TEI CRITICIZES FOREIGN CURRENCY REGULATIONS FOR DEVIATION FROM GAAP.

TEI argues that qualified business units (QBUs) should not be compelled to use the separate transaction method in all circumstances where the dollar is the functional currency, as is currently required by the regulations. Noting that many foreign affiliates do not provide their domestic tax departments with enough information to comply with this requirement, TEI contends that forcing this method on corporations will compel corporations "to establish a new reporting system -- an informational reporting requirement that, in our view, is excessively broad." TEI argues that "the entire concept of 'functional currency' is based on financial accounting principles," which support a more flexible accounting requirement.

Also singled out by TEI is the regulation section 1.985-3T requirement that the approximate separate transaction method be used by a QBU electing to use the dollar as its functional currency. The Institute suggests that this requirement will "impose burdensome information-gathering and reporting requirements, which would compel corporations to establish new accounting functions in order to comply." TEI argues that U.S. GAAP should be allowed as an alternative to the approximate transactions method.

TEI applauds the use of U.S. GAAP for determining when a currency is "hyperinflationary," which enables a QBU to elect to use the dollar as its functional currency. TEI argues, however, that this election should not be conditioned upon the conformity requirement that all related QBUs also use the dollar as the functional currency.

Finally, TEI argues that the regulations are unnecessarily restrictive in the requirement that exchange gain or loss computed using the weighted average exchange rate be based on the "average of the daily exchange rate" for each month within the QBU's taxable year. TEI suggests that corporations be permitted to elect either a daily average exchange rate or a month-end rate, provided that the method chosen is consistently applied.

On June 3, 1988, the Department of Treasury and the Internal Revenue Service issued temporary regulations under section 989 of the Code relating to the definition of qualified business units (T.D. 8206) and the transition rules for certain taxpayers using the net worth method of accounting for taxable years prior to January 1, 1987 (T.D. 8207). The temporary regulations were published in the Federal Register on June 6, 1988 (53 Fed. Reg. 20614, 20612), and were reprinted in the July 5, 1988, and the July 11, 1988, issues of the Internal Revenue Bulletin, 1988-27 I.R.B. 7 (T.D. 8206) and 1988-28 I.R.B. 18 (T.D. 8207). Identical proposed regulations were published in the Federal Register on June 6, 1988, at pages 53 Fed. Reg. 20651 (INTL-964-86), and 53 Fed. Reg. 20650 (INTL-983-86). The proposed regulations were reprinted in the July 5, 1988, and July 11, 1988, issues of the Internal Revenue Bulletin, 1988-27 I.R.B. 36 (INTL-983- 86) and 1988-28 I.R.B. 29 (INTL-964-86).

In these comments, Tax Executives Institute sets forth its specific concerns about the temporary and proposed regulations. For simplicity's sake, the regulations are referred to in the following comments as "the temporary regulations"; specific provisions are cited as "Temp. Reg. Sec." References to page numbers are to the regulations as reprinted in the Internal Revenue Bulletin.

DESCRIPTION OF TEI

Tax Executives Institute, Inc. is the principal association of corporate tax executives in North America. Our approximately 4,300 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that our diversity and the professional training of our members enable us to bring an important, balanced, and Practical perspective to the issues raised by the regulations relating to the foreign currency provisions of sections 985 through 989 of the Code.

GENERAL COMMENTS

Prior to the enactment of the Tax Reform Act of 1986, the law was unclear concerning the character, the timing of recognition, and the source of gain or loss resulting from fluctuations in the exchange rate of foreign currencies. See S. Rep. No. 99-313, 99th Cong., 2d Sess. 450 (1986) (hereinafter cited as the "Senate Report"). In addition, the law did not provide clear-cut rules for determining when the results of a foreign operation could be recorded in a foreign currency. Id. To provide a comprehensive set of rules for the U.S. tax treatment of foreign currency translation and transactions, in 1986 Congress enacted sections 985 through 989 of the Internal Revenue Code. The provisions represent a legislative attempt to bring clarity to the rules governing the U.S. tax treatment of currency translation and exchange gains and losses.

