TEI's comments on proposed regulations relating to section 987 qualified business units: on February 1, 2007, Tax Executives Institute submitted comments to The Internal Revenue Service on the proposed regulations relating to the Income and Currency Gain or Loss with respect to Section 987 Qualified Business Units Reg. 208270-86

Tax Executive, The, March-April, 2007

On September 6, 2006, the U.S. Department of Treasury and the Internal Revenue Service issued revised proposed regulations that provide guidance under section 987 of the Internal Revenue Code regarding the determination of the items of income or loss of a taxpayer with respect to a section 987 qualified business unit (QBU), as well as the timing, amount, character, and source of any section 987 gain or loss (the "2006 proposed regulations" or the "revised regulations"). The revised regulations were published in the September 7, 2006, issue of the FEDERAL REGISTER (71 Fed. Reg. 52875) and in the October 16, 2006, issue of the INTERNAL REVENUE BULLETIN (2006-42 I.R.B. 698).

The notice withdraws proposed regulations under section 987 that were published in the FEDERAL REGISTER on September 25, 1991 (the "1991 proposed regulations"), and significantly revises those regulations.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our nearly 7,000 members represent 3,000 of the leading corporations in the United States, Canada, 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.

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 the diversity and professional training of our members enable us to bring a balanced and practical perspective to the 2006 proposed regulations.

Executive Summary

TEI recommends that the 2006 proposed regulations reflect that virtually all assets used in the ordinary course of business--other than securities and investment in affiliates and associated acquisition debt--generate economic gains and losses. The calculation of net income or loss from the section 987 QBU should more closely follow sections 987(1) and (2), as well as the 1991 proposed regulations. An average exchange rate or a year-end spot rate to translate the assets and liabilities of the section 987 QBU at year end should be adopted. In the event this recommendation is not adopted, then TEI recommends the following modifications to simplify compliance:

* Reduce the scope of items classified as section 987 historic items; and

* Permit an election to use broader reasonable conventions for the spot rate under Prop. Reg. [section] 1.987-1(c)(1)(ii).

In addition, TEI recommends the following changes to the 2006 proposed regulations:

* Permit taxpayers to apply the regulations retroactively to all open years;

* Adopt a true fresh start for translating the opening balance sheet upon adoption of the fresh start method;

* Clarify the method for electing the transition method and confirm that no section 481 adjustments are required;

* Permit deferral of exchange gains to a broader group of intra-consolidated group transactions involving sections 351 and 332 transfers of section 987 QBUs;

* Clarify that an ordinary course of business transaction with its owner does not result in a transfer to or from a section 987 QBU for purposes of section 987(3) and calculations of exchange gains and losses under Prop. Reg. [section] 1.987-4; and

* Modify the calculation of exchange gains and losses under Prop. Reg. [section] 1.987-4 to incorporate nontaxable or certain timing items that otherwise affect the net worth of the section 987 QBU.

Exclusion of Non-Economic Gains or Losses

Enacted as part of the Tax Reform Act of 1986, (1) section 987 of the Code generally provides that a taxpayer having a qualified business unit (QBU) with a functional currency other than that of the taxpayer must determine its taxable income by computing the QBU's taxable income or loss separately and translating such income or loss at the appropriate exchange rate.

The 1991 proposed regulations represented the first attempt to clarify the application of Code section 987. (2) Those regulations, however, presented many administrative and conceptual challenges. TEI commends the Treasury Department and IRS for seeking taxpayer input as a prelude to substantially redesigning them. We also commend the government for providing a flexible effective date for the revised regulations, which recognizes the significant additional burden the 2006 proposed regulations will place upon taxpayers.

Despite their improvement, the revised regulations will require substantial expenditures of resources because of their departure from the use of a QBU's functional currency as the basis for calculating taxable income, as described in section 987(1). This departure will require taxpayers to maintain a separate set of books and records solely to comply with the revised regulations, which are different from U.S. Generally Accepted Accounting (GAAP) financial statements, as well as local statutory books. Under the 1991 proposed regulations, taxpayers could rely on U.S. GAAP financial statements as the starting point for the calculation of a QBU's taxable income. While it may be necessary to reduce the potential for abuse related to recognition of non-economic foreign currency losses, we suggest that the 1991 regulations' method of calculating net income or loss did not contribute to the potential abuse; rather, it was the types of assets and liabilities included in the equity pool calculation. (3) We submit that currency gains and losses from all assets and liabilities employed by a section 987 QBU in its normal course of business (e.g., cash, receivables, inventory, prepaids, property plant and equipment, and most intangibles) are economic gains and losses. Instead of imposing a significant conceptual change, the regulations could achieve similar results simply by excluding from the pools those assets and liabilities that truly generate non-economic currency gains or losses, such as investments in affiliates. Additionally, the 2006 proposed regulations should be modified to permit taxpayers to use the spot rate at the end of its tax year to convert assets and liabilities into U.S. dollars. This method will eliminate the foreign currency gains and losses on non-economic assets, while retaining the basic architecture of the 1991 proposed regulations and allowing taxpayers to comply with the regulations in a timely and cost-effective manner.