    LB&I Concept Unit     Unit NameOverview of IRC 987 and Branch Operations in a Foreign Currency     Primary UIL Code9470.01-00Branch operations in a foreign currency – IRC 987       Library LevelTitle  Knowledge BaseInternational  ShelfCross-Over  BookForeign Currency  ChapterBranch Operations in a Foreign Currency – IRC 987     Document Control Number (DCN)INT-C-239  Date of Last Update07/06/21        Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain a comprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law.  Table of Contents       (View this PowerPoint in “Presentation View” to click on the links below) General Overview Relevant Key Factors Diagram of Concept Facts of Concept Detailed Explanation of the Concept Examples of the Concept Index of Referenced Resources Training and Additional Resources Glossary of Terms and Acronyms Index of Related Practice Units       2  General Overview          Overview of IRC 987 and Branch Operations in a Foreign Currency In a global economy, many U.S. Corporations (“USC”) are doing business through foreign branches, divisions or disregarded entities that operate in currencies other than the U.S. dollar. The U.S. federal income tax system for U.S. owned Multinational Enterprises (“US MNE”) is based on worldwide income in U.S. dollars, so it is necessary to translate amounts that are measured or denominated in different currencies into U.S. dollars. A US MNE that conducts business in a foreign currency will realize currency gains and losses on certain transactions resulting from the fluctuations in value of the foreign currency compared to the US Dollar (“USD”). The US MNE will recognize transactional foreign currency gains and losses under IRC 988. Rather than directly participate in the foreign currency transactions, the US MNE can establish a separate branch, division or disregarded entity, whose activities rise to the level of a trade or business and for which it maintains separate books and records. This is referred to as a Qualified Business Unit (“QBU”) under IRC 989. The QBU has its own functional currency, and the US MNE can enter into foreign currency transactions through the QBU. This will allow US MNE to not recognize IRC 988 gain or loss since the transactions will now be in the functional currency of the QBU and no longer be IRC 988 transactions. Instead, if the functional currency of the QBU is different from the owner of such QBU, the QBU will generally be subject to IRC 987. Under IRC 987, income or loss of the QBU is generally computed separately in the QBU's functional currency and is translated into the owner’s functional currency at the appropriate exchange rate. If the QBU transfers money or other property back to its owner or another QBU of the owner, then those transfers could constitute a “remittance.” A remittance by the QBU may require that the owner recognize foreign currency gain or loss under IRC 987. A remittance may also occur as the result of a 987 QBU terminating. A termination may occur if, for example, the 987 QBU ceases its trade or business activity, or if substantially all the assets of the QBU are transferred (to the owner) or sold. A Controlled Foreign Corporation (CFC) with a branch that has a functional currency different from the CFC will also be subject to IRC 987.    Back to Table of Contents3  General Overview (cont’d)          Overview of IRC 987 and Branch Operations in a Foreign Currency IRC 987 generally provides: How a QBU should determine its annual taxable income and earnings and profits (E&P) and how to translate such income or E&P into the owner/taxpayer’s functional currency, AND How to compute foreign currency gain or loss on a remittance IRC 987 also provides the rules for determining the character (e.g., ordinary versus capital) and the source (e.g., U.S. or foreign) for any gain or loss under IRC 987. The character is generally ordinary. The source of the IRC 987 gains and losses under the IRC is determined by reference to the source of the income giving rise to remitted earnings (but see sourcing rules under IRC 987 Proposed Regulations where applicable). Presently there are several methodologies used by taxpayers to comply with the requirements under IRC 987. Some of the most common methods are: the methodology set forth in the 1991 Proposed Regulations; the “earnings only” variation on the 1991 Proposed Regulations; the methodology set forth in the 2006 Proposed Regulations; and the methodology set forth in the 2016 Final Regulations.                 