Prefatorily, Tax Executives Institute commends the Treasury and the Internal Revenue Service for their efforts to clarify the legislation through proposed and temporary regulations and notices. In general, we believe the temporary regulations further Congress's goal of providing concrete and coherent rules for the treatment of foreign currency translation. Specifically, the proposed rule in Temp. Reg. Sec. 1.985-1T(c)(5) -- providing that a QBU's functional currency for purposes of U.S. generally accepted accounting Principles (GAAP) will ordinarily be recognized for tax purposes -- promises to reduce reporting burdens substantially by allowing the taxpayer to use financial information gathered for legitimate non-tax business reasons. Inclusion of this rule in final regulations would be consistent with the deference Congress intended be accorded U.S. GAAP rules in foreign currency translation.

Regrettably, however, the temporary regulations deviate from U.S. GAAP principles in several material respects. For example, the temporary regulations decline to adopt the recommendation in our April 26, 1988, submission that a taxpayer be able to use U.S. GAAP accounting to approximate the separate transaction method, rather than having to develop and maintain an entirely new method of accounts. TEI submits that the abandonment of U.S. GAAP rules will create unnecessary and possibly insurmountable administrative burdens for taxpayers. We urge the Treasury to reconsider its position with respect to the use of U.S. GAAP for purposes of the foreign currency provisions. ¹ Our specific concerns in this regard are discussed below in section 3.

FOREIGN CURRENCY REGULATIONS

1. TEMP. REG. SEC. 1.985-1T: SEPARATE TRANSACTION METHOD

Temp. Reg. Sec. 1.985-1T(e) would generally provide that all nonfunctional currency transactions be translated in the QBU's functional currency on a separate transaction basis. The preamble to the temporary regulations invites comments on the "efficacy of requiring the use of a separate transactions method IN ALL CIRCUMSTANCES where a QBU has the dollar as functional currency. . . ." 1988-28 I.R.B. at 7 (emphasis added).

TEI rejects the position that QBUs should be required to use the separate transaction method in all circumstances where the dollar is the functional currency. Domestic corporations generally receive financial information from their foreign affiliates prepared in accordance with U.S. GAAP. The information may be provided in summary form and may not provide details concerning each currency transaction. Moreover, the information is frequently transmitted manually to the domestic tax department by foreign affiliates, thereby making follow-up and data analysis time-consuming, if possible at all. The mandatory use of the separate transaction method would compel corporations to establish an entirely new reporting system ² -- an informational requirement that, in our view, is excessively broad. Such a result is not warranted under, and indeed is contrary to, the legislative history of the statute.

The legislative history of section 985 explicitly confirms the desirability of applying U.S. GAAP principles to foreign currency translation and transactions. Indeed, the entire concept of "functional currency" is based on financial accounting principles. U.S. GAAP principles should therefore not be given short shrift in the final regulations.

The functional currency concept was adopted by the Financial Accounting Standards Board in 1981 with the issuance of Statement of Financial Accounting Standard No. 52 (FAS 52), relating to foreign currency translation. ³ Under FAS 52, the currency of the economic environment in which a foreign entity operates generally is used as the unit of measure for exchange gains or losses -- i.e., the functional currency.

In enacting section 985, Congress expressly acknowledged that financial accounting concepts such as FAS 52 provided a "reasonable basis for determining the amount and the timing of recognition of exchange gain or loss." See Senate Report at 450. See also Senate Report at 457 (requiring the use of financial accounting principles to identify the functional currency); Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 1086 & n.36, 1093 (1987) (hereinafter cited as the "1986 Bluebook").

The use of U.S. GAAP would neither materially alter the tax results of specific transactions nor in our view present more than a chimerical opportunity for abuse. Equally important, taxpayers would be able to comply by utilizing the accounting systems already in use and not incur the additional cost and burden of developing and maintaining entirely new systems. The legislative history of section 985 embraces financial accounting principles -- the adoption of U.S. GAAP -- with respect to the determination of a QBU's taxable income. The regulations should be revised to mirror congressional intent by providing that U.S. GAAP is a reasonable method of accounting where a QBU has the dollar as its functional currency.

