Apr 20

Branch Transactions – New Aggregation Election

Do you have a business that has a branch in a foreign country?  If so, new regulations will dictate how you determine your taxable income.

Many businesses have a branch in a foreign country.  This may include conducting business in the foreign country through an entity that is classified for U.S. tax purposes as a disregarded entity.  Under IRC §987, the income of a taxpayer is to be determined by computing the taxable income or loss separately for each branch in its functional currency and by translating the income or loss separately into U.S. dollars at the appropriate exchange rate.

New regulations under IRC §987 will come into effect for calendar year taxpayers on January 1, 2018.   These new regulations require a “Section 987 QBU” (generally a foreign branch that keeps books and records in a foreign currency) to determine its income or loss for each year in its functional currency and for the owner of the foreign branch to translate the items into the owner’s functional currency, generally the U.S. dollar.  The exchange rate would generally be the average exchange rate for the taxable year.  Recovery of basis with respect to a historic asset, such as depreciable equipment, is based on the historic exchange rate and not on the current exchange rate.

Under the new regulations, there is an election one can make to treat all Section 987 QBUs that use the same functional currency as if there were one Section 987 QBU.  This election may be very helpful.  Generally, when property is moved from one branch to another branch, the regulations deem there to be a constructive distribution of the property to the U.S. owner followed by a contribution of the property to the sister branch.  Under the regulations, an actual distribution or a deemed distribution from the branch triggers foreign currency gains.  For example, a U.S. taxpayer, that has one branch in Germany that uses the euro as its functional currency and one branch in Spain that also uses the euro, may decide to transfer a piece of equipment from Spain to Germany.  Absent an election to aggregate the Section 987 QBUs, that piece of equipment is deemed to be transferred from the Spanish branch to the U.S. owner and then contributed to the German branch.  The deemed distribution triggers the foreign currency gain.  By making the election to treat all branches or QBUs that use the same functional currency as one, this triggering of foreign currency gains is avoided.  The new regulations set forth the procedure for making such an election.

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