SP, Washington, DC 20224. Comments
on the collection of information should be
received by February 6, 2017. Comments
are specifically requested concerning:

Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the Internal Revenue Service,
including whether the information will
have practical utility;

The accuracy of the estimated burden
associated with the proposed collection of
information (see below);

How the quality, utility, and clarity of
the information to be collected may be
enhanced;

How the burden of complying with the
proposed collection of information may
be minimized, including through the ap-
plication of automated collection tech-
niques or other forms of information tech-
nology; and

Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of service to provide information.

The collection of information in this
proposed regulation is in: (1) §§ 1.987-
1(b)(6)(iii)(A) and 1.987-1(g)(3)(i)(E);
(2) §§ 1.987-3(b)(4)(iii)(C) and 1.987-
1(g)(3)(i)(F); (3) §§ 1.987-3(d) and
1.987-1(g)(3)(i)(G); and (4) §§ 1.987-
8(d) and 1.987-1(g)(3)(i)(H). Sections
1.987-1(b)(6)(iii)(A) and 1.987-1(g)(3)
(i)(E) allow a controlled foreign corpora-
tion to elect to apply section 987 and the
regulations thereunder (with certain ex-
ceptions) to a dollar QBU. Sections
1.987-3(b)(4)(iii)(C) and 1.987-1(g)(3)(i)
(F) allow a taxpayer to elect to apply a
foreign currency mark-to-market method
of accounting for qualified short-term sec-
tion 988 transactions. Sections 1.987-3(d)
and 1.987-1(g)(3)(i)(G) allow a taxpayer
to elect to translate all items of income,
gain, deduction, and loss of the section
987 QBU at the yearly average exchange
rate. Sections 1.987-8(d) and 1.987-
1(g)(3)(i)(H) allow a taxpayer to elect to

deem all of its section 987 QBUs to ter-
minate on the last day of each taxable
year. The preceding elections are to be
made pursuant to § 1.987-1(g). The col-
lection of information is voluntary to ob-
tain a benefit. The likely respondents are
business or other for-profit institutions.

Estimated total annual reporting bur-
den: 1,000 hours.

Estimated average annual burden hours
per respondent: 1 hour.

Estimated number of respondents:
1,000.

Estimated annual frequency of re-
sponses: on occasion.

An agency may not conduct or spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less it displays a valid control number
assigned by the Office of Management
and Budget.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial 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.

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### Background and Explanation of Provisions

The temporary regulations (published
in the Rules and Regulations section of
this issue of the Bulletin) contain rules
relating to the recognition and deferral of
section 987 gain or loss with respect to a
QBU. The temporary regulations also
contain rules regarding an annual deemed
termination election, an elective method
for translating taxable income or loss with
respect to a QBU, section 988 transactions
of a section 987 QBU, QBUs with the
U.S. dollar as their functional currency,
combinations and separations of section
987 QBUs, translation of income used to
pay creditable foreign income taxes, the
allocation of assets and liabilities of cer-
tain partnerships for purposes of section
987, and the deferral of section 988 loss
with respect to certain related-party loans.
The text of the temporary regulations also
serves as the text of these proposed regu-
lations. The preamble to the temporary
regulations explains those regulations and
these proposed regulations.

### Special Analyses

Certain IRS regulations, including
these, are exempt from the requirements
of Executive Order 12866, as supple-
mented and reaffirmed by Executive Or-
der 13563. Therefore, a regulatory impact
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 Reg-
ulatory 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 sec-
tion 7805(f) of the Code, these regulations
have been submitted to the Chief Counsel
for Advocacy of the Small Business Ad-
ministration for comment on their impact
on small business.

### Comments and Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are

submitted timely to the IRS as prescribed
in this preamble under the "Addresses"
heading. The Treasury Department and
the IRS request comments on all aspects
of the proposed rules. In addition, the
Treasury Department and the IRS request
comments on the application of section
987 to entities and QBUs described in
§ 1.987-1(b)(1)(ii) to which the final
regulations are not applicable (excluded
entities and QBUs). Comments are re-
quested on whether the Treasury Depart-
ment and the IRS should issue regulations
applying the foreign exchange exposure
pool methodology described in §§ 1.987-3
and -4 to excluded entities and QBUs.
Comments are also requested on the mod-
ifications, if any, that should be made to
the foreign exchange exposure pool meth-
odology adopted in the final regulations
with respect to excluded entities and
QBUs. All comments will be available at
www.regulations.gov or upon request. A
public hearing will be scheduled if re-
quested in writing by any person that
timely submits written comments. If a
public hearing is scheduled, notice of the
date, time, and place for the hearing will
be published in the Federal Register.

### Drafting Information

The principal author of these regula-
tions is Mark E. Erwin of the Office of
Associate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.

