Rev. Rul. 75-105

Advice has been requested regarding the application of the "net worth" or "balance sheet" method of reporting foreign branch income or loss in the circumstances described below.

The taxpayer, a domestic bank, operates from its home office located in the United States. It has branches in the United States and in foreign countries. In the operation of its foreign branches, the taxpayer does not supply any form of capital to such foreign branches unless required to do so under the laws of a foreign country in which one of its branches is located. The foreign branches accept deposits in foreign currency and make loans with the currency so obtained. The foreign branches acquire land and buildings, as well as other noncurrent assets (all assets other than current assets), in order to carry on the banking business in foreign countries. The costs of such assets are recorded on the branch books in the foreign country currency.

The taxpayer is required by Federal law to keep the accounts of each foreign branch bank independently of the accounts of other foreign branches operated by it and of its home office, and, at the end of each fiscal period, to transfer the profit or loss accrued at each branch to its general ledger as a separate item. See 12 U.S.C. 604 (1971). Each foreign branch remits all of its net income to the taxpayer monthly, unless it is prohibited from doing so by local law.

The taxpayer established a branch operation in foreign country X. Under the laws of country X the taxpayer was required to furnish its branch with a specified amount of funds to be credited to a reserve account. Such funds are required to be recorded in a liability account on the branch's books as "capital," "capital reserve," or "legal reserve." The funds are recorded on the branch's books in terms of the currency of country X. The dollar cost of the foreign currency is recorded as an amount due from the branch on the taxpayer's home office books. The withdrawal of such funds is restricted by the amount required to be maintained in the reserve account. The funds, however, may be used for the general purposes of the branch's business and are not segregated nor kept in any particular form of asset.

The treatment to be accorded the funds that the taxpayer is required to maintain in its branch office located in country X (denominated "capital," "capital reserve" or "legal reserve") in applying the "net worth" or "balance sheet" method is determined solely by what is done with those funds by the branch. If the funds are used as current assets, any gain or loss thereon by reason of fluctuation in the value of the foreign currency in relation to the dollar is recognized for Federal income tax purposes as provided by Rev. Rul. 75-106, page 31, this Bulletin. Thus, the funds so used are not excluded from the computation of current assets under the "net worth" or "balance sheet" method. If the funds are used to purchase noncurrent assets, the income tax bases of such assets are not adjusted for foreign currency fluctuations. Accordingly, gain or loss on such assets is not recognized for Federal income tax purposes on the account of fluctuations in value of the currency in which the books of the foreign branch are maintained.

Accordingly, it is held in the instant case, that in computing foreign branch income or loss under the "net worth" or "balance sheet" method, the amount of current assets shall be determined without any exclusion for any part of such assets representing "capital," "capital reserve" or "legal reserve" required by the laws of country X, where the taxpayer is free to use the assets in branch business in country X as it deems appropriate.

The application of the "net worth" or "balance sheet" method to the taxpayer's branch operation in country X may be illustrated as follows:

In a prior year, the taxpayer acquired assets and incurred liabilities in country X establishing its branch operation. The taxpayer furnished the branch with funds to be credited to a reserve account as required by the laws of country X. Such funds were initially used as current assets for the general purposes of the branch business. At the beginning of taxable year 1971, expressed in terms of country X's currency (units), the branch had current assets of 500,000 units and current liabilities of 400,000 units. The branch's noncurrent assets, all of which were nondepreciable, had an adjusted basis of $500,000, based on the currency exchange rates in existence at the time the assets were acquired. The currency exchange rate as of the beginning of taxable year 1971 was $3 to 1 unit. The amount required in the "capital reserve" account by country X was 400,000 units.

At the close of taxable year 1971, the branch had current assets of 500,000 units and current liabilities of 400,000 units. The adjusted basis of the branch's noncurrent assets was $500,000. The currency exchange rate at the close of the year was $3 to 2 units. The branch remitted 1,000 units to the home office during the year at a time when the currency exchange rate was $3 to 2 units.

During taxable year 1972, the branch converted 200,000 units of current assets to nondepreciable noncurrent assets when the currency exchange rate was $3 to 2 units. At the close of taxable year 1972, the branch had current assets of 300,000 units and current liabilities of 400,000 units. The adjusted basis of the branch's noncurrent assets was $800,000, based on the currency exchange rates in existence when the assets were purchased. The currency exchange rate at the end of the year was $3 to 3 units. The branch remitted 500 units to the home office when the currency exchange rate was $3 to 2 units, and 500 units to the home office when the currency exchange rate was $3 to 3 units.

Branch net worth at the beginning of 1971 is computed as follows:

     (1) Dollar value of the excess of

     (1) Dollar value of the excess of

     (1) Dollar value of the excess of current