Back to Table of Contents4  Relevant Key Factors            Overview of IRC 987 and Branch Operations in a Foreign Currency Key Factors The key factors when examining taxpayers having a QBU subject to IRC 987 are the following: 1. May apply to a division, branch, disregarded entity that is a QBU (Can also be a partnership or trust depending upon which methodology the taxpayer is using); 2. QBU (see Practice Unit “Overview of Qualified Business Units QBUs”): Separate books and records maintained, Trade or business activity; 3. Functional Currency (see Practice Units “Functional Currency Determination” and “Functional Currency of a QBU”): Typically, the currency of the economic environment in which a significant part of the QBU’s activities are conducted; 4. QBU subject to IRC 987: QBU with a functional currency different from its owner/taxpayer; 5. IRC 987 Methodologies commonly used by taxpayers: 1991 Proposed Regulations, “Earnings only” 2006 Proposed Regulations, and 2016 Final Regulations; 6. Taxable income or E&P of QBU subject to IRC 987: First determined in the functional currency of the QBU, Translated to the owner/taxpayer’s functional currency at the appropriate exchange rate; 7. IRC 987 gain/loss: Remittance triggers recognition.         Back to Table of Contents5  Diagram of Concept            Overview of IRC 987 and Branch Operations in a Foreign Currency Diagram of Concept Potential forms of US-owned Foreign QBUs subject to IRC 987 include:                                        Back to Table of Contents6  Diagram of Concept (cont’d)           Overview of IRC 987 and Branch Operations in a Foreign Currency Diagram of Concept Potential forms of CFC-Owned QBUs subject to IRC 987 include:                                       Back to Table of Contents7  Facts of Concept            Overview of IRC 987 and Branch Operations in a Foreign Currency Facts of Concept Under the 1991 Proposed Regulations, income or loss is computed annually in the QBU's functional currency. The QBU’s income is generally translated into the owner’s functional currency at an average exchange rate for the year. Gains and losses from exchange rate fluctuation between the QBU's functional currency and the owner’s functional currency on all the QBU’s capital and earnings are not recognized as they accrue. Instead, exchange gain or loss under IRC 987 is recognized when the QBU makes or is deemed to make a transfer that qualifies as a remittance to the owner. Under the 2006 Proposed Regulations and the 2016 Final Regulations, the translation of income and expenses of the 987 QBU into the owner’s functional currency occurs on an item-by-item basis using either the average annual exchange rate or the historical exchange rate depending upon the nature of the income or expense item being translated. For purposes of determining IRC 987 currency gain or loss, the balance sheet of the 987 QBU is translated back into the owner’s functional currency using the year end spot rate for financial assets and liabilities (i.e., accounts receivable and payable, etc.) and the historical rate for non-financial assets (i.e., land, building, equipment, etc.). The yearly change for financial assets and liabilities (after adjustments) is included in the Foreign Exchange Exposure Pool (“FEEP”). IRC 987 gain or loss is recognized upon a remittance or termination of the QBU, but such gain or loss relates to currency changes on only the financial (or IRC 988 type) assets and liabilities. The 2019 Final Regulations finalized portions of the 2016 Temporary Regulations most notably pertaining to Deferral Rules of certain IRC 987 gains and losses (applicable to all methodologies). The next slides provide general information concerning IRC 987 and Branch Operations regardless of methodology utilized.            