TEI submits comments on section 987 regulations.

• Position: TECHNICAL SUBMISSIONS

On March 7, Tax Executives Institute filed comments with the IRS regarding final, proposed, and temporary regulations addressing the recognition foreign currency gain or qualified business units under section 987. TEI's comments were prepared under the aegis of the Institute's U.S. International Tax Committee. Benjamin R. Shreck, TEI Tax Counsel, coordinated the preparation of the Institute's comments.

Background

On December 8, 2016, the U.S. Department of the Treasury ("Treasury") and the Internal Revenue Service ("IRS" or the "Service") published final regulations under section 987 (the "Final Regulations") (1) related to income and currency gain or loss with respect to a section 987 qualified business unit ("QBU"). (2) The Treasury and the 1RS also published temporary regulations (the "Temporary Regulations") (3) under section 987 contemporaneously with the Final Regulations. The text of the Temporary Regulations serves as the text of proposed regulations also issued under section 987 on December 8, 2016. (4)

Treasury and 1RS requested comments on these regulations by March 8, 2017. On behalf of Tax Executives Institute, Inc. ("TEI"), I am pleased to respond to the government's request for comments.

Tax Executives Institute

TEI is the preeminent association of in-house tax professionals, worldwide. Our more than 7,000 members represent 2,800 of the leading companies in North and South America, Europe, and Asia. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing 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 in a cost-efficient manner.

TEI's members 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, including complying with complex regulations regarding foreign business activities and currency transactions, such as those under section 987. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the issues raised by the Final and Temporary Regulations.

TEI Comments

1. Technical Comments

   2. Overview

      The Final and Temporary Regulations have three main components: (i) temporary regulations establishing loss deferral rules for transactions entered into after January 6, 2017, subject to an anti-abuse rule for tax avoidance transactions occurring after December 6, 2016; (ii) final and temporary regulations providing certain elections, which for calendar year taxpayers may apply, by election, as of January 1, 2017 (i.e., taxable years beginning after December 8, 2016); and (iii) final regulations governing the recognition of income and the establishment of built-in gain and loss accounts, which for calendar-year taxpayers apply as of January 1, 2018. The Final Regulations also set forth transition rules dictating a "fresh-start" method (the "Fresh Start Method") as of the date of adoption.

      The Final Regulations create several issues for taxpayers as they adopt the new approach for computing currency gains or losses of section 987 QBUs. Many of these issues require taxpayers to change their tax and accounting systems and processes, as well as dedicate significant amounts of time, resources, and funds to comply with the regulations. The timeline for making changes to a taxpayer's underlying accounting systems may range from 12 months to several years. Indeed, because any changes would be made "solely" for tax compliance purposes--as there are no similar changes required for U.S. GAAP or IFRS--companies may not expend the necessary resources to fully modify their ERP systems. Thus, many taxpayers may track the section 987 calculations required by the new regulations manually, substantially increasing the chances of compliance errors. Even for those taxpayers who choose to modify their systems to comply with the new regulations, the technology system changes may take years, forcing taxpayers to hire additional, temporary resources to be in compliance as of the January 1, 2018, effective date.

      Finally, many issues raised by the Final Regulations were not present under the section 987 regulations proposed in 1991 (the "1991 Proposed Regulations"). (5) Many taxpayers have followed the 1991 Proposed Regulations for computing gains and losses under section 987 in lieu of the regulations proposed under section 987 in 2006 (the "2006 Proposed Regulations"). (6) Thus, many taxpayers are faced with changing the approach to complying with section 987 that they followed for a quarter century--and 30 years after the passage of the Tax Reform Act of 1986 (TRA of 1986), (7) which enacted section 987. We discuss these issues further below,

   3. Change in the approach for computing taxable income

      Taxpayers historically computed the taxable income of a non-functional currency section 987 QBU by taking the QBU's functional currency trial balance and making appropriate tax adjustments to conform the balance to U.S. federal income tax principles in the QBU's functional currency. After computing taxable income in the QBU's functional currency, taxpayers then translated the income to the tax owner's functional currency using the average exchange rate for the year. Under this approach, all assets and liabilities maintained their functional currency basis and each item was converted using the same exchange rate.

      The Final Regulations dramatically shift how taxable income is computed for non-functional currency QBUs. The Final Regulations require taxpayers to analyze each individual asset and liability to determine whether it is an "historic" or "marked" item. (8) Historic items are converted to the tax owner's functional currency based on the average exchange rate in the year the item came into existence, which may be difficult to determine.

      Moreover, the Final Regulations may require a tax adjustment to be computed as a marked item in one section 987 QBU and an historic item in another section 987 QBU. Each item is aged at the account level in each QBU. For example, suppose QBU A has a prepaid item that when aged on a first-in first-out basis is determined to originate within 2016. QBU B has a prepaid item that has a balance that is comprised of items from 2016, 2015 and 2014. When computing QBU B's taxable income, the taxpayer would need to compute part of the adjustment at the 2014, 2015 and 2016 yearly-average historic exchange rates. Therefore, when preparing tax adjustment workbooks, the system must accept multiple exchange rates (current year and prior year) for the same adjustment, significantly complicating the process. Key factors in the determination of a marked versus historic item are the life of the item and its currency denomination, which leads to differing approaches for similar items. For example, long-term deferred revenue and prepaid accounts are historic, whereas the same items which are short-term are marked. Amounts in the QBU's functional currency are marked but those in a non-functional currency are historic.

      This key difference--between the 1991 Proposed Regulations' approach to section 987 QBUs that required a single exchange rate and the approach of the Final Regulations that may require multiple exchange rates--will force taxpayers to modify nearly all of their tax return work papers to accommodate adjustments at different exchange rates. These changes will require taxpayers to spend considerable amounts of time and resources complying with the regulations,

   4. New Tax Adjustments

      The Final Regulations may also require tax adjustments that did not arise under the 1991 Proposed Regulations. For example, assume that B is a Country X disregarded entity with the FC as its functional currency and is wholly owned by U.S. corporation P. B has an intangible asset it is amortizing for both book and tax purposes over the same period under the 1991 Proposed Regulations. When computing taxable income under the 1991 Proposed Regulations, no book to tax adjustments were required. Under the Final Regulations, however, this asset would be an historic item requiring computation of its tax amortization at an historic exchange rate. This change in methodology creates a new booktax difference that did not exist under the historic approach taken under the 1991 Proposed Regulations. As above, taxpayers will be required to change their work papers, systems, and processes to comply with the approach in the Final Regulations, resulting in additional significant compliance costs,

   5. Section 988 Transactions of QBUs

      Most taxpayers' accounting systems automatically compute realized and unrealized exchange gains and losses in a manner that is largely consistent with U.S. federal income tax principles. Under the 1991 Proposed Regulations, when a section 987 QBU had a regarded section 988 transaction, the currency gain or loss was computed based on the fluctuation between the QBU's currency and the non-functional currency. Under the Final Regulations, if a section 987 QBU has a transaction in the functional currency of its tax owner then there should be no foreign currency gain or loss because the gain or loss is treated as an item of its tax owner. With this new approach, taxpayers will need to either update their existing accounting systems or devise manual workarounds. Even more challenging, under the Final Regulations when a section 987 QBU has a transaction in non-functional currency other than the currency of its tax owner, the currency gain or loss is valued by computing the exchange rate movement between the tax owner's functional currency and the non-functional...