IRS finalizes certain temporary foreign currency tax regulations

Jun 14, 2019
International tax

The U.S. Treasury Department (Treasury) and the Internal Revenue Service (IRS) have released final regulations (T.D. 9857) regarding the taxable income or loss of a taxpayer with respect to a qualified business unit (QBU) subject to section 987. The final regulations were published in the Federal Register on May 13, 2019.

The final regulations adopt with certain modifications temporary regulation sections 1.987-2T and 1.987-4T relating to combinations and separations of QBUs, and temporary regulation section 1.987-12T relating to the recognition and deferral of foreign currency gain or loss with respect to certain QBU terminations and certain other transactions involving partnerships. The regulations also withdraw temporary regulation section 1.987-7T regarding the allocation of assets and liabilities of Section 987 aggregate partnerships (defined below).


Section 987 was added to the Internal Revenue Code in 1986. Sections 987(1) and (2) provide 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, using U.S. tax principles, and then translating such income or loss to the QBU owner’s functional currency using the appropriate exchange rate (generally, the average exchange rate for the year). Section 987(3) addresses the calculation of translation gains and losses and the timing of such gains or loss.

In December 2016, Treasury and the IRS issued proposed (Reg-128276-12), temporary (T.D. 9795) and final (T.D. 9794) regulations implementing section 987. The 2016 regulations apply only to individuals and C corporations that own section 987 QBUs directly (including through disregarded entities) or indirectly through section 987 Aggregate Partnerships. The regulations do not apply to banks, insurance companies, leasing companies, finance coordination centers, regulated investments companies, trusts, real estate trusts, estates, S corporations, or partnerships other than section 987 Aggregate Partnerships.  For purposes of these rules:

  • A section 987 QBU is a clearly identifiable separate trade or business with its own books and records. A section 987 QBU does not include a corporation or partnership, but such entities may own section 987 QBUs. Also, a section 987 QBU cannot own another Section 987 QBU; and
  • A section 987 Aggregate Partnership is a partnership in which (1) all the capital and profits interests are owned directly or indirectly by related persons (within the meaning of sections 267(b) or 707(b) and generally taking into account constructive ownership principles), and (2) there are one or more trades or businesses, at least one of which would be a section 987 QBU if the partner owned that trade or business directly.

The applicability date for most of the 2016 regulations was originally the first taxable year beginning after Dec. 6, 2017 (i.e., Jan. 1, 2018, for calendar year taxpayers).However, taxpayers were allowed to early-adopt the regulations for years beginning in 2017, and the Treasury extended the effective date twice, as described below.

Following the release of the 2016 regulations, the Treasury and the IRS issued the following additional guidance:

  • Notice 2017-07, published on Jan. 17, 2017, announcing that certain rules under temporary regulation section 1.987-12T would be modified to prevent potential abuse by taxpayers making retroactive check-the-box elections
  • Notice 2017-38, published on July 24, 2017, identifying the regulations as a significant tax regulation requiring additional review under Executive Order 13789
  • Notice 2017-57, released on Oct. 16, 2017, announcing the effective date of the 2016 regulations would be extended by one year (i.e., Jan. 1, 2019, for calendar year taxpayers)
  • Notice 2018-57, published on June 25, 2018, announcing that the applicability date of the 2016 regulations would be further extended by one additional year (i.e., Jan. 1, 2020, for calendar year taxpayers).

Combinations and separations of section 987 QBUs

The May 13 final regulations provide that section 987 gain or loss is generally not recognized when two or more section 987 QBUs (combining QBUs) with the same owner combine into a single section 987 QBU (combined QBU) or when a section 987 QBU (separating QBU) separates into multiple section 987 QBUs (each, a separated QBU).

