International Tax Aspects of Foreign Currency Transactions

Table of ContentsPage1. Determination of the Functional Currency and Definition of a “QBU”..................................1 A. Functional currency is determined at the “qualified business unit” level. ..........................1 B. Definition of a Qualified Business Unit. .............................................................................1 C. § 985 – Selection of the Functional Currency .....................................................................2 D. Changes in Functional Currency .........................................................................................6 2. Section 988 — Non Functional Currency Transactions..........................................................7 A. Separate transaction principle..............................................................................................7 B. Certain Differences between § 988 and GAAP (FAS 52)...................................................7 C. Definition of § 988 Transaction...........................................................................................9 D. Timing of Recognition of Foreign Exchange Gain or Loss; Computing the Amount ofCurrency Gain or Loss from Section 988 Transactions. ...........................................................12 E. Character and Source of Section 988 Gain or Loss...........................................................18 F. Reg. § 1.6011-4 Reporting (Form 8886). ..........................................................................21 3. Section 986 — Translation Rules for Earnings and Profits and Foreign Income Taxes.......22 A. § 986 E&P Translation Rules ............................................................................................22 B. Translation of Foreign Income Taxes................................................................................27 4. Section 987 — Translating Branch Income and Loss ...........................................................33 A. Historical Approaches to Branch Translation ...................................................................33 B. Section 987 ........................................................................................................................35 C. 1991 Proposed Regulations ...............................................................................................36 D. The 2006 Proposed § 987 Regulations ..............................................................................38 5. Special Considerations for Hyperinflationary Currencies.....................................................44 A. Definitions .........................................................................................................................44 B. DASTM (§ 1.985-3) ..........................................................................................................44 C. Use of the Official vs. Free Market Exchange Rate ..........................................................47 D. Restricted or “Blocked” Currencies ..................................................................................48 E. Hyperinflationary Debt Instruments..................................................................................50 6. Subpart F Treatment of Foreign Currency Gains and Losses ...............................................51 A. General rule .......................................................................................................................51 B. Exceptions to Subpart F Treatment ...................................................................................51 C. Subpart F Elections............................................................................................................53 7. Foreign Currency Hedging Transactions...............................................................................54 A. Integrated Treatment under § 988(d) and Reg. § 1.988-5 .................................................54 B. § 1221(b)(2) hedging transactions.....................................................................................56 C. Hedges of Investment in an Entity’s Balance Sheet..........................................................59