* * * * *

### Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1, as
amended elsewhere in this issue of the
Federal Register, is proposed to be further
amended as follows:

#### PART 1-INCOME TAXES

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

Authority: 26 U.S.C. 985, 987, 989(c)
and 7805 * * *

Par. 2. Section 1.987-1 is amended by
adding paragraphs (b)(1)(iii), (b)(6),
(c)(1)(ii)(B),(c)(3)(i)(E),(d)(3),(f),(g)(2)
(i)(B) and (C), and (g)(3)(i)(E) through
(H) to read as follows:

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

** * * *

(b) * * *
(1) * * *

(iii) [The text of the proposed amend-
ment to § 1.987-1(b)(1)(iii) is the same as
the text of § 1.987-1T(b)(1)(iii) published
elsewhere in this issue of the Bulletin].
* * * * *

(6) [The text of the proposed amend-
ment to § 1.987-1(b)(6) is the same as the
text of § 1.987-1T(b)(6) published else-
where in this issue of the Bulletin].

* * * * *

(c) * * *

(1) * * *

(ii) * * *

(B) [The text of the proposed amend-
ment to § 1.987-1(c)(1)(ii)(B) is the same as
the text of § 1.987-1T(c)(1)(ii)(B) published
elsewhere in this issue of the Bulletin].

* * * * *

(c) * * *

(3) * * *

(i) * * *

(E) [The text of the proposed amend-
ment to § 1.987-1(c)(3)(i)(E) is the same
as the text of § 1.987-1T(c)(3)(i)(E) pub-
lished elsewhere in this issue of the Bul-
letin].

* * * * *

(d) * * *

(3) [The text of the proposed amend-
ment to § 1.987-1(d)(3) is the same as the
text of § 1.987-1T(d)(3) published else-
where in this issue of the Bulletin].

* * * * *

(f) [The text of the proposed amend-
ment to § 1.987-1(f) is the same as the
text of § 1.987-1T(f) published elsewhere
in this issue of the Bulletin].

* * * * *

(g) * * *

(2) * * *

(i) * * *

(B) [The text of the proposed amend-
ment to § 1.987-1(g)(2)(i)(B) is the same
as the text of § 1.987-1T(g)(2)(i)(B) pub-
lished elsewhere in this issue of the Bul-
letin].

(C) [The text of the proposed amend-
ment to § 1.987-1(g)(2)(i)(C) is the same
as the text of § 1.987-1T(g)(2)(i)(C) pub-
lished elsewhere in this issue of the Bul-
letin].

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(3)

(i) * * *

(E) [The text of the proposed amend-
ment to § 1.987-1(g)(3)(i)(E) is the same
as the text of § 1.987-1T(g)(3)(i)(E) pub-
lished elsewhere in this issue of the Bul-
letin].

(F) [The text of the proposed amend-
ment to § 1.987-1(g)(3)(i)(F) is the same
as the text of § 1.987-1T(g)(3)(i)(F) pub-
lished elsewhere in this issue of the Bul-
letin].

(G) [The text of the proposed amend-
ment to § 1.987-1(g)(3)(i)(G) is the same
as the text of § 1.987-1T(g)(3)(i)(G) pub-
lished elsewhere in this issue of the Bul-
letin].

(H) [The text of the proposed amend-
ment to § 1.987-1(g)(3)(i)(H) is the same
as the text of § 1.987-1T(g)(3)(i)(H) pub-
lished elsewhere in this issue of the Bul-
letin].

* * * * *

Par. 3. Section 1.987-2 is amended by
adding paragraph (c)(9) to read as fol-
lows:

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

* * * * *

(c) * * *

(9) [The text of the proposed amend-
ment to § 1.987-2(c)(9) is the same as the
text of § 1.987-2T(c)(9) published else-
where in this issue of the Bulletin].

Par. 4. Section 1.987-3 is amended by
adding paragraphs (b)(2)(ii), (b)(4), (c)
(2)(ii) and (v), (d), and Example 9 through
Example 14 of paragraph (e) to read as
follows:

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

(b)

(2) * * *

(ii) [The text of the proposed amend-
ment to § 1.987-3(b)(2)(ii) is the same as
the text of § 1.987-3T(b)(2)(ii) published
elsewhere in this issue of the Bulletin].

(4) [The text of the proposed amend-
ment to § 1.987-3(b)(4) is the same as the
text of § 1.987-3T(b)(4) published else-
where in this issue of the Bulletin].

* * * * *

(c) * * *

(2) * * *

(ii) [The text of the proposed amend-
ment to § 1.987-3(c)(2)(ii) is the same as
the text of § 1.987-3T(c)(2)(ii) published
elsewhere in this issue of the Bulletin].
* * * * *

(v) [The text of the proposed amend-
ment to § 1.987-3(c)(2)(v) is the same as
the text of § 1.987-3T(c)(2)(v) published
elsewhere in this issue of the Bulletin].

(d) [The text of the proposed amend-
ment to § 1.987-3(d) is the same as the
text of § 1.987-3T(d) published elsewhere
in this issue of the Bulletin].

