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On December 7, 2016, the Treasury Department (the Treasury) and the Internal Revenue Service (the IRS) released final (T.D. 9794), temporary (T.D. 9795), and proposed regulations (REG-128276-12)¹ under Section 987. The long-awaited final regulations provide guidance to corporate and individual taxpayers on determining their taxable income or loss (or earnings and profits (E&P), as applicable) with respect to certain branch operations (known as a qualified business unit (QBU)) that uses a different functional currency than the QBU's owner (a Section 987 QBU), as well as the timing, amount, character, and source of any Section 987 gain or loss arising from such a QBU. The temporary regulations provide guidance on the recognition and deferral of Section 987 gain or loss in connection with certain QBU terminations and transactions involving partnerships, as well as other related elections and special rules. The final and temporary regulations also amend existing regulations under Section 861 and Sections 985, 988, and 989 of subpart J, including temporary rules: (i) regarding Section 988 transactions into which a QBU entered; and (ii) requiring the deferral of Section 988 losses that arise with respect to related-party loans.

As discussed later, Section 987 losses resulting from certain outbound transfers, as well as any previously unrecognized Section 987 gains or losses existing on the transition date, may be effectively disallowed under the new rules. Therefore, taxpayers should immediately consider these final and temporary regulations for year-end reporting and planning purposes, including in anticipation of major tax reform in 2017.

Background

Section 987 was added to the Code in 1986. Section 987(1)² and (2) generally provide that, when a taxpayer owns one or more QBUs whose functional currency differs from the taxpayer's, the taxpayer determines its taxable income or loss by computing the taxable income or loss of each QBU separately in its functional currency and translating the income or loss into the taxpayer's functional currency at the appropriate exchange rate.³ Section 987(3) further requires the taxpayer to make "proper adjustments" for transfers of property between QBUs having different functional currencies, including treating post-1986 remittances from each such QBU as made on a pro rata basis out of post-1986 accumulated earnings and treating Section 987 gain or loss as ordinary income or loss and sourcing such gain or loss by reference to the source of the income giving rise to post-1986 accumulated earnings. Section 989(c) grants Treasury authority to prescribe regulations (as may be necessary or appropriate) to carry out the purposes of subpart J, including regulations under Section 989(c)(5) providing for the appropriate treatment of related-party transactions (including transactions between QBUs of the same taxpayer).

Proposed regulations under Section 987 were originally published on September 25, 1991, (the 1991 proposed regulations). The 1991 proposed regulations generally provided that the net income of the QBU was determined annually and translated into the functional currency of the taxpayer at the weighted average exchange rate. The 1991 proposed regulations also provided for the recognition of Section 987 gain or loss by determining exchange gain or loss (by reference to the taxpayer's functional currency) with respect to the "earnings and capital" of a QBU. Under the "earnings and capital" approach, all branch equity (whether it consisted of monetary or non-monetary assets) gave rise to Section 987 gain or loss.

On April 3, 2000, the IRS issued Notice 2000-20, which requested comments on the revision of the 1991 proposed regulations. In particular, the IRS expressed concerns that taxpayers may have used the earnings and capital approach to recognize noneconomic losses when the US dollar was strong against other currencies.

On September 7, 2006, the Treasury and IRS published new proposed regulations under Section 987 (the 2006 proposed regulations) and withdrew the 1991 proposed regulations. The 2006 proposed regulations provided that the income and deductions of the QBU were determined annually and generally translated at the average exchange rate for the year (similar to the 1991 proposed regulations), but deductions such as depreciation and amortization for so-called historic assets were translated at historic rates. Translating these items at historic rates represented a major difference from the statute and the 1991 proposed regulations, and prevented the imputation of foreign currency gains or losses to those assets. The 2006 proposed regulations then applied a financial assets and liabilities approach to determine Section 987 gain or loss, called the foreign exchange exposure pool method (the FEEP method). Under the FEEP method, exchange gain or loss for "marked items" is determined annually but is pooled and deferred until a remittance is made. A marked item is generally defined as an asset or liability that would generate Section 988 gain or loss if that asset or liability were held or entered directly by the owner of the Section 987 QBU. As compared to the 1991 proposed regulations, the FEEP method was intended by the Treasury and IRS to more accurately reflect foreign currency gain and loss that is economically realized, while minimizing or eliminating the realization of non-economic foreign currency gain and loss.