2. TEMP. REG. SEC. 1.985-1T: FACTS AND CIRCUMSTANCES TEST

TEI endorses the adoption of a facts-and-circumstances test in Temp. Reg. Sec. 1.985-1T(c)(2)(i) to determine the functional currency of a qualified business unit (QBU). We remain concerned, however, that the list of factors provided in the regulation would skew the analysis by over-emphasizing discrete currency transactions. To ensure that the determination is based on the predominant economic unit in which financial decisions are made, TEI recommends that language such as the following (which is taken from paragraph 6 of FAS 52) be added to the regulations:

An additional fact or circumstance which should be considered in determining the economic environment in which a significant part of a QBU's activities is conducted is the predominant currency unit in which financial decisions are made. For example, the U.S. dollar may be the functional currency for foreign operations of a domestic parent corporation where such foreign operations are a direct and integral component or extension of the parent company's operations.

See also FAS 52, para. 81. This addition would accord with congressional intent that the factors used to identify a QBU's functional currency should "generally correspond to the current criteria that [are] used to identify a functional currency for financial accounting purposes." Senate Report at 457 (footnote omitted). The following example should be added to Temp. Reg. Sec. 1.985-1T(f) to confirm that factors such as pricing may affect the determination of a QBU's functional currency:

S, a foreign corporation organized in T, is wholly owned by P, a domestic corporation. The currency of T is the LC. S's books and records are maintained in LCs. S purchases most of the products it sells from related parties, including P. These purchases are made in the LC. In addition, most of S's gross receipts are generated by transactions denominated in LCs. S pays local taxes, employee wages, and other local expenses in LC.

The U.S. dollar is S's functional currency under U.S. GAAP. S determines its LC price for goods sold to obtain a return sufficient to generate a certain U.S. dollar amount after reduction for all LC costs. Changes in the LC-U.S. dollar exchange rate from period to period will result in corresponding changes in S's LC prices to customers in order to cover LC and other costs and generate a certain U.S. dollar return.

Under these facts, the predominant currency unit in which financial decisions are made, i.e., pricing, is the U.S. dollar. Thus, even though S maintains books and records in LCs, S's functional currency is the U.S. dollar.

3. TEMP. REG. SEC. 1.985-3T: APPROXIMATE SEPARATE TRANSACTION METHOD

Temp. Reg. Sec. 1.985-3T would require that the approximate separate transaction method be used by a QBU electing to use the dollar as its functional currency pursuant to Temp. Reg. Sec. 1.985- 2T. The proposed translation rules would impose burdensome information-gathering and reporting requirements, which would compel corporations to establish new accounting functions in order to comply.

In our April 26 pre-regulation comments, TEI suggested that taxpayers could best satisfy the requirement concerning the use of a method of accounting approximating the separate transaction method through the use of U.S. GAAP. The legislative history of the foreign currency provisions clearly contemplates that a taxpayer may use a method of accounting as long as it APPROXIMATES the separate transaction method. See Senate Report at 459. TEI submits that, given congressional recognition of the U.S. GAAP method of accounting as "reasonable," the final regulations should adopt U.S. GAAP as an alternative to the approximate separate transaction method proposed under the regulations.

The temporary regulations relating to the approximate separate transaction method reflect a misapprehension of the real world and the administrative burdens the regulations would spawn. For example, Temp. Reg. Sec. 1.985-3T(d)(2)(ii) requires that the amount of any distributions taken into account in computing exchange gain or loss is to be determined by translating those distributions at the average exchange rate for the period made. The use of an average exchange rate, however, would serve NO other function, for either income tax or financial reporting purposes. Under U.S. GAAP, branch profit remittances are translated at the rate in effect on the date when made; branch taxes are translated at the rate in effect on the date paid. ⁴ Before mandating the implementation of an entirely new system of accounting, the Treasury should give due consideration, and indeed deference, to methods already used by taxpayers which, in our view, render both realistic and fair results.