(e) Examples. * * *

Example 9 [The text of the proposed
amendment to § 1.987-3(e) Example 9 is
the same as the text of § 1.987-3T(e)
Example 9 published elsewhere in this
issue of the Bulletin].

Example 10 [The text of the proposed
amendment to § 1.987-3(e) Example 10 is
the same as the text of § 1.987-3T(e)
Example 10 published elsewhere in this
issue of the Bulletin].

Example 11 [The text of the proposed
amendment to § 1.987-3(e) Example 11 is
the same as the text of § 1.987-3T(e)
Example 11 published elsewhere in this
issue of the Bulletin].

Example 12 [The text of the proposed
amendment to § 1.987-3(e) Example 12 is
the same as the text of § 1.987-3T(e)
Example 12 published elsewhere in this
issue of the Bulletin].

Example 13 [The text of the proposed
amendment to § 1.987-3(e) Example 13 is
the same as the text of § 1.987-3T(e)
Example 13 published elsewhere in this
issue of the Bulletin].

Example 14 [The text of the proposed
amendment to § 1.987-3(e) Example 14 is
the same as the text of § 1.987-3T(e)
Example 14 published elsewhere in this
issue of the Bulletin].

Par. 5. Section 1.987-4 is amended by
adding paragraphs (c)(2) and (f) to read as
follows:

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

* * * * *

(c) * * *

(2) [The text of the proposed amend-
ment to § 1.987-4(c)(2) is the same as the
text of § 1.987-4T(c)(2) published else-
where in this issue of the Bulletin].
* * * * *

(f) [The text of the proposed amend-
ment to § 1.987-4(f) is the same as the
text of § 1.987-4T(f) published elsewhere
in this issue of the Bulletin].

* * * * *

Par. 6. Section 1.987-6 is amended by
adding paragraph (b)(4) to read as fol-
lows:

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

* * * * *

(b) * * *

(4) [The text of the proposed amend-
ment to § 1.987-6(b)(4) is the same as the
text of § 1.987-6T(b)(4) published else-
where in this issue of the Bulletin].

* * * * *

Par. 7. Section 1.987-7 is amended by
adding paragraph (b) to read as follows:

§ 1.987-7 Section 987 aggregate
partnerships.

* * * * *

(b) [The text of the proposed amend-
ment to § 1.987-7(b) is the same as the
text of § 1.987-7T(b) published elsewhere
in this issue of the Bulletin].

* * * * *

Par. 8. Section 1.987-8 is amended by
adding paragraph (d) to read as follows:

§ 1.987-8 Termination of a section 987
QBU.

* * * * *

(d) [The text of the proposed amend-
ment to § 1.987-8(d) is the same as the
text of § 1.987-8T(d) published else-
where in this issue of the Bulletin].
* * * * *

Par. 9. Section 1.987-12 is revised to
read as follows:

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<!-- PageBreak -->

§ 1.987-12 Deferral of section 987 gain
or loss.

[The text of the proposed amendment
to § 1.987-12 is the same as the text of
§ 1.987-12T published elsewhere in this
issue of the Bulletin].

Par. 10. Section 1.988-1 is amended
by adding paragraph (a)(3) to read as fol-
lows:

##### § 1.988-1 Certain definitions and special rules.

* * * * *

(a) * * *

(3) [The text of the proposed amend-
ment to § 1.988-1(a)(3) is the same as the
text of § 1.988-1T(a)(3) published else-
where in this issue of the Bulletin].

* * * * *

Par. 11. Section 1.988-2 is amended
by revising paragraph (b)(16) and adding
paragraph (i) to read as follows:

§ 1.988-2 Recognition and computation
of exchange gain or loss.

* * * * *

(b) * * *

(16) [The text of the proposed amend-
ment to § 1.988-2(b)(16) is the same as
the text of § 1.988-2T(b)(16) published
elsewhere in this issue of the Bulletin].

(i) [The text of the proposed amend-
ment to § 1.988-2(i) is the same as the
text of § 1.988-2T(i) published elsewhere
in this issue of the Bulletin].

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.

(Filed by the Office of the Federal Register on December 7,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 8, 2016, 81 F.R. 88882)

Disclosures of Return
Information Reflected on
Returns to Officers and
Employees of the
Department of Commerce
for Certain Statistical
Purposes and Related
Activities

REG-133353-16

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Notice of proposed rulemaking
by cross-reference to temporary regulation.

SUMMARY: In the Rules and Regula-
tions section of this issue of the Bulletin
the IRS is issuing temporary regulations
authorizing the disclosure of specified re-
turn information to the Bureau of the Cen-
sus (Bureau) for purposes of structuring
the censuses and national economic ac-
counts and conducting related statistical
activities authorized by title 13. The tem-
porary regulations are made pursuant to a
request from the Secretary of Commerce.
The temporary regulations also provide
clarifying language for an item of return
information and remove duplicative para-
graphs contained in the existing final reg-
ulations. These regulations require no ac-
tion by taxpayers and have no effect on
their tax liabilities. Thus, no taxpayers are
likely to be affected by the disclosures
authorized by this guidance. The text of
the temporary regulations published in the
Rules and Regulations section of the Fed-
eral Register serves as the text of these
proposed regulations.