The Treasury and IRS received many comments regarding the complexity and administrability of the 2006 proposed regulations. Nevertheless, as noted in the preamble, the final regulations adopt the 2006 proposed regulations without fundamental changes. According to Treasury and the IRS, however, in order to reduce complexity and improve administrability, the final and temporary regulations modify the 2006 proposed regulations by permitting more items to be marked, simplifying the treatment of marked items, and simplifying the basis adjustments for items that are not marked.⁴ In particular, the final regulations allow taxpayers to: (a) use the yearly average exchange rate as the historic rate; (b) treat prepaid expenses and liabilities for advance payments of unearned income as Section 987 marked items; (c) apply a purported simplified method to inventory; and (d) translate both basis recovery and amount realized with respect to marked assets at the yearly average exchange rate.

Scope of the final and temporary regulations

In general, an individual or a corporation is subject to the final and temporary regulations if that person is an owner of a Section 987 QBU.⁵ The final and temporary regulations do not apply to banks, insurance companies, leasing companies, finance coordination centers, regulated investment companies, or real estate investment trusts, unless those financial entities engage in transactions primarily with related persons that are not financial entities (e.g., "in-house" banks and treasury centers). Further, the final regulations do not apply to trusts, estates, S corporations, and partnerships other than Section 987 aggregate partnerships as described later. Until regulations are issued for those excluded entitles, they must use a reasonable method to comply with Section 987 and cannot rely on the final regulations.

In general, an owner may elect to treat, solely for purposes of Section 987, all of its directly owned Section 987 QBUs with the same functional currency as a single Section 987 QBU. An owner also may elect to treat all Section 987 QBUs with the same functional currency owned indirectly through a single Section 987 aggregate partnership as a single Section 987 QBU.

Attribution and taxable income determinations

As noted, the final regulations retain most of the fundamental mechanics of the 2006 proposed regulations. As such, an owner of a Section 987 QBU must first determine which items are properly attributed to its Section 987 QBU. Reg. Section 1.987-2 provides the rules for attributing assets and liabilities, and items of income, gain, deduction, and loss, to a Section 987 QBU. Items are attributed to a Section 987 QBU to the extent they are reflected on the Section 987 QBU's separate books and records, except for non-portfolio stock, partnership interests, certain acquisition indebtedness, and items that were included or excluded from the QBU's books and records with a principal purpose of avoiding taxation under Section 987. Once items are attributed to a Section 987 QBU, Reg. Sections 1.987-3 through -6 provide detailed rules for computing and determining the character and source of the taxable income (or E&P, as applicable) of an owner with respect to its Section 987 QBU.

Under the final regulations, a Section 987 QBU owner must include in its taxable income (or E&P, as applicable):

1. The income, deduction, gain, or loss of the Section 987 QBU for the year translated into the owner's functional currency at the yearly average exchange rate (or, if so elected, the spot rate) or historic rates for historic assets based on the rules of Reg. Section 1.987-3⁶

2. The amount of Section 987 gain or loss recognized on remittances⁷ made by the QBU during the year. Section 987 gain or loss is determined from the rules of Reg. Sections 1.987-4 (including a complex eight-step process described in Reg. Section 1.987-4(d)) and -5.

Under these rules, an owner of a Section 987 QBU must divide the QBU's balance sheet items into two categories — marked and historic items. The bases of marked items are generally translated into the owner's functional currency at the year-end spot exchange rate, and historic items are generally translated into the owner's functional currency at the historic exchange rate; that is, the exchange rate in effect when the item was originally acquired.

