year.The foreign QBU sends remittances to the United States.Both the first and second answer choices.
Sharp, Ltd., a foreign corporation organized in country X, is wholly owned by Palico, Inc., a domestic corporation. Sharp, Ltd. conducts all of its operations through two branches. Branch A is located in country A and branch B is located in country B. Sharp, Ltd., branch A and branch B are QBUs. The currency of country A is the Q and the currency of country B is the R. The functional currencies of Sharp, Ltd, branch A, and branch B are determined using a two-step process:
1 The functional currency of branches A and B. Branch A and branch B both conduct all of their activities in their respective local currencies. The Q is the currency of branch A and the R is the currency of branch B under GAAP. After applying the principles in the regulations, it is determined that the functional currency of branch A is the Q and the functional currency of branch B is the R.
2 The functional currency of Sharp, Ltd. Sharp, Ltd.’s functional currency is determined by disregarding the fact that A and B are branches. When A’s activities and B’s activities are viewed as a whole, Sharp, Ltd. determines that it conducts only significant activities in the R. Therefore, Sharp, Ltd.’s functional currency is the R.
During the current year, branch A had income of Q3,000 and branch B had income of R50,000 as determined under Section 987. The weighted average exchange rate for the year is Q1 = R20. Branch A’s income is translated into R60,000 for purposes of computing Sharp, Ltd.’s income and earnings and profits for the year. Therefore, the total earnings and profits of Sharp, Ltd. from branch A and branch B is R110,000 (Treasury Regulation 1.985-1(f), examples (7) and (9)).
The use of a functional currency is treated as a method of accounting. Therefore, any change in the functional currency is treated as a change in the taxpayer’s method of accounting. Permission to change functional currencies generally will not be granted unless significant changes in the facts and circumstances of the QBU’s economic environment occur. If the principles used to determine the functional currency for GAAP are substantially similar to those required for income tax purposes, permission to change functional currencies will ordinarily not be granted unless the taxpayer also changes to the new functional currency for GAAP.
Election to use the dollar as functional currency of a qualified QBU
A QBU with a functional currency other than the U.S. dollar may elect to use the dollar as its functional currency subject to regulatory guidelines. The regulations state that only eligible QBU’s are permitted to make this election. An eligible QBU means a QBU whose functional currency is (without an election) a hyperinflationary currency (Treasury Regulation 1.985-2(b)(1)). A hyperinflationary currency is the currency of a country in which the cumulative inflation during a base period is at least 100%, as determined by reference to the consumer price index of the country in the monthly issues of International Financial Statistics or a successor publication of the International Monetary Fund. If a country is not listed
A U.S. person electing to use the dollar as the functional currency for a QBU that is a branch must file Form 8819, “Dollar Election under Section 985,” with that person’s timely filed federal income tax return (including extensions) for the tax year the election is effective.
The election to use the dollar as the functional currency for other eligible QBUs (partnership, trust, or estate, CFC, branch of a CFC, or a non-CFC or branch of a non-controlled foreign corporation) is made by filing Form 8819 within 180 days after the end of the tax year for which the dollar election is effective. Prior to filing Form 8819, the controlling U.S. shareholders (or the foreign corporation, if the dollar election is made by the corporation) must provide written notice that the dollar election will be made to all U.S. persons known to be shareholders of the foreign corporation.
Form 8819 requires that the following information be provided: the name, address, and identification number of the person making the election and the tax year for which the dollar election is effective, the entity for which the election is made, including name, address, identifying number and ownership interest, the names, addresses, and identifying numbers of all persons related to the electing QBU and who are eligible QBUs or who have a branch that is an eligible QBU.
If the election is made by or for a foreign corporation the following information must be provided: the name of the foreign corporation, the country of organization or creation, and the principal place of business for each eligible QBU. In addition, foreign corporations making the election must provide the name, address, and identifying number of every U.S. person notified of the dollar election and the country where the principal place of business of the eligible QBU is located.
If an eligible QBU is a non-CFC or a branch of a non-CFC, the dollar election must be made on Form 8819 by the corporation or the majority domestic corporate shareholders on behalf of the corporation. The same rules apply for the QBUs that apply for CFCs or branches of CFCs, except that “controlling U.S. shareholders” is used instead of “majority domestic corporate shareholders.” The term majority domestic corporate shareholders means those domestic corporate shareholders who in the aggregate own greater
Immediate recognition
Deferral is not available for transactions in, or holdings of, nonfunctional currency cash. Unrealized exchange gain or loss attributable to nonfunctional legacy currency is realized as if the currency were disposed of on the last day of the taxable year immediately prior to the year of change.
Election
Taxpayers may determine that the benefit of deferral is not worth the administrative costs associated with tracking exchange gains and losses on large quantities of trade accounts. A taxpayer may elect to recognize exchange gains and losses on all accounts receivable and payable immediately prior to the year of change. The affected taxpayer must attach a statement to its tax return for the taxable year of change, which includes the following: “Taxpayer certifies that a QBU of the taxpayer has elected to realize currency gain or loss on legacy currency-denominated accounts receivable and payable upon change of functional currency to the euro.” A QBU making this election must do so for all its legacy currency denominated Section 988 transactions.
Branches of QBUs
If a branch changes its functional currency from a legacy currency to the euro when the taxpayer’s functional currency is not the euro, no adjustment to the currency basis pool is necessary. The branch’s euro equity pool is simply the product of the legacy currency and the appropriate exchange rate. However, if a branch changes its functional currency from a legacy currency to the euro for a taxable year during which the taxpayer’s functional currency is the euro, the taxpayer realizes gain or loss attributable to the branch’s unremitted earnings computed as if the branch terminated on the last day prior to the year of change. This amount is recognized ratably over four years beginning with the taxable year of change.
Section 988 transactions
Some of the principal