DATES: Written and electronic com-
ments and requests for a public hearing
must be received by March 9, 2017.

Applicability Date: For dates of appli-
cability, see § 301.6103(j)(1)-1(e).

ADDRESSES: Send submissions to CC:
PA:LPD:PR (REG-133353-16), room
5203, Internal Revenue Service, Post Of-
fice Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may
be hand-delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG-133353-16), Couri-
er's Desk, Internal Revenue Service, 1111

Constitution Avenue, N.W., Washington,
DC 20224, or sent electronically, via the
Federal eRulemaking Portal at www.
regulations.gov (IRS REG-133353-16).

FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, William Rowe, (202) 317-6834;
concerning submissions of comments, Re-
gina Johnson, (202) 317-5177 (not toll-
free numbers).

## SUPPLEMENTARY INFORMATION:

### Background and Explanation of Provisions

This document contains proposed
amendments to 26 CFR part 301 relating
to section 6103(j)(1)(A) of the Internal
Revenue Code (Code). Section 6103
(j)(1)(A) authorizes the Secretary of the
Treasury to furnish, upon written request
by the Secretary of Commerce, such re-
turns or return information as the Secre-
tary of Treasury may prescribe by regula-
tion to officers and employees of the
Bureau for the purpose of, but only to the
extent necessary in, the structuring of cen-
suses and national economic accounts and
conducting related statistical activities au-
thorized by law. Section 301.6103(j)(1)-1
of the regulations further defines such pur-
poses by reference to 13 U.S.C. chapter 5
and provides an itemized description of
the return information authorized to be
disclosed for such purposes. This docu-
ment contains proposed regulations autho-
rizing the disclosure of additional items of
return information requested by the Sec-
retary of Commerce. These proposed reg-
ulations also provide clarifying language
for an item of return information and re-
move duplicative paragraphs contained in
the existing regulations. Temporary regu-
lations in the Rules and Regulations sec-
tion of this issue of the Bulletin amend 26
CFR part 301. The text of those temporary
regulations serves as the text of these pro-
posed regulations. The preamble to the
temporary regulations explains the tempo-
rary regulations and these proposed regu-
lations.

### Special Analyses

Certain IRS regulations, including this
one, are exempt from the requirements of
Executive Order 12866, as supplemented

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<!-- PageBreak -->

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 eco-
nomic impact on a substantial number of
small entities because the regulations do
not impose a collection of information on
small entities. Accordingly, a regulatory
flexibility analysis is not required under
the Regulatory Flexibility Act (5 U.S.C.
chapter 6). Pursuant to section 7805(f) of
the Internal Revenue Code, this regulation
has been submitted to the Chief Counsel
for Advocacy of the Small Business Ad-
ministration for comment on its impact on
small businesses.

### Comments and Requests for Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are
submitted timely to the IRS as prescribed
in this preamble under the "Addresses"
heading. The IRS and Treasury Depart-
ment request comments on all aspects of
the proposed regulations. All comments
that are submitted will be available for
public inspection and copying at www.
regulations.gov or upon request. A public
hearing may be scheduled if requested in
writing by any person that timely submits
written or electronic comments. If a public
hearing is scheduled, notice of the date,
time, and place for the public hearing will
be published in the Federal Register.

### Drafting Information

The principal author of these proposed
regulations is William Rowe, Office of the
Associate Chief Counsel (Procedure &
Administration).

* * * * *

### Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301 is
amended as follows:

PART 301-PROCEDURE AND
ADMINISTRATION

Paragraph 1. The authority citation for
part 301 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805

Par. 2. Section 301.6103(j)(1)-1 is
amended by adding paragraphs (b)(2)(iii)
(K) through (M), (b)(3)(xxxi) through
(xxxv), and (b)(6)(i)(C) through (E), and
revising paragraphs (b)(2)(iii)(I), (b)(3)
(v), (b)(3)(xxv) through (xxx), and (e) to
read as follows:

§ 301.6103(j)(1)-1 Disclosures of re-
turn information reflected on returns to
officers and employees of the Department
of Commerce for certain statistical pur-
poses and related activities.

* * * * *

(b) * * *

(2) * * *

(iii) * * *

(I) [The text of proposed amendments
to § 301.6103(j)(1)-1(b)(2)(iii)(I) is the
same as the text of § 301.6103(j)(1)-1T(b)
(2)(iii)(I) published elsewhere in this issue
of the Bulletin].