The difference between the Section 987 QBU's opening and closing value as reflected on its balance sheet (essentially, a net worth computation) is then determined and: (i) adjusted for amounts transferred to or from the Section 987 QBU to the owner (i.e., steps 2-5); (ii) decreased or increased by the Section 987 taxable income or loss, respectively, of the Section 987 QBU for the tax year (i.e., step 6); and (iii) increased or decreased for the amount of non-deductible expenses or tax-exempt income, respectively, of the Section 987 QBU for the tax year (i.e., steps 7-8). The unrecognized Section 987 gain or loss for the tax year (determined from the eight-step process) is then added to the Section 987 QBU's net accumulated unrecognized Section 987 gain or loss for all prior tax years to which the final regulations apply to determine the net unrecognized Section 987 gain or loss of the Section 987 QBU.

The unrecognized Section 987 gain or loss is identified annually and deferred until a remittance is made from the Section 987 QBU to the owner or to another Section 987 QBU held by the same owner. The amount taken into account upon a remittance under Reg. Section 1.987-5(b) equals the product of the owner's portion of the Section 987 QBU's net unrecognized Section 987 gain or loss, multiplied by the owner's remittance proportion (which generally equals the amount of the remittance divided by the aggregate basis of the Section 987 QBU's gross assets, without a reduction for the remittance).

Under Reg. Section 1.987-6, recognized Section 987 gain or loss is treated as ordinary in character and must be sourced using the asset method set forth in Reg. Section 1.861-9T(g), In applying the asset method, an owner must consistently use the tax book value or fair market value to determine the value of the QBU's assets. In addition, solely for purposes of determining a taxpayer's foreign personal holding company income for the year, any recognized Section 987 gain or loss that is characterized (under the asset method) by reference to assets that give rise to subpart F income, is included in the foreign currency sub-category of foreign personal holding company income (FPHCI) and does not qualify for exclusion under the business needs exception of Reg. Section 1.954-2(g)(2)(ii).

Section 988 transactions entered by a Section 987 QBU

The temporary regulations provide rules addressing Section 988 transactions entered by a Section 987 QBU. Under the temporary regulations, whether a transaction is a Section 988 transaction is generally determined by reference to the functional currency of the QBU; the amount of Section 988 gain or loss from Section 988 transactions, however, is determined by reference to the owner's functional currency, rather than the Section 987 QBU's functional currency. In addition, like the 2006 proposed regulations, the temporary regulations provide that nonfunctional currency-denominated debt instruments, payables and receivables, and cash (when disposed) denominated in (or determined by reference to) the owner's functional currency are not Section 988 transactions.⁸

Also, consistent with the statutory language of Section 987, the temporary regulations provide that Section 987 does not apply to a QBU that has the US dollar as its functional currency and that would be subject to Section 987 if it had a functional currency other than the US dollar. Because Treasury decided, however, that a controlled foreign corporation (CFC) owner of a US-dollar QBU should recognize foreign currency gains or losses from transactions that would be Section 988 transactions if entered directly by the owner, the temporary regulations provide that a CFC owner of a US-dollar QBU will be subject to Section 988 for any item that is reflected on the books of the US-dollar QBU and that would be a Section 988 transaction if such item were acquired, accrued or entered directly by the CFC. Thus, except for a special rule addressing the computation of income that is effectively connected income (ECI), the item is treated as reflected on the books and records of the CFC. In lieu of applying Section 988 at the CFC level, the temporary regulations allow a CFC that directly or indirectly owns a US-dollar QBU to apply Section 987 to the US-dollar QBU.

The temporary regulations also provide that a taxpayer may elect, on a QBU-by-QBU basis, to mark to market a Section 988 transaction (including a Section 988 transaction that is denominated in the owner's functional currency) that occurs in the ordinary course of the QBU's business and has a term of one year or less. If the election is made (or the Section 988 transaction must be marked to market under Sections 475 or 1256), the Section 988 gain or loss is determined by reference to the QBU's functional currency.

