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 an ongoing basis, the most significant complexity of the revised regulations arises from the application of the exchange rate to section 987 historic items. This complexity can best be addressed by modifying the 2006 proposed regulations to more closely follow the statutory language for computing income. In the absence of such an approach, TEI recommends that (i) the scope of section 987 historic items be narrowed, and (ii) the application of a broader reasonable convention election under Prop. Reg. [section] 1.987-1(c)(1)(ii) be permitted.

A. Section 987 Historic Items. Prop. Reg. [section] 1.987-2(b) defines a section 987 historic item as an asset or liability that is reflected on the books and records of a section 987 QBU and is not a section 987 marked item. Section 987 historic items and their related items of income or expense must be translated into the QBU owner's functional currency utilizing the spot rate at the acquisition date as defined in Prop. Reg. [section] 1.987-1(c)(3). Prop. Reg. [section] 1.987-1(d) defines a section 987 "marked" item as an asset or liability that would be a section 988 transaction if held directly by the QBU owner. Marked items are translated at the year-end spot rate and their related income and expense are translated at the yearly average exchange rate, as defined in Prop. Reg. [section] 1.987-1(c)(2).

Although this framework is consistent with the overriding principle of the 2006 proposed regulations to have gain or loss computed on items whose value fluctuates with a change of exchange rates, virtually all items typically considered current assets under GAAP (e.g., inventories and pre-paid and deferred items) similarly fluctuate in value and generate economic gains and losses. These GAAP items also have short lives, so, consistent with the treatment of section 987 marked items, any fluctuation is quickly recognized. TEI therefore suggests that current assets under GAAP should be considered section 987 marked items. Such an approach creates a better matching with current liabilities that are section 987 marked items. Moreover, consistent application of this approach will prevent improper manipulation and minimize the extensive computations otherwise required for these assets, particularly inventory items.

B. Reasonable Convention Election. Prop. Reg. [section] 1.987-1(c)(1)(i) defines the spot rate as the rate determined under the principles of Treas. Reg. [section][section] 1.988-1(d)(1), (2), and (4) on the relevant day. Prop. Reg. [section] 1.987-1(c)(1)(ii) permits taxpayers to elect to use spot-rate conventions that reasonably approximate the spot rate on a particular day; thus, a reasonable convention is allowed in lieu of a spot rate for purposes of translating various historic items. For many historic items, the asset is created over time through the purchase of various component parts (e.g., a production line or building). Taxpayer systems do not have the functionality to track the purchase of each and every item, and often the only date identified in the system is when the asset is placed in service. Similarly, inventory is continuously purchased and manufactured; creating a system to track the spot rate for these millions of items is neither practical nor does it drive material differences from an overall tax liability standpoint.