Back to Table of Contents8  Detailed Explanation of the Concept          Overview of IRC 987 and Branch Operations in a Foreign Currency Important terms and concepts.       AnalysisResources        Generally, IRC 987 applies to operations being conducted by a foreign branch. The foreign Prop. Treas. Reg. 1.987-1 through  branch, division or disregarded entity must have a functional currency that is different from its1.987-3 (1991 Proposed Regulations)  owner. A partnership can also be subject to IRC 987 depending upon which methodology the Prop. Treas. Reg. 1.987-1 through  taxpayer is using.1.987-10 (2006 Proposed  IRC 987 utilizes the terms and concepts shown below and on the next two slides.Regulations)    Final Treas. Reg. 1.987-1 through           1.987-12 (2016 Final Regulations)        QBU  IRC 989(a)  For a division, branch or disregarded entity to constitute a QBU, separate books and records Treas. Regs. 1.989(a)-1  need to be maintained and there needs to be a trade or business activity conducted by the   QBU.         Functional Currency  IRC 985  The currency of the economic environment in which a significant part of the QBU’s activities is Treas. Reg. 1.985-1(c)(1)  conducted if the QBU keeps its books and records in that currency.                Back to Table of Contents9  Detailed Explanation of the Concept (cont’d)           Overview of IRC 987 and Branch Operations in a Foreign Currency  AnalysisResources    QBU Subject to IRC 987 IRC 987 For IRC 987 to apply to a QBU, the QBU must have a different functional currency from its Prop. Treas. Reg. 1.987-1(a) (1991) owner. Prop. Treas. Reg. 1.987-1(b)(2)  (2006)   Final Treas. Reg. 1.987-1(b)(2)  (2016)    Taxable Income of QBU Subject to IRC 987 IRC 987(1) Under IRC 987, a QBU must first determine its taxable income or E&P in its functional IRC 987(2) currency. The taxable income or E&P is then translated into and included in the owner’s Prop. Treas. Reg. 1.987-1(b) (1991) income at the appropriate exchange rate for the year. Prop. Treas. Reg. 1.987-3 (2006)   Final Treas. Reg. 1.987-3 (2016)   IRC 989(b)(4)    IRC 987 Exchange Gain/Loss IRC 987(3)(A) and (B) Remittances from a QBU to its owner, or a termination of the QBU are required to trigger Prop. Treas. Reg. 1.987-2 (1991) recognition of any IRC 987 gain or loss. Prop. Treas. Reg. 1.987-4 and 5  (2006)   Final Treas. Reg. 1.987-4 and -5  (2016)         Back to Table of Contents10  Detailed Explanation of the Concept (cont’d)2         Overview of IRC 987 and Branch Operations in a Foreign Currency    AnalysisResources         Remittance Prop. Treas. Reg. 1.987-2(b)(4)      (1991)  The net transfer of any money or property from the QBU to its owner or to another QBU of the     Prop. Treas. Reg. 1.987-5(c) through  owner (or the contribution of a liability to a QBU), which exceeds the transfers of money or   other property from the owner to the QBU. When a remittances occurs depends upon the(e) (2006)  methodology the taxpayer is following to account for its IRC 987 transactions. Final Treas. Reg. 1.987-5(c) through   1991 Proposed Regulations – daily netting(e) (2016)   2006 Proposed Regulations / 2016 Final Regulations – annual netting          Deferral of Certain IRC 987 Exchange Gains and Losses Treas. Reg. 1.987-12 (2019)        The Deferral Rules were first promulgated as temporary regulations and then finalized under   Treas. Reg. 1.987-12 in 2019. The Explanation of Provisions states that these rules were   established to defer IRC 987 losses when there was a continuity of ownership of the QBU   within a single controlled group. This deferral was also applied to similar IRC 987 gains   UNLESS the assets of the IRC 987 QBU was transferred by a U.S. person to a related   foreign person. This regulation applies to all taxpayers regardless of 987 methodology utilized   and pertains to two types of specified events:    Deferral Events; and    Outbound Loss Events.                  Back to Table of Contents11  Examples of the Concept            Overview of IRC 987 and Branch Operations in a Foreign Currency Example Example: If a disregarded entity that is a QBU with the LC as its functional currency (“987 QBU”) is owned directly by a US taxpayer: (1) the income/loss of the 987 QBU for the tax year is first determined in the QBU’s functional currency and then (1a) translated at the appropriate exchange rate for the year and included in the taxable income of US taxpayer.                                  