Treatment of partnerships

Under the 2006 proposed regulations, the definition of a QBU under Reg. Section 1.989(a)-1 would have been amended to remove partnerships, and thus, all partnerships would have been treated as aggregates of their partners, rather than as entities separate from their partners for purposes of subpart J, including Section 987. In response to commenters' concerns, only partnerships that are wholly owned by related persons (Section 987 aggregate partnerships) have been removed from the definition of a QBU under Reg. Section 1.989(a)-1. All other partnerships continue to be defined as QBUs, and their Section 987 determinations are not addressed in the final or temporary regulations. The Treasury and IRS anticipate that regulations for applying Section 987 to non-aggregate partnerships will be developed under a separate project and may adopt a different approach. Accordingly, the Treasury and IRS requested comments describing how an entity approach might apply to non-aggregate partnerships.

Under the aggregate approach for wholly owned partnerships, assets and liabilities of a QBU of a partnership are allocated to each partner based on the partner's liquidation value percentage. In general, this percentage is the percentage of the partnership's cash that the partner would receive if the partnership sold all of its assets, paid off all of its liabilities, and then liquidated.

Otherwise, in contrast to the 2006 proposed regulations, which provided detailed rules regarding the treatment of partnerships and the coordination of Section 987 with subchapter K, the final and temporary regulations largely reserve and request comments on how Section 987 should apply.

Section 987 QBU terminations

The final and temporary regulations treat the termination of a Section 987 QBU as a remittance of all of the QBU's gross assets to its owner immediately before the termination. Thus, a Section 987 QBU termination generally results in the recognition of any previously unrecognized Section 987 gain/loss.

Except for certain Section 381(a) transactions, a Section 987 QBU terminates when:

— The trade or business of the QBU ceases, subject to a maximum two-year winding-up period

— The QBU transfers substantially all of its assets (as defined in Section 368(a)(1)(C)) to its owner

— The owner of the QBU ceases to exist, or

— A CFC owner of the QBU ceases to be a CFC

The final regulations provide special termination rules for certain Section 332 liquidations and Section 381(a)(2) reorganizations. Inbound and outbound liquidations and reorganizations terminate a Section 987 QBU. A Section 987 QBU termination also occurs in liquidations or reorganizations when Section 987 ceases to apply because the distributee or acquiring corporation, as applicable, uses the same functional currency as the QBU. Finally, a Section 987 QBU will terminate in foreign-to-foreign reorganizations involving a CFC transferor and a related non-CFC acquirer. All other Section 381(a) transactions will not result in a Section 987 QBU termination.

In addition, for taxpayers that do not want to keep track of historical exchange rates in applying the FEEP method, the temporary regulations allow a taxpayer to elect to deem its Section 987 QBUs to terminate on the last day of each tax year. If such an election is made, the QBU is treated as having remitted all of its gross assets on the last day of the tax year, resulting in the recognition of any net unrecognized Section 987 gain or loss. The owner is then treated as transferring all of the assets and liabilities of the terminated QBU to a new QBU on the first day of the following tax year. The temporary regulations provide two rules that are intended to prevent the election from being made opportunistically. First, the temporary regulations prevent taxpayers from cherry-picking QBUs with unrealized Section 987 losses by requiring the election to be made not only for all the QBUs held by the taxpayer but also for QBUs owned by persons related to the taxpayer under the rules in Sections 267(b) and 707(b).⁹ Second, the temporary regulations limit the year in which the election can be made to either the first tax year beginning on or after the transition date (as defined in Reg. Section 1.987-11(c)) or a subsequent taxable year in which the aggregate Section 987 loss of the taxpayer's controlled group would not exceed $5 million. Once made, the election cannot be revoked. Finally, if the taxpayer makes the election, the taxpayer may elect to translate all items of income, gain, deduction and loss of the QBU into the owner's functional currency at the average exchange rate for the year (the so-called hybrid method). This election can be made on a QBU-by-QBU basis.