* * * * *

(K) through (M) [The text of proposed
amendments to § 301.6103(j)(1)-1(b)
(2)(iii)(K) through (M) is the same as the
text of § 301.6103(j)(1)-1T(b)(2)(iii)(K)
through (M) published elsewhere in this
issue of the Bulletin].

* * * * *

(3) * * *

(v) [The text of proposed amendments
to § 301.6103(j)(1)-1(b)(3)(v) is the same
as the text of § 301.6103(j)(1)-1T(b)
(3)(v) published elsewhere in this issue of
the Bulletin].

* * * * *

(xxv) through (xxxv) [The text of pro-
posed amendments to § 301.6103(j)(1)-
1(b)(3)(xxv) through (xxxv) is the same as
the text of § 301.6103(j)(1)-1T(b)(3)
(xxv) through (xxxv) published elsewhere
in this issue of the Bulletin].

* * * * *

(6) * * *

(i) * * *

(C) through (E) [The text of proposed
amendments to § 301.6103(j)(1)-
1T(b)(6)(i)(C) through (E) is the same as
the text of § 301.6103(j)(1)-1T(b)(6)
(i)(C) through (E) published elsewhere in
this issue of the Bulletin].

* * * * *

(e) Applicability date. Paragraphs (b)
(2)(iii)(I), (b)(2)(iii)(K) through (M), (b)
(3)(v), (b)(3)(xxv) through (xxxv), and
(b)(6)(i)(C) through (E) of this section
apply to disclosure of the Bureau of the

Census made on or after December 9,
2016. For rules that apply to disclosure to
the Bureau of the Census before that date,
see 26 CFR 301.6103(j)(1)-1 (revised as
of April 1, 2016).

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.

(Filed by the Office of the Federal Register on December 8,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 9, 2016, 81 F.R. 89022)

# Health Insurance Providers Fee

REG-134438-15

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains
proposed regulations that would modify
the current definition of "net premiums
written" for purposes of the fee imposed
by section 9010 of the Patient Protection
and Affordable Care Act, as amended.
The proposed regulations will affect per-
sons engaged in the business of providing
health insurance for United States health
risks.

DATES: Comments and requests for a
public hearing must be received by March
9, 2017.

ADDRESSES: Send submissions to: CC:
PA:LPD:PR (REG-134438-15), room
5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand-
delivered Monday through Friday be-
tween the hours of 8 a.m. and 4 p.m. to
CC:PA:LPD:PR (REG-134438-15), Cou-
rier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW, Washington,
DC 20224, or sent electronically, via the
Federal eRulemaking portal at www.
regulations.gov (IRS REG-134438-15)

FOR FURTHER INFORMATION CON-
TACT:Concerning the proposed regula-
tions, Rachel S. Smith, (202) 317-6855;
concerning submissions of comments and

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<!-- PageBreak -->

request for a hearing, Regina Johnson,
(202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

## Background

Section 9010 of the Patient Protection
and Affordable Care Act (PPACA),
Public Law No. 111-148 (124 Stat. 119
(2010)), as amended by section 10905 of
PPACA, and as further amended by sec-
tion 1406 of the Health Care and Educa-
tion Reconciliation Act of 2010, Public
Law 111-152 (124 Stat. 1029 (2010))
(collectively, the Affordable Care Act or
ACA) imposes an annual fee on covered
entities that provide health insurance for
United States health risks. Section 9010
did not amend the Internal Revenue Code
(Code) but contains cross-references to
specified Code sections. In this preamble
all references to section 9010 are refer-
ences to section 9010 of the ACA and all
references to "fee" are references to the
fee imposed by section 9010.

Section 9010(a) imposes an annual fee
on each covered entity engaged in the
business of providing health insurance.
The fee is due by the annual date specified
by the Secretary, but in no event later than
September 30th of each calendar year in
which a fee must be paid (fee year).

Section 9010(b) requires the Secretary
to determine the annual fee for each cov-
ered entity based on the ratio of the cov-
ered entity's net premiums written for
health insurance for any United States
health risk that are taken into account for
the calendar year immediately before the
fee year (data year) to the aggregate net
premiums written for health insurance of
United States health risks of all covered
entities that are taken into account during
the data year. In calculating the fee, the
Secretary must determine each covered
entity's net premiums written for United
States health risks based on reports sub-
mitted to the Secretary by the covered
entity and through the use of any other
source of information available to the Sec-
retary. Section 9010 does not define the
term "net premiums written."

On November 29, 2013, the Treasury
Department and the IRS published in the
Federal Register (TD 9643; 78 FR
71476) final regulations regarding the fee
(final regulations). The final regulations

define net premiums written to mean pre-
miums written, including reinsurance pre-
miums written, reduced by reinsurance
ceded, and reduced by ceding commis-
sions and medical loss ratio (MLR) re-
bates with respect to the data year. Net
premiums written do not include premi-
ums written for indemnity reinsurance
(and are not reduced by indemnity rein-
surance ceded) because indemnity rein-
surance is not considered health insurance
for purposes of section 9010. However,
net premiums written do include premi-
ums written (and are reduced by premi-
ums ceded) for assumption reinsurance;
that is, reinsurance for which there is a
novation and the reinsurer takes over the
entire risk.