Temp. Reg. Sec. 1.985-3T(d)(5) would adopt a similarly flawed approach with respect to the translation of a corporation's balance sheet. Certain items (such as hyperinflationary cash, bad debt reserves, and paid-in capital) would be translated at an average exchange rate in effect during a specific time period. Again, such a translation method does not comport with U.S. GAAP reporting and would involve development of an entirely new set of rules for translating balance sheets.

Corporations generally translate balance sheets in accordance with U.S. GAAP and, in particular, FAS 52. With respect to operations in hyperinflationary countries, paragraphs 47 and 48 of FAS 52 provide that balance sheet items (except certain enumerated items) are to be translated at the current rate (which is defined as the rate in effect on the date of the balance sheet), not the average rate for a prior period.

Other deviations from U.S. GAAP contained in the temporary regulations are as follows:

o Temp. Reg. Sec. 1.985-3T(d)(5)(ii) would require that bad debt reserves be translated at the average daily exchange rate for the ENTIRE taxable year. U.S. GAAP translates bad debt reserves at the current rate.

o Temp. Reg. Sec. 1.985-3T(d)(5)(v) would require that cash on hand be translated at the average exchange rate for the period just ended, i.e, the average December exchange rate (for a calendar-year taxpayer). U.S. GAAP translates cash on hand at the current rate.

o Temp. Reg. Sec. 1.985-3T(d)(5)(viii)(B) would require that accounts payable be translated at the average exchange rate for the period just ended, i.e., the average December exchange rate (for a calendar-year taxpayer). U.S. GAAP translates accounts payable at the current rate.

Taken as a whole, the regulations in their current form would require a taxpayer to develop and maintain a radically new, additional set of accounts, thereby disrupting long-accepted accounting standards and creating massive compliance efforts. We submit that such an approach would undermine the underlying intent of the foreign currency provisions -- to harmonize taxation and financial reporting principles with respect to foreign currency translation and transactions. In the past, the Treasury has sanctioned the U.S. GAAP method of accounting as a reasonable method for translating a foreign corporation's earnings and profits and balance sheet. See Treas. Reg. Sec. 1.964-1 (requiring the preparation of a profit and loss statement "from the books of account regularly maintained by the corporation for the purpose of accounting to its shareholders"). The final regulations should similarly authorize the use of an approximate separate transaction method consistent with current financial reporting requirements.

4. TEMP. REG. SEC. 1.985-1T AND 1.985-3T: WEIGHTED AVERAGE EXCHANGE RATES

Temp. Reg. Sec. 1.985-1T sets forth the requirements for taxpayers using the separate transaction method of accounting. Under the examples provided in Temp. Reg. Sec. 1.985-1T(f), exchange gain or loss would be computed using a weighted average exchange rate. Although the temporary regulations fail to define the term "weighted average exchange rate," the temporary regulations issued with respect to the approximate separate transaction method do offer some guidance. Specifically, Temp. Reg. Secs. 1.985-3T(c)(5) and (6) would define the "average exchange rate" as the "average of the daily exchange rate" for each month within the QBU's taxable year.

The use of a daily exchange rate to compute exchange gain or loss would unnecessarily restrict taxpayers. The legislative history of the foreign currency rules provides that income or loss is to be translated at a "prescribed ('appropriate') exchange rate for the taxable year." 1986 Bluebook at 1109. At the time the foreign currency provisions were adopted, the "appropriate" exchange rate for translating balance sheets was prescribed by the regulations under section 964 of the Code. These regulations allowed taxpayers flexibility in determining the weighted average rate. See Treas. Reg. Sec. 1.964-1(d)(2). TEI submits that the final regulations under section 985 should accord taxpayers similar flexibility in computing a weighted average exchange rate by electing to use either the daily average exchange rate or the month-end rate, as long as the method is consistently applied. ⁵

5. TEMP. REG. SEC. 1.985-2T: U.S. DOLLAR ELECTION

Temp. Reg. Sec. 1.985-2T would provide that the election to use the dollar as the functional currency of a QBU under section 985(b)(3) of the Code is available only to a QBU whose functional currency is a hyperinflationary currency. See Temp. Reg. Sec. 1.985- 2T(b)(1). The term "hyperinflationary currency" would be defined as the currency of any country where there is a cumulative inflation of at least 100 percent for a specified 36-month period. Temp. Reg. Sec. 1.985-2T(b)(2).