Deferral of Section 987 gains and loss

The temporary regulations defer Section 987 losses (and, in limited cases, gains) that would otherwise be allowed under the final regulations if such losses (or gains) result from a "deferral event" or an "outbound loss event". A deferral event generally occurs when there is a transfer of substantially all of the assets of a QBU or an interest in the QBU to a member of the transferor's controlled group (defined as all persons with relationships to each other specified in Sections 267(b) or 707(b)). Section 987 gain or loss that is deferred upon a deferral event is recognized upon subsequent remittances from the QBU or when the successor QBU ceases to be owned by a member of the deferral QBU owner's controlled group.

An outbound loss event generally occurs when a US person transfers substantially all of the assets of a QBU or an interest in the QBU to a foreign person that is a member of the transferor's controlled group. Only Section 987 losses are deferred in an outbound loss event. The loss that is deferred under the temporary regulations (the outbound Section 987 loss) is added to the basis of the stock that is received (if the loss results from a nonrecognition transaction) or, if the loss does not arise from a nonrecognition transaction, is suspended until the first tax year when the US transferor and the foreign transferee cease to be members of the same controlled group.

If the deferral event or the outbound loss event occurs prior to the effective date of the final regulations, adjustments must be made as part of the fresh start transition method (discussed later) under the final regulations. Notably, this may result in the deferred loss (to the extent it has not yet been recognized) being completely eliminated in the transition tax year.

The temporary regulations provide two avenues that allow taxpayers to avoid the application of the deferral event and outbound loss event rules. First, those rules do not apply to a QBU to which an annual deemed termination election (discussed previously) is in effect. Second, those rules do not apply if the amount of Section 987 gain or loss that would be deferred is de minimis (defined by the Treasury and IRS as $5 million or less).

An anti-abuse rule provides that no Section 987 loss is recognized if a transaction or series of transactions are undertaken with a principal purpose of avoiding the purposes of the loss deferral rules under Reg. Section 1.987-12T. The outbound loss event or deferral event rules apply to any event that occurs on or after January 6, 2017, unless the deferral or loss event is undertaken with a principal purpose of recognizing Section 987 loss. In such case, those rules apply as of December 7, 2016.

Section 987 elections and recordkeeping requirements

The Treasury and IRS provided several elections in the final and temporary regulations to mitigate some of the potential complexity and compliance burden. As described in Reg. Section 1.987-1(g), any Section 987 election must be made by the owner (or the controlling domestic shareholders in the case of CFCs) and must be made by attaching a statement to the timely filed tax return for the first tax year in which the election is relevant for determining the owner's taxable income for its Section 987 QBU. Except for the grouping election and the annual deemed termination election (discussed earlier), Section 987 elections are made on a QBU-by-QBU basis. While Section 987 elections are not methods of accounting, revocation of any election requires the consent of the IRS and must be based on significantly changed circumstances or other substantial non-tax business reasons.

Under the final regulations, a taxpayer that is an owner of a Section 987 QBU must keep a copy of its Section 987 elections and maintain records that sufficiently establish the QBU's taxable income or loss and any Section 987 gain or loss. These recordkeeping requirements are not satisfied unless the owner maintains 12 categories of information specified in Reg. Section 1.987-9(b), including annual computations of unrecognized Section 987 gain or loss.

