International Tax Aspects of Foreign Currency Transactions

(3) Examples.(a)(b)(c)Reg. § 1.985-1(f), Example 4 – US Dollar Financing VehicleRequired to Use a US Dollar Functional Currency. CFC isorganized as a financing vehicle primarily for USP and domesticaffiliates. Thus, it primarily derives income from borrowing in USdollars and lending in US dollars back to the US Parent and itssubsidiaries. It incurs some local currency expenses. The CFC hasits activities primarily in U.S. dollars and thus is required to use theU.S. dollar for tax purposes.Id., Example 6 – Subsidiary with Dollar as GAAP FunctionalCurrency, but Possibly LC as Tax Functional Currency. Sub buysproducts from related and unrelated parties in LC, derives grossreceipts in LC and pays operating expenses in LC. However, salesprice is set to determine a set level of dollar profits. Sub has a USDollar functional currency for GAAP. However, since the factorsfor GAAP and tax are not substantially similar, Sub may use theLC or the Dollar for tax purposes.Id., Example 7 – Treatment of CFC with Branches. CFC has nooperations of its own, but operates solely through Branches X andY. Each of the branches is a QBU. CFC must first determine thefunctional currency of each of its QBUs, and then determine itsoverall functional currency based on its total activities (includingthose of its branches X and Y).Note that a strict application of example 7 can readily result in abook-tax difference – e.g., causing a pure holding company thatuses the Dollar for GAAP to have a non-dollar functional currencyfor tax based on the activities of its non-Dollar branches.(d)Example 12 – Foreign Corp with ECI. Foreign corporation F sellsUS real property and earns Effectively Connected income under§ 897(a). Because F earns ECI, its US real property income istreated as a separate QBU that must use the US Dollar.(e) FSA #0991 (Feb. 1992). The IRS considered the functionalcurrency of a CFC that used the US dollar for GAAP and tax. TheExamining agent wanted to place the QBU on the local currencyfor tax and argued that since the CFCs’ activities were primarily inlocal currency, the CFC’s use of the US dollar was inappropriate.The FSA illustrates the factual nature of § 985 inquiry. The IRSnoted that it had a strong argument for requiring the CFC to use thelocal currency, if the CFC conducted its activities primarily in that4© 2013 William R. Skinner, Esq.Fenwick & West LLPwrskinner@fenwick.com