TEI applauds the use of U.S. GAAP for purposes of determining which currencies are hyperinflationary. This rule would permit taxpayers to use information gathered for financial accounting purposes to determine which QBUs qualify for the dollar election, thereby minimizing additional reporting requirements. Subchapter J's goal of simplifying foreign currency translation would be furthered if the final regulations provided that a currency will be presumed to be hyperinflationary for purposes of section 985 if it is treated as hyperinflationary for U.S. GAAP purposes. Such a presumption would be similar to that contained in Temp. Reg. Sec. 1.985-1T(c)(5). ⁶

TEI objects, however, to the requirement in the temporary regulations that taxpayers making the dollar election with respect to an eligible QBU must use the dollar as the functional currency of all related QBUs. See Temp. Reg. Sec. 1.985-2T(d)(3). Such a broad conformity requirement not only seems unnecessary to curb any perceived abuses, but could also pose significant problems for taxpayers operating in many hyperinflationary economies. A QBU electing to use the dollar as its functional currency will ordinarily be one with substantial fixed assets in the foreign country in which it operates. In hyperinflationary economies, the use of the local currency in determining historical cost may substantially distort income measurement because of the rapid devaluation of the currency. In our view, there is no legitimate policy reason to require related QBUs operating in countries where they do not have substantial fixed assets to use the dollar as its functional currency. Moreover, the conformity requirement raises issues concerning what happens when a currency ceases to be hyperinflationary.

In this regard, TEI suggests that the regulations provide a procedure to be followed in the event a country's currency ceases to be hyperinflationary. As proposed, Temp. Reg. Sec. 1.985-2T does not address whether a QBU must retain the U.S. dollar as its functional currency if the economy in which the QBU operates is no longer hyperinflationary. The regulations are similarly silent on whether a QBU may elect the U.S. dollar as its functional currency in a year subsequent to the year in which the local currency becomes hyperinflationary. We suggest that, once an election to use the U.S. dollar has been made, that election remain in effect even after the local currency ceases to be hyperinflationary. Such a rule would obviate the need for the Treasury to develop, and for taxpayers to comply with, transition rules addressing the switch to a non-dollar functional currency. In addition, the regulations should provide that a taxpayer may elect the dollar as its functional currency in a year subsequent to the year in which the local currency becomes hyperinflationary.

TEI further recommends streamlining Temp. Reg. Sec. 1.985- 2T(c)(2)(iii) which provides that the controlling shareholder must file notices with all U.S. shareholders when an election is made to use the U.S. dollar as the functional currency. Final regulations should not require that notice be given to any shareholder that is a member of the electing shareholder's consolidated return group. Requiring notices to members of a consolidated return group would serve no practical purpose and would only increase the administrative burden on the taxpayer. ⁷

6. TEMP. REG. SEC. 1.985-2T: DUAL RECORDKEEPING

Some QBUs legitimately maintain dual sets of books and records - - one set in local currency following local statutory rules and the second one in U.S. dollars following U.S. GAAP. Such a QBU may conduct its affairs in a way that the local currency could appropriately be found to be the currency of "the economic environment" in which a significant part of its activities are conducted. In our April 26 submission, we urged that, even under circumstances NOT involving hyperinflationary economies, the taxpayer should be permitted to elect the dollar as the functional currency. The absence of such an election in the regulations is inconsistent with the general design and purpose of section 985.

