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

Accordingly, TEI recommends that the final regulations permit taxpayers to elect to use the yearly average exchange rate for all historic items as a reasonable convention. Consistent use of the yearly average rate for the year the asset was acquired represents a significant simplification with only a de minimis effect (which could be positive or negative) on taxable income.

The application of a yearly average exchange rate should also be allowed for any items related to current assets (e.g., cost of goods sold, salaries, or routine selling, general, and administrative expenses). In other words, the final regulations should permit a taxpayer to elect to translate all income and expense items--except depreciation and amortization--by applying a yearly average exchange rate. The reasonable convention election will also permit depreciation and amortization to be translated using the yearly average exchange rate for the year the associated asset was placed in service. The simplicity of this approach significantly outweighs the precision achieved through a spot-rate method and is more closely aligned with the statute. If a taxpayer wishes to track historical items more precisely, the 2006 proposed regulations already permit this approach.

Transition Issues

A. Election to Apply Regulations. Prop. Reg. [section] 1.987-11(a) provides that the regulations are effective for "taxable years beginning one year after the first day of the first taxable year following the publication of a Treasury decision adopting the rule as a final regulation in the Federal Register." The preamble to the revised regulations states: "Pending finalization, the IRS and Treasury would consider positions consistent with these proposed regulation[s] to be reasonable constructions of the statute." 2006-42 I.R.B. at 715.

Because of the uncertainty surrounding section 987 since its enactment, many taxpayers may prefer to adopt the proposed regulations (even in the absence of finality) as soon as possible. While the preamble has encouraging language, it lacks the certainty of providing a specific retroactive election. Therefore, TEI recommends that the final regulations incorporate a specific rule permitting retroactive application. If the final regulations will not be issued in the near future, we urge the IRS to issue a notice permitting taxpayers an election to apply the 2006 proposed regulations immediately.

Moreover, TEI recommends that taxpayers be permitted to retroactively apply the 2006 proposed regulations to all open tax years. While such a provision may be unconventional, we believe it is appropriate, given (i) the material differences between the 2006 and 1991 proposed regulations, and (ii) the fact that the 1991 proposed regulations compelled many taxpayers to recognize gains that are now viewed as non-economic and inappropriate under the 2006 proposed regulations.

B. Fresh Start Method. Prop. Reg. [section] 1.987-10 permits taxpayers to transition to the new foreign exchange exposure pool method by use of one of two methods: (i) the deferral transition method and (ii) the fresh start method. Under the deferral transition method, the unrecognized section 987 gain is determined at the time of a deemed termination on the last day of the tax year preceding the transition date, based on the taxpayer's prior section 987 method. The gain or loss is not immediately recognized, but is treated as net unrecognized section 987 gain or loss. The assets and liabilities are deemed transferred to a new section 987 QBU with the assets booked up from their historic rates to reflect the unrecognized gain. This method is available only to taxpayers whose prior section 987 method was reasonable. (4) Thus, a taxpayer that has not been using a reasonable method to comply with section 987 may use only the fresh start method.