Section 988 losses realized by a borrower on an intercompany loan

In a major change from current law, the temporary regulations also address the treatment of Section 988 losses realized by a borrower on a nonfunctional currency related-party loan. Under Reg. Section 1.988-2T(b)(16)(ii), a Section 988 loss realized on a nonfunctional currency loan from a related person (within the meaning of Sections 267(b) or 707(b)) is deferred if the transaction resulting in the loss has a principal purpose of avoiding federal income tax. Any deferred loss is deferred until the end of the term of the loan, determined immediately prior to the transaction. Previously, the final Section 988 regulations reserved on the treatment of such borrowers' exchange losses. The provisions of Reg. Section 1.988-2T(b)(16)(ii) apply to any exchange loss realized on or after December 7, 2016.

Other general effective/applicability dates and transition rules

A taxpayer must transition to the final regulations on the first day of the first tax year to which the final regulations apply to a taxpayer.

In general, the final regulations apply to tax years beginning on or after one year after the first day of the first tax year following December 7, 2016 (i.e., January 1, 2018, for calendar-year taxpayers). A taxpayer may elect to apply the final regulations to tax years beginning after December 7, 2016, but only if the taxpayer consistently applies the regulations to all Section 987 QBUs directly or indirectly owned on the transition date by the taxpayer, other members of the taxpayer's US consolidated group, or any CFC of the taxpayer.

In a key change from the 2006 proposed regulations, the final regulations require all Section 987 QBUs of a taxpayer (except taxpayers that have previously applied the 2006 proposed regulations) to transition to the final regulations using the fresh start transition method described in Reg. Section 1.987-10(b). The 2006 proposed regulations generally allowed taxpayers to elect either the deferral transition method or the fresh start method. The deferral method generally preserved previously unrecognized Section 987 gain or loss, while the fresh start method did not. Because of perceived administrative difficulties with multiple transition methods and concerns about opportunistic tax-planning by taxpayers, the final regulations do not include an election to use the deferral method.

Under the fresh start transition method, the Section 987 QBU is deemed to terminate on the day before the transition date. The owner of the QBU is treated as having transferred all of its assets and liabilities attributable to the QBU to a new Section 987 QBU on the transition date. No Section 987 gain or loss is determined or recognized by the owner as a result of the deemed termination. The final regulations require detailed "Section 987 Transition Information" to be filed (or otherwise reported on a form to be published by the IRS) with the timely filed return for the first tax year to which the regulations apply, including a description of each Section 987 QBU to which the rules apply, the QBU's principal place of business, a description of the prior Section 987 method used by the taxpayer, and any assumptions used by the taxpayer for determining the exchange rates used to translate the amount of assets and liabilities transferred to the Section 987 QBU on the transition date.

Implications

The final regulations prescribe an entirely different approach to computing Section 987 gain or loss than has been used by most taxpayers for the past 30 years and impose a significant recordkeeping and compliance burden on taxpayers, regardless of whether they have previously computed Section 987 gain or loss. That said, the addition of the annual deemed termination election and certain other simplifying elections in the final and temporary regulations may help many taxpayers mitigate some of the computational difficulties under the FEEP method.

In a major change from most taxpayers' prior treatment, Section 987 gains and losses of a CFC will now be considered to generate subpart F income to the extent assets of a Section 987 QBU of the CFC generate subpart F income.

But far more importantly, the final and temporary regulations implement significant changes to the recognition of built-in Section 987 gain or loss computed under prior approaches. Specifically, taxpayers subject to the final and temporary regulations should review the pools of their Section 987 QBUs and consider the applicability dates of the final and temporary regulations as well as the consequences of the fresh start transition method, attribution rules, and the Section 987 gain and loss deferral rules. Taxpayers with built-in Section 987 gains, in particular, should consider whether to apply the final regulations early.

As noted in the preamble, under the fresh start transition method, unrecognized Section 987 gain or loss determined under a prior Section 987 method is not taken into account, and thus, any such unrecognized gains or losses existing at the time of the transition date would be permanently disallowed unless otherwise attributable to and preserved in the historic rate bases of marked assets and liabilities on the transition date. Consequently, any unrecognized Section 987 gain or loss attributable to a Section 987 QBU's nonmonetary assets or accumulated earnings will not be taken into account for US federal tax purposes. Given the strengthening of the US dollar against most other currencies in recent years, many taxpayers may not be able to benefit from unrecognized Section 987 losses.