Section 985(b)(3) provides that the taxpayer may elect to use the dollar as a QBU's functional currency if the unit keeps its books and records in dollars or the taxpayer uses a method of accounting approximating the separate transaction method. Although the legislative history does not specify how the maintenance of a dual set of books affects the application of section 985(b), Congress clearly contemplated that a taxpayer may keep dual records in certain circumstances. ⁸ Affording taxpayers such an election will minimize compliance burdens by eliminating the need to adjust local currency books for U.S. GAAP adjustments.

7. TEMP. REG. SEC. 1.989(A)-1T: BOOKS AND RECORDS

This section provides the general definitional terms relating to a QBU. Although the temporary regulations generally reflect legislative intent, the final regulations should clarify that no expansion of the IRS's authority to compel production of such books and records in the United States is intended.

TRANSITION RULES

8. TEMP. REG. SEC. 1.989(C)-1T: ADJUSTED BASIS OF ASSETS AND LIABILITIES

Section 989(c) of the Code authorizes the Treasury to promulgate procedures to be followed by taxpayers with QBUs that used the net worth method of accounting prior to the enactment of the 1986 Act. Pursuant to this authority, Temp. Reg. Sec. 1.989(c)-1T sets forth transition rules for QBUs whose functional currency is other than the dollar and that used the net worth method of accounting for years beginning before January 1, 1987.

Temp. Reg. Sec. 1.989(c)-1T(c)(1) would provide that the functional currency adjusted basis of a QBU asset acquired prior to January 1, 1987, is the functional currency basis of the asset at the date of acquisition, as adjusted according to U.S. GAAP and tax accounting principles. Temp. Reg. Sec. 1.989(c)-1T(d) would provide a similar rule for liabilities: the amount of a QBU's liabilities incurred before 1987 is the functional currency amount of the liability on the date incurred, as adjusted in accordance with U.S. GAAP and tax accounting principles.

TEI submits that the final regulations should allow taxpayers wherever possible to use existing accounting information, rather than requiring the development of new accounting data. More important, assets and liabilities acquired prior to 1987 should be subject to the rules that existed under prior law. Thus, the regulations should be revised to allow the functional currency basis of current assets and liabilities to be the U.S. dollar equivalent using the exchange rate in effect on the last day of the taxpayer's last taxable year beginning in 1986.

9. TEMP. REG. SEC. 1.989(C)-1T(F): AGGREGATION

The preamble to the temporary regulations with respect to the calculation of remittances from branches states:

The Service is especially interested in receiving comments concerning methods for calculating remittances from foreign branches under section 987 that would permit the calculation of currency gain or loss with respect to remittances on an aggregate basis.

1988-28 I.R.B. at 19.

TEI believes that the calculation of currency gain or loss on an aggregate basis is appropriate. Aggregation would be analogous to the required pooling of earnings and profits for determining deemed paid tax credits under section 902 upon receipt of dividends from a controlled foreign corporation. Such an approach might be illustrated by expanding the example in Temp. Reg. Sec. 1.989(c)-1T(f) to read, as follows:

Under Section 987, B has earnings of 8,000 FC in 1987 worth $1,000. B also has earnings of 9,000 FC in 1988 worth $1,000. In 1988 B remits 10,000 FC to its home office in the United States. On the date of remittance, 10,000 FC equals $1,000. The exchange loss recognized would be:

          1987      8,000 FC       $ 1,000

The preamble to the temporary regulations with respect to the transfer of branch equity states:

The Service is also interested in receiving comments as to whether branch equity should be deemed remitted on a transfer of branch assets and liabilities in a transaction in which gain or loss would not otherwise be recognized.

1988-28 I.R.B. 19.

TEI believes that, in such circumstances, branch equity should NOT be deemed to be remitted. Branch assets and liabilities are typically transferred in a tax-free reorganization when the foreign branch is incorporated as a corporation in a foreign country. Assuming that the reorganization meets the active trade or business requirements under section 367 of the Code, such a reorganization will ordinarily be tax free. The purpose of the regulations under section 367 in allowing certain tax-free reorganizations is to preserve the basis in an ongoing business situation. Recognition of future gain or loss is preserved by requiring the new entity to use a carryover basis. We submit that such a reorganization should continue to be wholly tax-free. Branch equity should thus not be deemed to be remitted on a transfer that would otherwise be free from tax.

