In December of 2016, the Treasury issued final and temporary functional currency regulations that apply to certain types of so-called “qualified business units”. A qualified business unit or “QBU” includes a corporation. In addition, activities of a corporation or an individual qualify as a QBU if the activities constitute a trade or business and a separate set of books and records are maintained with respect to the activities. For example, if a U.S. corporation operates a branch in France that conducted a trade or business in France, with respect to which it maintains separate books and records, the branch in France would be a QBU. If the French branch uses the Euro as its functional currency and the U.S. corporation uses the Dollar as its functional currency, the French branch would be a “Section 987 QBU”.
These regulations generally apply to a “Section 987 QBU” of an individual or a corporation. A “Section 987 QBU” is a qualified business unit that does not use the Dollar Approximate Separate Transaction method rules and has a functional currency different from that of its owner.
To determine the taxable income of the U.S. owner, each item of income, gain, deduction or loss of the QBU is determined in the functional currency of the Section 987 QBU and translated into the functional currency of the owner at the appropriate exchange rate. Under the new regulations absent an election to the contrary, the appropriate exchange rate is the yearly average exchange rate. The basis of property and depreciation deductions are translated at the historic exchange rate, which is the average rate for the year the asset was acquired.
Section 987 currency gain or loss is taken into account by the owner of a Section 987 QBU when the QBU makes a remittance of cash or property to the owner or the QBU terminates. For example, if a U.S. corporation with a branch in France decides to terminate the branch, then all the Section 987 currency gain or loss must be taken into account by the owner. If the French branch distributes to the U.S. owner cash equal to say one-third of its assets, one-third of the Section 987 gain or loss must be taken into account.
Section 987 gain or loss is treated as ordinary gain or loss and is sourced with reference to the assets in the QBU.
Under the new regulations, transactions that are not otherwise taxable events, such as the transfer of money from a branch to the owner of the branch, can trigger Section 987 gains or losses due to the fluctuation of the currency used by the QBU.