International Tax Aspects of Foreign Currency Transactions

Gain or loss is computed, without regard to 1.988-2(b)(8) (thenetting rule), as if the transferor QBU sold the units of property atFMV immediately before the transfer.(i)Example. X is a US dollar taxpayer with two branches, Yand Z, operating in the €. Y holds $25 in cash with a 20 €tax basis and 23 € fair market value. If Y transfers the $25of cash to X, this will cause Y to recognize 3 € of § 988gain under the branch transfer rule. The transfer also has§ 987 consequences as a transfer of property by Y to X.(ii) Example 2. Same, except that Y transfers the $25 to Z,which is also a € branch. In this case, since Z can step inthe shoes of Y, the branch transfer rule does not apply.The same rule can also apply to a transfer of a § 988 transactionfrom a foreign QBU to a U.S. QBU, or vice versa, because of thechange to the source of exchange gain or loss on the item.D. Timing of Recognition of Foreign Exchange Gain or Loss; Computing theAmount of Currency Gain or Loss from Section 988 Transactions.(1) General Principles. Foreign currency gain or loss is taken into accountwhen the § 988 transaction is settled or otherwise disposed of – i.e., whenthe taxpayer realizes and recognizes gain or loss on the overall transaction.See Treas. Regs. §§ 1.988-2(a) through (d). Typically, this occurs throughrealization events such as—(a)(b)(c)(d)Making or receiving paymentDisposing of units of non-functional currencySelling a loan receivable to another taxpayerTransferring property in settlement of a loan payableThis transaction-by-transaction, realization-based approach to computingexchange gain or loss contrasts sharply with GAAP’s mark-to-marketrules. At one time, the IRS considered allowing taxpayers to elect a bookconformity method that would mark-to-market all § 988 transactions (noless frequently than quarterly) consistent with financial accountingtreatment. See INTL-0015-91 (May 16, 1992), Prop. Reg. § 1.988-5(f).However, this proposal was not adopted. Perhaps the IRS and Treasuryquestioned their authority to extend mark-to-market accounting across theboard for § 988 transactions.12© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com