CONCLUSION

Tax Executives Institute appreciates this opportunity to present our views on the proposed and temporary regulations relating to the foreign currency provisions. If you should have any questions, please do not hesitate to call Bernard J. Jerlstrom, Chair of TEI's International Tax Committee, or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey).

Respectfully submitted,

² For example, Temp. Reg. Sec. 1.985-3T(c)(7)(ii) would require that third-country currency transactions be reflected on a separate transaction method. Separate transactions of foreign affiliates, however, are not normally reported to the domestic parent for accounting (or any other) purposes. As a consequence, a domestic tax department has no current means of determining the exchange rate for each transaction completed by a foreign operation. Under the temporary regulations, corporations would be required to establish a new reporting system.

³ The FAS 52 principle was adopted by the Treasury, without substantial change, in its draft proposal for taxation of foreign currency gains and losses. See U.S. Treasury Department, Discussion Draft on Taxing Gains and Losses, 45 Fed. Reg. 81711 (Sec. 11, 1980). The Treasury's recommendation was later incorporated into the Administration's tax reform proposals. See U.S. Treasury Department, The President's Tax Proposals to the Congress for Fairness, Growth and Simplicity 415 (May 1985).

⁴ This approach is consistent with the treatment of such items in computing the taxable income of a QBU that has a functional currency other than the U.S. dollar. Exchange gain or loss is determined by translating the currency at the rate in effect on the date of the remittance; to compute the amount of the foreign tax paid, exchange gain or loss is determined by translating the currency at the exchange rate in effect on the date of payment. I.R.C. Sec. 986(b), 987(4), and 989(b). See also 1986 Bluebook at 1109-10.

⁵ Recently, the IRS issued Notice 88-102, which provides additional guidance with respect to the computation of a weighted average exchange rate. Under that Notice, the "weighted average exchange rate" is defined as the simple average of the daily exchange rates for the taxable year. Unfortunately, the rules contained in Notice 88-102 are premised on several incorrect assumptions. First, the Notice mistakenly assumes that items of income and expense are accrued ratably over the taxable year; in fact, the earnings of many companies are realized seasonally. Requiring the use of an average daily rate throughout the year could materially distort the financial results of such companies. Moreover, the Notice ignores the tremendous administrative burdens such a computation would require. Notice 88-102 could be read to require taxpayers to wait until after the end of their taxable years in order to book transactions. In addition, the Notice incorrectly assumes that exchange rates are available for each day of the taxable year. In reality, almost all exchanges are closed on Sundays and holidays; daily quotes are simply not available.

TEI strongly recommends that the IRS and Treasury to (sic) reconsider its position and allow taxpayers more flexibility in computing a weighted average.

⁶ Temp. Reg. Sec. 1.985-1T(c)(5) would generally provide that if a QBU has its residence outside the United States (as determined under section 988(a)(3)(B)), the QBU's functional currency for purposes of U.S. GAAP will ordinarily be accepted as the QBU's functional currency for income tax purposes.

⁷ Temp. Reg. Sec. 1.985-2T(c) would require a branch of a U.S. person to elect to use the U.S. dollar as its functional currency for the first taxable year beginning in 1987 by filing an amended return within 180 days of the date the temporary regulations were published in the Federal Register (i.e., by November 30, 1988). A CFC, however, would be required to make its U.S. dollar election within 270 days of the close of its 1987 taxable year (or by September 26, 1988, for calendar-year taxpayers). Given the importance of the U.S. dollar election and the requirement for conformity among hyperinflationary QBUs, TEI submits that CFCs and branches should both be allowed an extended period of time in which to make the U.S. dollar election.

⁸ For example, a QBU operating in a hyperinflationary economy and keeping its books and records in the local currency would be required to maintain a second set of books in dollars in order to elect to use the dollar as its functional currency under section 985(b)(3)(A).