International Tax Aspects of Foreign Currency Transactions

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change has more immediate impacts. To translate retained earnings (andany § 987 gain or loss with respect to capital), the branch is deemed toterminate on the transition date. It recomputes its income and remittancesduring the interim look-back period as if it had always applied DASTM.Any resulting income adjustment is taken into account over a 4-yearspread period.C. Use of the Official vs. Free Market Exchange Rate.(1) The government in a hyperinflationary currency may attempt to peg anofficial $USD exchange rate lower than the rate on the black market. Onequestion that arises is which rate to use as the “spot rate” for U.S. taxpurposes.(2) Reg. § 1.988-1(d)(1) sets forth the general rule that the spot rate shall bedetermined based on the prices at which the currency freely changes handsin representative amounts. Reg. § 1.988-1(d)(4) provides that the ratewhich “most clearly reflects income” should be used as the spot rate incases in which the government rate and free market rate differ.(a)(b)Id., Example 1 – CFC operating in the LC as its functionalcurrency pays a 100LC dividend to USP at a time when the officialgovernment rate is $1 : 1LC, but the free market exchange rate is$1 : 4LC. USP then donates the 100 LC to charity. It isappropriate to use the free market exchange rate to translate boththe dividend and charitable contribution deduction into US Dollars.Id., Example 2 – where a taxpayer was engaged in arbitrage byacquiring units of non-functional currency at the government rateand selling them on the black market, it was appropriate to use theofficial government rate as the cost basis of the purchased units.(c) FSA #003308. Taxpayer sought to use the LAFISE statisticsrather than the IMF statistics normally relied upon by thegovernment. The IRS rejected the taxpayer’s argument that theLAFISE (free market exchange rate) could be used to compute anannual exchange rate for branch P&L, rather than a spot rate under§ 988. However, in the case of a remittance translated at the spotrate under § 987, the IRS stated that “it generally would beappropriate to use a free market rate rather than an official rate fordetermining the spot rate, provided that the free market rate isconsistently used and further provided that the free market ratemore accurately reflects income than the official rate.”(3) Cases on Mexican Debt-Equity Swaps.47© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com
(a)Certain cases have addressed a Mexican government program toinduce corporations to retire its Dollar-denominated debt. In eachof the cases, the corporation purchased the debt at a discount onthe open market. Then, the Mexican government exchanged alarger amount of pesos with the company which were restricted foruse inside Mexico.(b) Kohler v. United States, 2006-2 USTC para. 50,611 (7 th Cir.)(Posner, J.). Here, the company bought back $22 mm face value ofdebt for $11 mm. The Mexican government swapped the debt for“restricted” pesos that would be worth $19.5 mm if unrestricted.The Court viewed Kohler as receiving a taxable gain on retirementof the debt. However, contrary to the IRS’ conclusion, the fact thatthe pesos were restricted for use inside Mexico meant that theirFMV must have been less than $19.5 mm. The IRS’sdetermination of a value of $19.5 mm was implausible andarbitrary and capricious.(c)G.M. Trading Corp. v. Commissioner, 121 F.3d 977 (5th Cir.1997). Similar transaction as above. However, the Fifth Circuitanalyzed the transaction as a non-shareholder contribution tocapital under § 118. Thus, the taxpayer received the excessamount of pesos tax-free, but also did not receive tax basis for thatamount of value.D. Restricted or “Blocked” Currencies.(1) Foreign exchange restrictions may completely block a US taxpayer’sability to remit funds from a foreign country. This may create a harshresult under subpart F or § 482 in charging the taxpayer with phantomincome that it cannot by law receive in cash. While case law ruled againstthe taxpayers on this point, 35 the regulations now permit taxpayers to electto defer reporting of income attributable to blocked currency.(2) Reg. § 1.482-1(h)(2).(a)Taxpayers transacting with a subsidiary operating under foreignexchange restriction may elect to defer reporting the incomeattributable to the blocked currency until it can be remitted underforeign law. The election to defer reporting applies to “any portionof the arm’s length amount,” 36 including stated payments.However, if the payments may be remitted through any other3536See Eder v. Commissioner, 138 F.2d 27 (2d Cir. 1944) (“blocked” Colombian pesos could be taxed to anindividual under the foreign personal holding company rules).Reg. § 1.482-1(h)(2)(iv).48© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com
Page 1 and 2: Overview of the Taxation of Foreign
Page 3 and 4: Table of ContentsPage1. Determinat
Page 5 and 6: processes orders and maintains sepa
Page 7 and 8: (3) Examples.(a)(b)(c)Reg. § 1.985
Page 9 and 10: D. Changes in Functional Currency.(
Page 11 and 12: (1) Application of Mark-to-market.(
Page 13 and 14: (ii) Accrued foreign income tax pay
Page 15 and 16: Gain or loss is computed, without r
Page 17 and 18: (4) Rules Applicable to Debt Instru
Page 19 and 20: The obligor of a non-functional cur
Page 21 and 22: (iii) Rollover of an Existing Contr
Page 23 and 24: can rebut this presumption by showi
Page 25 and 26: (a)(b)Specifically, losses attribut
Page 27 and 28: (i)Actual distributions of PTI to t
Page 29 and 30: the paid-in-capital account under R
Page 31 and 32: (d)Taxes for which the taxpayer mak
Page 33 and 34: were typically translated at the sp
Page 35 and 36: (b)Brazilian ORTNs.During a period
Page 37 and 38: Under the profit and loss method, t
Page 39 and 40: egard to the form of enterprise thr
Page 41 and 42: D. The 2006 Proposed § 987 Regulat
Page 43 and 44: Examples:i. Cashii. Payables and Re
Page 45 and 46: 3) Owner ceases to exist in a non-
Page 47 and 48: 5) Simply following GAAP may not be
Page 49: (5) Consequences of a Change to DAS
Page 53 and 54: E. Hyperinflationary Debt Instrumen
Page 55 and 56: (c)(d)The underlying transaction is
Page 57 and 58: allow a CFC to avoid the need to tr
Page 59 and 60: (a) PLR 200813026. IRS granted a PL
Page 61 and 62: (a)(b)(c)(d)Reg. § 1.446-4 provide
Page 63: 60© 2013 William R. Skinner, Esq.F

International Tax Aspects of Foreign Currency Transactions

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