The deferral rules in Reg. Section 1.987-12T will prevent taxpayers from recognizing Section 987 losses upon the incorporation of a QBU branch or certain transfers of QBU assets between members of a controlled group and apply immediately to transactions undertaken with a principal purpose of recognizing Section 987 loss. While the temporary regulations only defer losses, the loss may be permanently disallowed upon the fresh start transition to the final regulations. In addition, it appears that, if a transaction (or series of transactions) runs afoul of the anti-abuse rule, the loss is permanently disallowed.

Finally, all taxpayers with related-party nonfunctional currency loans (regardless of whether they own any Section 987 QBUs) should consider the new temporary rule of Reg. Section 1.988-2T(b)(16)(ii). As discussed previously, this new rule for Section 988 losses of borrowers represents a major change from prior law. Notably, the language of the rule differs from the language in Reg. Section 1.267(f)-1(e)(4) regarding the treatment of the creditor with respect to a nonfunctional currency loan, that: 1) does not specify whether the "transaction" refers to the origination of the loan itself or the event that resulted in the loss; and (2) uses a significant purpose standard rather than a principal purpose standard. Given these discrepancies, conforming amendments may be forthcoming to Reg. Section 1.267(f)-1(e)(4). Because of the December 7, 2016 effective date, and highly volatile exchange rates, taxpayers should immediately consider these new rules for any anticipated Section 988 losses resulting from actual or deemed payments or receipts involving related-party nonfunctional currency-denominated debt instruments.

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ENDNOTES

¹ The text of the temporary regulations also serves as the text of the proposed regulations. In addition, the proposed regulations request comments on how Section 987 should be applied to certain excluded entities and QBUs.

² These citations to the statute do not contain typographical errors — the subsections of Section 987 are in fact indicated by numerals and not by lower-case letters.

³ Section 989(b)(4) provides that, except as provided in regulations, the appropriate exchange rate with respect to a QBU means the average exchange rate for the tax year of the QBU.

⁴ Under the final and temporary regulations, marked items include: (i) assets or liabilities that would be Section 988 transactions (e.g., nonfunctional currency-denominated debt instruments, payables and receivables, derivatives, and cash (when disposed)) if such items were held by or entered directly by the owner of the Section 987 QBU; or (ii) prepaid expenses and liabilities for advance payments of unearned income with original terms of one year or less. Historic items are assets or liabilities that are not marked items.

⁵ For this purpose, an owner does not include another Section 987 QBU, even if that Section 987 QBU legally owns the stock of another Section 987 QBU (i.e., the final regulations adopt the "flat" approach to ownership). Also, a Section 987 QBU does not include a QBU subject to the Dollar Approximate Separate Transactions Method (DASTM) hyperinflationary currency rules of Reg. Section 1.985-3.

⁶ There are complex translation rules for cost of goods sold (COGS) under Reg. Section 1.987-3(c)(2)(iv) and 1.987-3(c)(3).

⁷ Reg. Section 1.987-5(c) defines a remittance as the excess, if any, of: (i) the aggregate of all amounts transferred from the Section 987 QBU to the owner during the tax year; over (ii) the aggregate of all amounts transferred from the owner to the Section 987 QBU during the taxa year. In general, an owner's remittance from a Section 987 QBU is determined on the last day of the owner's tax year (or, if earlier, on the day the Section 987 QBU is terminated under Reg. Section 1.987-8).

⁸ Note that nonfunctional currency-denominated derivatives entered by the QBU are not subject to this rule, and thus, may give rise to exchange gain or loss under Section 988.

⁹ This rule does not apply (and thus an election can be made on a QBU-by-QBU basis) if the QBU for which the election would be made has an unrecognized Section 987 gain or loss of $1 million or less.