IRS proposes new regulations regarding foreign currency gain or loss
TAX ALERT |
On December 18, the IRS released proposed regulations (see REG-119514-15), providing guidance on the treatment of foreign currency gain or loss of a controlled foreign corporation (CFC) under the business needs exclusion from foreign personal holding company income (FPHCI), as well as guidance regarding the use of the mark-to-market method of accounting for certain gains and losses from section 988 transactions.
Generally, foreign currency (Fx) gains are included in a CFC’s FPHCI– a type of income that may be currently included in the gross income of a CFC’s U.S. shareholders as subpart F income, irrespective of whether it is distributed to the shareholder. However, Fx gains or losses that are attributable to transactions that are directly related to a CFC’s business needs may be eligible to be excluded from a CFC’s FPHCI under what is called the “business needs exclusion.” In order for the business needs exclusion to apply, the transaction or property cannot give rise to subpart F income, other than Fx gain or loss. This means that, under current law rules, if a transaction or property gives rise to even a small amount of subpart F income, other than Fx gain or loss, the business needs exclusion will not apply, and the entire amount of Fx gain or loss may be includable in the CFC’s FPHCI computation.
In order to address this issue, the proposed regulations provide that the Fx gain or loss stemming from a transaction or property – otherwise qualifying for the business needs exclusion – that produces both subpart F and non-subpart F, may be bifurcated and allocated pro-rata between the subpart F and non-subpart F income of the transaction or property. Fx gain or loss allocated to the portion of subpart F income would generally be includable in the CFC’s FPHCI, while amounts allocated to the portion of non-subpart income would generally be eligible for the business needs exclusion.
This, in effect, eliminates the ‘cliff effect’ that may result when a transaction or property produces a de minimis amount of subpart F income, thus rendering it ineligible for the business needs exclusion under current law rules.
In addition, the proposed regulations also address a taxpayer’s use of the mark-to-market method of accounting for certain Fx gains and losses as well as provide for the expansion of the hedge accounting and timing rules to certain Fx transactions, which will be covered in a separate, forthcoming alert.
Practitioners and business owners will have until March 18, 2018 to provide electronic comments and requests for a public hearing on these new proposed regulations.
The rules governing foreign currency transactions for CFC’s are quite complex, and all aspects of a transaction should be taken into account when determine the tax consequence. Accordingly U.S. multinational businesses should make sure and consult their tax advisors as soon as possible regarding the tax effects of foreign currency transactions.