The preamble to the final regulations
explained that, for covered entities that
file the Supplemental Health Care Exhibit
(SHCE) with the National Association of
Insurance Commissioners (NAIC), net
premiums written for health insurance
generally will equal the amount reported
on the SHCE as direct premiums written
minus MLR rebates with respect to the
data year, subject to any applicable exclu-
sions under section 9010. The instructions
to Form 8963, Report of Health Insurance
Provider Information, provide additional
information on how to determine net pre-
miums written using the SHCE and any
equivalent forms as the source of data, and
can be updated to reflect changes to the
SHCE.

## Explanation of Provisions

The proposed regulations would amend
and clarify the rules for how "net premiums
written" take into account certain premium
adjustments and payments.

### 1. Retrospective Premium Adjustments

Following the publication of the final
regulations, the Treasury Department and
the IRS received comments requesting
that premium adjustments related to retro-
spectively rated contracts be taken into
account in determining net premiums
written. The NAIC's Accounting Prac-
tices and Procedures Manual Statement of
Statutory Accounting Principles No. 66,
Retrospectively Rated Contracts, defines a
retrospectively rated contract as a contract
which has the final policy premium calcu-

lated based on the loss experience of the
insured during the term of the policy (in-
cluding loss development after the term of
the policy) and on the stipulated formula
set forth in the policy or a formula re-
quired by law. These premium adjust-
ments, made periodically, may involve ei-
ther the payment of return premium to the
insured (a "retrospectively rated contract
payment") or payment of an additional
premium by the insured (a “retrospec-
tively rated contract receipt"), or both,
depending on experience.

Commenters recommended that in cal-
culating net premiums written, premiums
written should be increased by retrospec-
tively rated contract receipts and reduced
by retrospectively rated contract pay-
ments. Commenters asserted that retro-
spectively rated contract payments are re-
funded to policyholders in much the same
way as MLR rebates. Therefore, without
an adjustment for retrospectively rated
contract payments, covered entities that
make these payments will bear a liability
for an amount of the annual fee that cor-
relates to premiums from which they do
not actually receive an economic benefit.

In response to these comments, the
proposed regulations would modify the
current definition of net premiums written
to account for premium adjustments re-
lated to retrospectively rated contracts,
computed on an accrual basis. These
amounts are received from and paid to
policyholders annually based on experi-
ence. Retrospectively rated contract re-
ceipts and payments do not include
changes to funds or accounts that remain
under the control of the covered entity,
such as changes to premium stabilization
reserves.

### 2. Risk Adjustment Payments and Charges

Following the publication of the final
regulations, questions also arose about the
treatment of risk adjustment payments un-
der the ACA. Section 1343 of the ACA
provides a permanent risk adjustment pro-
gram for certain plans in the individual
and small group markets. In general, the
program transfers risk adjustment funds
from health insurance plans with rela-
tively lower-risk enrollees to issuers that
disproportionately attract high-risk popu-

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lations, such as individuals with chronic
conditions. Section 1343(a)(1) generally
requires each state, or the Department of
Health and Human Services (HHS) acting
on behalf of the state, to assess a charge
on health plans and health insurance issu-
ers in the individual or small group mar-
kets within a state (with respect to health
insurance coverage) if the actuarial risk of
the enrollees of such plans or coverage for
a year is less than the average actuarial
risk of all enrollees in all plans or cover-
age in the state for the year that are not
self-insured group health plans. Section
1343(a)(2) generally requires each state,
or HHS acting on behalf of the state, to
make a payment to health plans and health
insurance issuers in the individual or
small group markets within a state (with
respect to health insurance coverage) if
the actuarial risk of the enrollees of such
plans or coverage for a year is greater than
the average actuarial risk of all enrollees
in all plans and coverage in the state for
the year that are not self-insured group
health plans.

Although not specifically listed, net
premiums written, as defined in the final
regulations, include risk adjustment pay-
ments received by a covered entity under
section 1343(a)(2) of the ACA and are
reduced for risk adjustment charges paid
by a covered entity under section 1343(a)
(1) of the ACA. Nonetheless, several cov-
ered entities asked whether net premiums
written included risk adjustment payments
received and charges paid. Therefore,
these proposed regulations add specific
language to the definition of net premiums
written to clarify that net premiums writ-
ten include risk adjustment payments re-
ceived and are reduced for risk adjustment
charges paid. If a covered entity did not
include risk adjustment payments re-
ceived as direct premiums written on its
SHCE or did not file an SHCE, these
amounts are still part of net premiums
written and must be reported as such on
Form 8963. For this purpose, risk adjust-
ment payments received and charges paid
are computed on an accrual basis.