Back to Table of Contents12  Examples of the Concept (cont’d)            Overview of IRC 987 and Branch Operations in a Foreign Currency Example (cont’d) Example (cont’d) (2) When a remittance is made from the 987 QBU to the US taxpayer, (2a) IRC 987 gain or loss will generally be determined. The amount of gain or loss depends on the IRC 987 methodology used by the US taxpayer. Consider whether the deferral rules in Treas. Reg. 1.987-12 apply to such remittance.                                  Back to Table of Contents13  Index of Referenced Resources                 Overview of IRC 987 and Branch Operations in a Foreign Currency IRC 985 IRC 987 IRC 988 IRC 989(a) IRC 989(b)(4) Treas. Regs. 1.989(a)-1 Prop. Treas. Reg. 1.987-1 through 1.987-3 (1991 Proposed Regulations) Prop. Treas. Reg. 1.987-1 through 1.987-10 (2006 Proposed Regulations) Final Treas. Reg. 1.987-1 through 1.987-12 (2016 / 2019 Final Regulations)                      Back to Table of Contents14  Training and Additional Resources        Overview of IRC 987 and Branch Operations in a Foreign Currency  Type of ResourceDescription(s) Reference Materials BNA Tax Management Int’l Portfolio 921-2nd   Bittker and Lokken - Fundamentals of International Taxation Para 74.2   Keyes - Federal Taxation of Financial Instruments and Transactions, Chapter 15   Mertens - Law of Federal Income Taxation, Chapter 45C    Other Training Materials IE Phase III: IRC 985 and 989: Foreign Currency Terms and Definitions   IE Phase III: Section 986 Translation Rules   IE Phase III: Sec 987 - Branch Rules and CTB Rules   IE Phase III: Foreign Currency Section 988 Transactions   IE Phase III: Foreign Currency Hedging   IE Phase III: Financial Products Basics - Four Major Categories   IE Phase I: Module E - Lesson 1 Foreign Currency   IE Phase III, Module D - Interaction of International and Financial Products Issues   FP Phase 1: Lesson 9 - Foreign Currency   FP Phase III: Lesson 4 - Foreign Currency                    Back to Table of Contents15  Glossary of Terms and Acronyms    Term/AcronymDefinitionCFCControlled Foreign Corporation  E&PEarnings and Profits  FBRForeign Branch  FEEPForeign Exchange Exposure Pool  FXForeign Currency Exchange  LCLocal Currency  MNEMulti-National Enterprise  QBUQualified Business Unit  USUnited States  USCU.S. Corporation  USDUS Dollar                 Back to Table of Contents16  Index of Related Practice Units    Associated UIL(s)Related Practice Unit9470Change in Functional Currency Section 985 Procedural Matters and Calculation  9470Character of Exchange Gain or Loss  9470Definition of Appropriate Exchange Rate Overview  9470Disposition of a Portion of an Integrated Hedge  9470Exchange Gains or Losses on Payables and Receivables  9470Functional Currency Determination  9470How to Assess Penalties for Failure to File a Form 8886 Disclosing IRC 988 Losses  9470Official vs Free Market Exchange Rate  9470Overview of IRC Section 988 Nonfunctional Currency Transactions  9470Overview of Qualified Business Units QBUs  9470Sourcing of Exchange Gains or Losses in Currency Transactions  9470Functional Currency of a QBU  9470Disposition of Nonfunctional Currency  9470Overview of IRC 986(c) Gain or Loss Prior to Tax Cuts and Jobs Act of 2017  9470Computation and Review of IRC 986(c) Gain or Loss – Pre-TCJA        Back to Table of Contents17

<p>IRS Issues Practice Unit on Branch Currency Transactions</p>

IRS Issues Practice Unit on Branch Currency Transactions

Internal Revenue Service

The IRS has issued a practice unit that provides an overview of section 987 and branch operations in a foreign currency, identifying key factors for purposes of examining taxpayers with a qualified business unit subject to section 987.

<p>The IRS has issued a practice unit that provides an overview of section 987 and branch operations in a foreign currency, identifying key factors for purposes of examining taxpayers with a qualified business unit subject to section 987.</p>