Specifically, regulation section 1.987-2(c)(9)(i) specifies 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. Under regulation section 1.987-2(c)(9)(ii), however, if a combined QBU has a functional currency different than one or more of the combining QBUs, the QBU with the different functional currency is treated as having changed its functional currency and must make the adjustments required by section 985 and regulation section 1.985. Similarly, regulation section 1.987-2(c)(9)(iii) indicates that the separation of a separating QBU into two or more separated QBUs that have the same owner after the separation does not give rise to a transfer of any of the separating QBU's assets or liabilities to the owner. Regulation section 1.987-4(f) provides rules for calculating the net unrecognized section gain or loss of a combined QBU and a separated QBU.

Deferral of section 987 gain or loss on terminations

The 2016 regulations generally require gain or loss on certain section 987 QBU assets and liabilities to be measured annually, but the gain or loss is not recognized until there is a net remittance or termination of the section 987 QBU. A section 987 QBU terminates when its activities cease, substantially all of its assets are transferred to its owner, a CFC owner ceases being a CFC, or the owner ceases to exist in a transaction other than certain liquidations and reorganizations described in section 381(a).

Due to concerns by the Treasury and the IRS regarding taxpayers selectively recognizing section 987 losses, however, regulation section 1.987-12 generally defers section 987 gain or loss recognition in two types of transactions: (i) deferral events, and (ii) outbound loss events. The rules for deferral events defer both gains and losses while the rules for outbound loss events only defer losses.

Deferral event

A deferral event is a termination of a section 987 QBU provided that immediately after the transaction assets of the section 987 QBU are reflected on the books of a successor QBU. A section 987 QBU is a successor QBU if immediately after the deferral event, the section 987 QBU satisfies the following conditions:

  • the books of the successor QBU reflect assets that immediately before the deferral event were reflected on the books of the terminated QBU;
  • the owner of the successor QBU and the terminated QBU are members of the same controlled group; and
  • if the owner of the terminated QBU was a U.S. person, the successor QBU is owned by a U.S. person.

The following three categories of termination events are not treated as deferral events:

  • terminations described in regulation section 1.987-8(b)(1) (trade or business ceases);
  • terminations described in regulation section 1.987-8(b)(3) (the owner of a QBU ceases to be a CFC); or
  • terminations described in regulation section 1.987-8(c) (certain inbound, outbound, or foreign-to-foreign reorganizations).

Outbound loss event

An outbound loss event is a termination of a section 987 QBU that occurs in connection with an outbound transfer by a U.S. person of the assets of a section 987 QBU to a foreign person that is a member of a controlled group or an outbound transfer of an interest in a section 987 aggregate partnership or disregarded entity through which the owner owns a section 987 QBU.

Partner’s share of assets and liabilities of a Section 987 aggregate partnership

The final regulations withdraw temporary regulation section 1.987-7T, which required the assets and liabilities of a section 987 QBU held by a section 987 aggregate partnership to be allocated to the partners based on the liquidation value of the partners’ interests in the partnership. Until new regulations are issued, taxpayers may use any reasonable method for determining a partner's share of the assets and liabilities reflected on the books of a section 987 QBU held indirectly through a section 987 aggregate partnership.

Applicability dates

The combinations and separations rules contained in regulation sections 1.987-2(c)(9) and 1.987-4(f) generally apply to tax years beginning on or after the day that is three years after the first day of the first tax year following Dec. 7, 2016 (i.e., Jan. 1, 2020, for calendar year taxpayers).

The deferral events and outbound loss events rules contained in regulation section 1.987-12 generally apply to a deferral event or outbound loss event that occurs on or after Jan. 6, 2017. Regulation section 1.987-12 also applies to any deferral event or outbound loss event resulting from a check-the-box election made on or after Jan. 6. 2017, and that is effective before Jan. 6, 2017. However, regulation section 1.987-12 applies to any deferral event or outbound loss event occurring on or after Dec. 7, 2016, if such deferral event or outbound loss event was undertaken with a principal purpose of recognizing a section 987 loss.


The May 13 final regulations are an important development. Taxpayers should carefully analyze these to determine the implications to their section 987 QBUs.

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