### 3. Other Premium Adjustments

These proposed regulations would au-
thorize the IRS to provide rules in guid-
ance published in the Internal Revenue

Bulletin for additional amounts to be
taken into account in determining net pre-
miums written. If the Treasury Depart-
ment and the IRS determine that pub-
lished guidance providing additional
adjustments to net premiums written is
warranted, such guidance will be pub-
lished in the Internal Revenue Bulletin.

## Proposed Effective/Applicability Date

These regulations are proposed to ap-
ply with respect to any fee that is due on
or after September 30, 2018.

## Special Analyses

Certain IRS regulations, including
these, are exempt from the requirements
of Executive Order 12866, as supple-
mented and reaffirmed by Executive Or-
der 13563. Therefore, a regulatory assess-
ment is not required. Because these
regulations do not include a collection
of information, a Regulatory Flexibility
Analysis under the Regulatory Flexibility
Act (5 U.S.C. chapter 6) is not required.
Pursuant to Code section 7805(f), this no-
tice of proposed rulemaking will be sub-
mitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business.

## Comments and Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written (a signed
original and eight (8) copies) or electronic
comments that are submitted timely to the
IRS. Comments are requested on all as-
pects of these proposed regulations. The
Treasury Department and the IRS specif-
ically request comments on the following:

1\. How the adjustments to net premi-
ums written under these proposed reg-
ulations tie to amounts reported on the
SHCE.

2\. Whether there should be a transition
rule for premium adjustments related to
retrospectively rated contracts and how
any such rule should be implemented.

All comments will be available for public
inspection and copying. A public hearing
may be scheduled if requested in writing
by any person that timely submits written
comments. If a public hearing is sched-
uled, notice of the date, time, and place for

the hearing will be published in the Fed-
eral Register.

## Drafting Information

The principal author of these proposed
regulations is Rachel S. Smith, IRS Office
of the Associate Chief Counsel (Pass-
throughs and Special Industries). How-
ever, other personnel from the Treasury
Department and the IRS participated in
their development.

* * * * *

## Proposed Amendments to the Regulations

Accordingly, 26 CFR part 57 is pro-
posed to be amended as follows:

### PART 57-HEALTH INSURANCE PROVIDERS FEE

Paragraph 1. The authority citation for
part 57 continues to read in part as fol-
lows:

Authority: 26 U.S.C. 7805
* * * * *

Par. 2. Section 57.2 is amended by
revising paragraph (k) to read as follows:

§ 57.2 Explanation of terms.

* * * * *

(k) Net premiums written-(1) In gen-
eral. The term net premiums written
means premiums written, adjusted as pro-
vided in paragraph (k)(2) of this section.

(2) Adjustments. Net premiums written
include adjustments to account for:

(i) Assumption reinsurance, but not in-
demnity reinsurance. Net premiums writ-
ten include reinsurance premiums written,
reduced by reinsurance ceded, and re-
duced by ceding commissions with re-
spect to the data year. Net premiums writ-
ten do not include premiums written for
indemnity reinsurance and are not reduced
by indemnity reinsurance ceded because
indemnity reinsurance within the meaning
of paragraph (h)(5)(i) of this section is not
health insurance under paragraph (h)(1) of
this section. However, in the case of as-
sumption reinsurance within the meaning
of paragraph (h)(5)(ii) of this section, net
premiums written include premiums writ-
ten for assumption reinsurance, reduced
by assumption reinsurance premiums ceded.

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(ii) Medical loss ratio (MLR) rebates.
Net premiums written are reduced by
MLR rebates with respect to the data year.
For this purpose, MLR rebates are com-
puted on an accrual basis.

(iii) Premium adjustments related to
retrospectively rated contracts. Net pre-
miums written include retrospectively
rated contract receipts and are reduced by
retrospectively rated contract payments
with respect to the data year. For this
purpose, net premium adjustments related
to retrospectively rated contracts are com-
puted on an accrual basis.

(iv) Amounts related to the risk adjust-
ment program under section 1343 of the
ACA. Net premiums written include risk
adjustment payments (within the meaning

of 42 U.S.C. 18063(b)) received with re-
spect to the data year and are reduced by
risk adjustment charges (within the mean-
ing of 42 U.S.C. 18063(a)) paid with re-
spect to the data year. For this purpose,
risk adjustment payments and risk adjust-
ment charges are computed on an accrual
basis.

(v) Additional adjustments published
in the Internal Revenue Bulletin. The IRS
may provide rules in guidance published
in the Internal Revenue Bulletin (see
§ 601.601(d)(2) of this chapter) for addi-
tional adjustments against premiums writ-
ten in determining net premiums written.

Par. 3. Section 57.10 is amended by
revising paragraph (a) and adding para-
graph (c) to read as follows:

§ 57.10 Effective/applicability date.

