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In T.D. 9857 effective May 13, 2019, Treasury and the IRS finalized with certain clarifications Treas. Reg. Sections 1.987-2T and -4T (related to combinations and separations of qualified business units (QBUs) subject to IRC Section 987) and Treas. Reg. Section 1.987-12T (addressing recognition and deferral of IRC Section 987 gain and loss upon certain QBU terminations and certain other transactions involving partnerships). In addition, Treasury and the IRS withdrew Treas. Reg. Section 1.987-7T (regarding the allocation of assets and liabilities of certain partnerships for purposes of IRC Section 987). No changes were made to the applicability dates of the final IRC Section 987 regulations (T.D. 9794) or certain other temporary (T.D. 9795) and proposed (REG-128276-12) IRC Section 987 regulations. Those regulations were previously delayed by Notice 2018-57 to tax years beginning on or after three years after the first date of the first tax year following December 7, 2016 (i.e., January 1, 2020, for in-scope, calendar-year taxpayers). Treasury and the IRS continue to study other provisions of the temporary regulations under IRC Section 987 that were not specifically addressed by T.D. 9857.

Background and explanation of revisions

On December 7, 2016, Treasury and the IRS released final (T.D. 9794), temporary (T.D. 9795), and proposed regulations (REG-128276-12) under IRC Section 987 (see attachment). The final regulations provide guidance to corporate and individual taxpayers on determining taxable income with respect to QBUs whose functional currency differs from their owner (each a "IRC Section 987 QBU"), as well as the timing, amount, character and source of any IRC Section 987 gain or loss arising from a QBU. The temporary regulations provided rules on combining and separating QBUs (Treas. Reg. Sections 1.987-2T and 1.987-4T), rules providing a liquidation value percentage methodology for allocating assets and liabilities of IRC Section 987 aggregate partnerships (Treas. Reg. Section 1.987-7T), and rules requiring the deferral of foreign currency gain or loss under IRC Section 987 with respect to certain transactions defined as deferral events or outbound loss events (Treas. Reg. Section 1.987-12T).

In Notice 2017-57, issued October 16, 2017, Treasury and the IRS announced that future guidance would defer the applicability dates of certain provisions of the temporary regulations and 2016 final regulations by one year. (See Tax Alert 2017-1621.) On June 25, 2018, in Notice 2018-57, Treasury and the IRS announced amendments to further delay the applicability of the 2016 final regulations and certain provisions of the temporary regulations by one additional year. Consequently, the 2016 final regulations and certain provisions of the temporary regulations apply to tax years beginning on or after three years after the first date of the first tax year following December 7, 2016 (i.e., January 1, 2020, for in-scope, calendar-year taxpayers). (See Tax Alert 2018-1241).

Executive Order 13789 (the Executive Order), issued on April 21, 2017, instructed the Secretary of the Treasury to review all significant tax regulations issued on or after January 1, 2016 and try to alleviate the burdens of those regulations. On October 16, 2017, the Secretary published a final report (82 FR 48013) indicating that the Treasury and the IRS intended to modify the 2016 final regulations to reduce their burden and compliance challenge.

Treasury and the IRS received numerous comments in response to the Executive Order and Notice 2017-38 (Implementation of Executive Order 13789) recommending the withdrawal or a delayed applicability date of Treas. Reg. Sections 1.987-2T, 1.987-4T, and 1.987-12T because of their complexity and the significant compliance burden on taxpayers. After considering the comments Treasury and the IRS decided to finalize those temporary regulations as Treas. Reg. Section 1.987-2(c)(9), 1.987-4(c)(2) and -4(f), and 1.987-12, respectively, to prevent the selective recognition of IRC Section 987 losses and deferral of IRC Section 987 gains.

After considering comments on Treas. Reg. Section 1.987-7T, Treasury and the IRS decided to withdraw Treas. Reg. Section 1.987-7T and make conforming changes to an example in Treas. Reg. Section 1.987-12. Treasury and the IRS will allow taxpayers to use any reasonable method for determining a partner's share of assets and liabilities in the books and records of an eligible QBU held indirectly through a partnership until new regulations are proposed and finalized. Thus, taxpayers may rely on Subchapter K principles or an approach similar to the liquidation value percentage method under Treas. Reg. Section 1.987-7T. To use the liquidation value percentage method, however, taxpayers would have to make corresponding adjustments to the determination of net unrecognized IRC Section 987 gain or loss.

