Increased compliance burden under new sec. 987 prop. regs.

• Author: Keil, Trinity

In September 2006, the IRS issued new proposed regulations (REG-208270-86, 9/7/06) (2006 Prop. Regs.) that provide guidance under Sec. 987 in determining foreign currency gains and losses of qualified business units (QBUs) operating in a functional currency other than their owner's. The 2006 Prop. Regs. are a drastic change from the 1991 proposed regulations (1991 Prop. Regs.) and, if finalized as currently written, would impose significant recordkeeping and tax compliance burdens.

Compliance Requirements

In general, the 2006 Prop. Regs. are proposed to apply starting with the first tax year beginning one year after the first day of the tax year following the date the rules are adopted as final. It is not anticipated that the new rules would be applicable before calendar-year 2009; however, taxpayers would be able to elect to apply the 2006 Prop. Regs. to tax years beginning after the date the rules are adopted as final regulations; see the preamble to REG208270-86.

On finalization of the 2006 Prop. Regs., taxpayers would be required to adopt the new regulations as prescribed under transition rules in Prop. Regs. Sec. 1.987-10. In the meantime, taxpayers that currently account for Sec. 987 gains or losses under the 199i Prop. Regs. or another reasonable method may continue to do so until the 2006 Prop. Regs. are finalized.

1991 Prop. Regs.

The 1991 Prop. Regs. (now withdrawn) used the profit and loss (P&L) method to determine branch income. The QBU's P&L is maintained in its functional currency and adjusted to conform to GAAR The adjusted P&L is then translated into the taxpayer's functional currency using the average exchange rate for the year; see 1991 Prop. Kegs. Sec. 1.987-1(b).

Under 1991 Prop. Regs. Sec. 1.987-2(c), the taxpayer has to maintain an "equity pool" and a" basis pool" for the QBU. The equity pool is maintained in the QBU's functional currency and is adjusted for the QBU's P&L, as well as for transfers to and from the QBU. The basis pool is adjusted by the QBU's P&L translated into the taxpayer's functional currency at the annual average rate; transfers to and from the QBU are translated into the taxpayer's functional currency at the spot rate on the transfer date.

A Sec. 987 gain or loss must be recognized when there is a net "remittance" of cash or property from the QBU to the taxpayer. A remittance occurs when there is an excess of the amounts transferred from the QBU to the taxpayer over the amounts transferred from the...