International Tax Aspects of Foreign Currency Transactions

were typically translated at the spot rate on the date of payment,which differed from the average exchange rate used to translate the§ 987 branch’s P&L more generally.(a)(b)(c)The Notice provides several examples to illustrate the applicationof § 905(c) adjustments. In the examples, an additional taxpayment or a refund results in an adjustment to the tax-equivalentamount and § 987 taxable income translated at the applicable§ 905(c) rate used to translate the taxes.For example, in Example 3, branch taxes for 1988 are translated at1 u : $1.2, where as the branch’s § 987 taxable income is translatedat 1u : $1. The branch earns 100u and pays 20u of taxes. Underthe Notice, the taxpayer initially has $104 of taxable income.When 10u of taxes are refunded, this results in an adjustment of$(2) to the QBU’s income, as the applicable exchange rate forbranch earnings rather than tax equivalent amount would havebeen $10 rather than $12.The 1991 Proposed Regulations generally adopted the principles ofNotice 89-74. Prop. Reg. § 1.987-1(b)(2) (1991) provides thatforeign income taxes paid by a QBU of a US taxpayer that areclaimed as a credit give rise to a “tax equivalent amount” that istranslated separately into dollars for computing the § 987 QBU’staxable income.The Proposed Regulations also provided that the tax equivalentamount is excluded from the branch’s § 987 equity and basis pool,and thus does not affect the amount of § 987 gain or lossrecognized on a remittance of property. See Prop. Reg. § 1.987-1(b)(3)(iii) (1991).1991 Prop. Reg. § 1.987-1, Example 4. This example illustrates acase where there is an additional foreign tax payment relating to1990 in the following year, when the exchange rate has changed.The additional assessment changes the tax equivalent amount, andtherefore, results in a change to the US Dollar taxable incomeattributable to the branch for 1990.1991 Prop. Reg. § 1.987-1, Example 5. B is a QBU branch of X, adomestic corporation. The functional currency of B is the FC. Theexchange rate for 1992 is 1FC:$1 throughout the year. X elects tocredit (rather than deduct) any creditable tax under § 901. In 1992,B has 100FC of income and pays 40FC of creditable tax on thatincome. B adds 60FC to its equity pool and $60 to its basis pool.Under section 1.987-1(b)(3)(iii), the 40FC is excluded from B's30© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com