Applicability dates

Unless a taxpayer elects under Treas. Reg. Section 1.987-11(b) to apply the regulations early, the combination and separation rules of Treas. Reg. Sections 1.987-2(c)(9), 1.987-4(c)(2) and 1.987-4(f) apply to tax years beginning on or after the day that is three years after the first day of the first tax year following December 7, 2016 (i.e., January 1, 2020, for in-scope, calendar-year taxpayers).

The deferral and outbound loss event rules of Treas. Reg. Section 1.987-12 retain the applicability dates of former Treas. Reg. Section 1.987-12T. Accordingly, Treas. Reg. Section 1.987-12 generally applies to any deferral or outbound loss event occurring on or after January 6, 2017, including any deferral or outbound loss event that occurs due to an entity classification election made under Treas. Reg. Section 301.7701-3 on or after that date. Treas. Reg. Section 1.987-12, however, applies to a deferral or outbound loss event that occurs on or after December 7, 2016, if the deferral or outbound loss event was undertaken with the principal purposes of recognizing IRC Section 987 loss. The same rule applies to any deferral or outbound loss event resulting from an entity classification election made under Treas. Reg. Section 301.7701-3 on or after December 22, 2016, that was effective before December 7, 2016, and undertaken with the principal purpose of recognizing IRC Section 987 loss.

Implications

The finalization of these temporary regulations makes permanent the combination and separation rules of former Treas. Reg. Sections 1.987-2T and -4T and the deferral event and outbound loss event rules of former Treas. Reg. Section 1.987-12T, which were otherwise scheduled to expire on December 6, 2019. While their finalization is unsurprising, there are some important implications for taxpayers.

Importance for taxable income and IRC Section 951A determinations

As discussed in prior Alerts, all owners of IRC Section 987 QBUs should be currently calculating IRC Section 987 gain or loss on an annual basis. For US owners of IRC Section 987 QBUs, IRC Section 987 determinations can directly affect taxable income, and thus, may be relevant for other US tax reform provisions, including the so-called BEAT provisions of IRC Section 59A, the interest limitation rules of IRC Section 163(j), and the IRC Section 904(d) foreign branch income basket rules. Similarly, for CFC owners of IRC Section 987 QBUs, IRC Section 987 determinations can directly affect the tested income or tested loss of a CFC under IRC Section 951A (the GILTI provisions). In making such determinations, all owners of IRC Section 987 QBUs should be considering the deferral and outbound loss event rules of Treas. Reg. Section 1.987-12, which currently apply. Taxpayers should also continue to monitor the status of the other final IRC Section 987 regulations, which continue to be delayed until January 1, 2020, for in-scope, calendar-year taxpayers under the provisions of Notice 2018-57. In addition, as first indicated in Notice 2017-57, we may see amendments to the final regulations, as "Proposed modification of regulations under [IRC Section] 987 on income and currency gain or loss with respect to a [IRC Section] 987 qualified business unit" is on Treasury's 2018–2019 Priority Guidance Plan. As of now, however, the final regulations (and the required foreign exchange exposure pool method) are generally effective January 1, 2020, for calendar-year taxpayers.

Importance for taxpayers that have engaged in deferral or outbound-loss-event transactions

Treas. Reg. Section 1.987-12(i) currently retains the fresh start coordination rules from former Treas. Reg. Section 1.987-12T(i). Consequently, all owners of IRC Section 987 QBUs that have engaged in deferral or outbound-loss-event transactions should consider the potential consequences of the fresh start transition method for any deferred IRC Section 987(3) gain or loss and related stock basis adjustments. Under Notice 2018-57, fresh start transition has been delayed until January 1, 2020, for in-scope, calendar years unless a taxpayer elected to early apply the final IRC Section 987 regulations under Treas. Reg. Section 1.987-11(b).

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ATTACHMENT

 Final and temporary US foreign currency regulations