(a) In general. Except as provided in
paragraphs (b) and (c) of this section,
§§ 57.1 through 57.9 apply to any fee that
is due on or after September 30, 2014.
* * * * *

(c) Paragraph (k) of § 57.2. Paragraph
(k) of § 57.2 applies to any fee that is due
on or after September 30, 2018.

John Dalrymple,
Deputy Commissioner for
Services and Enforcement.

(Filed by the Office of the Federal Register on December 8,
2016, 8:45 a.m., and published in the issue of the Federal
Register for December 9, 2016, 81 F.R. 89017)

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# Definition of Terms

Revenue rulings and revenue procedures
(hereinafter referred to as "rulings") that
have an effect on previous rulings use the
following defined terms to describe the
effect:

Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle also applies to B, the
earlier ruling is amplified. (Compare with
modified, below).

Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.

Distinguished describes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.

Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A

and B, the prior ruling is modified because
it corrects a published position. (Compare
with amplified and clarified, above).

Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.

Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.

Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the new
ruling does more than restate the sub-

stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is
self contained. In this case, the previously
published ruling is first modified and then,
as modified, is superseded.

Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.

Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.

# Abbreviations

The following abbreviations in current
use and formerly used will appear in ma-
terial published in the Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

TFE-Transferee.

TFR-Transferor.

CI-City.

GR-Grantor.

IC-Insurance Company.

Ct.D .- Court Decision.

I.R.B .- Internal Revenue Bulletin.

TR-Trust.

CY-County.

LE-Lessee.

TT-Trustee.

D-Decedent.

LP-Limited Partner.

LR-Lessor.

X-Corporation.

DE-Donee.

Del. Order-Delegation Order.

Nonacq .- Nonacquiescence.

O Organization.

DR-Donor.

P-Parent Corporation.

PHC-Personal Holding Company.

PO-Possession of the U.S.

PR-Partner.

PRS-Partnership.

PTE-Prohibited Transaction Exemption.
Pub. L .- Public Law.

REIT-Real Estate Investment Trust.

Rev. Proc .- Revenue Procedure.

Rev. Rul .- Revenue Ruling.

S-Subsidiary.

S.P.R .- Statement of Procedural Rules.

Stat .- Statutes at Large.

T-Target Corporation.

T.C .- Tax Court.

T.D .- Treasury Decision.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

GP-General Partner.

T.I.R .- Technical Information Release.

COOP-Cooperative.

TP-Taxpayer.

U.S.C .- United States Code.

DC-Dummy Corporation.

M-Minor.

Y-Corporation.

Z-Corporation.

DISC-Domestic International Sales Corporation.

E-Estate.

EE-Employee.

E.O .- Executive Order.

ER-Employer.

ERISA-Employee Retirement Income Security Act.
EX-Executor.

F-Fiduciary.

FC-Foreign Country.

FICA-Federal Insurance Contributions Act.

FISC-Foreign International Sales Company.

FPH-Foreign Personal Holding Company.

BK-Bank.

B.T.A .- Board of Tax Appeals.

C-Individual.

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## Numerical Finding List1

Bulletin 2017-1 through 2017-2

Notices:

2017-1, 2017-2 I.R.B. 367
2017-3, 2017-2 I.R.B. 368

Proposed Regulations:

REG-128276-12, 2017-2 I.R.B. 369
REG-134438-15, 2017-2 I.R.B. 373
REG-133353-16, 2017-2 I.R.B. 372

### Revenue Procedures:

2017-1, 2017-1 I.R.B. 1

2017-2, 2017-1 I.R.B. 106

2017-3, 2017-1 I.R.B. 130

2017-4, 2017-1 I.R.B. 146

2017-5, 2017-1 I.R.B. 230
2017-7, 2017-1 I.R.B. 269

### Revenue Rulings:

2017-2, 2017-2 I.R.B. 364

Treasury Decisions:

9794, 2017-2 I.R.B. 273

9795, 2017-2 I.R.B. 326

9801, 2017-2 I.R.B. 355

9802, 2017-2 I.R.B. 361

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## Finding List of Current Actions on Previously Published Items1

Bulletin 2017-1 through 2017-2

Notices:
2002-1
Amplified by
Notice 2017-1, 2017-2 I.R.B. 367
2011-86
Obsoleted by
Notice 2017-1, 2017-2 I.R.B. 367

Revenue Procedures:

2017-01 I.R.B. 1

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016-27 through 2016-52 is in Internal Revenue Bulletin
2016-52, dated December 26, 2016.

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# Internal Revenue Service Washington, DC 20224

Official Business
Penalty for Private Use, $300

# INTERNAL REVENUE BULLETIN

The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue
Bulletins are available at www.irs.gov/irb/.

# We Welcome Comments About the Internal Revenue Bulletin

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page
(www.irs.gov) or write to the Internal Revenue Service, Publishing Division, IRB Publishing Program Desk, 1111 Constitution Ave.
NW, IR-6230 Washington, DC 20224.