The Treasury and IRS have issued proposed regulations (NPRM REG-119514-15). These proposals address how to treat the foreign currency gain or loss of a controlled foreign corporation (CFC) under the business needs exclusion from foreign personal holding company income (FPHCI). Also, the proposed regulations provide an election to use a mark-to-market accounting method for foreign currency gain or loss attributable to a Code Sec. 988 transaction. Further, the proposals allow U.S. shareholders of CFCs to revoke certain elections concerning the treatment of foreign currency gain or loss. Code Sec. 988 provides special rules for the treatment of exchange gains or losses from transactions that are denominated in a currency other than the taxpayer’s functional currency or that are determined by reference to the value of one or more nonfunctional currencies. The foreign currency gain or loss is determined separately from the underlying transaction.
Generally, the proposed regulations will apply to tax years ending on or after they are published as final regulations. The proposed regulations may be relied upon with respect to bona fide hedging transactions for certain periods. Comments are requested.
Business Needs Exclusion
Foreign currency gains are generally included in the FPHCI of a CFC. FPHCI is a type of foreign base company income. Such income may be currently included in the gross income of a U.S. shareholder as subpart F income, whether or not the income is distributed to the shareholder. Foreign currency gains or losses attributable to a transaction directly relating to the business needs of the CFC are excluded from FPHCI. The business needs exclusion may also apply to foreign currency gain or loss attributable to a bona fide hedging transaction. Under the current regulations, the business needs exclusion applies only if the transaction or property does not give rise to subpart F income, other than foreign currency gain or loss.
The proposed regulations provide that the foreign currency gain or loss attributable to a transaction or property that produces both subpart F and nonsubpart F income, and otherwise satisfies the business needs exclusion, is allocated between the two types of income in proportion to the income from the transaction or property. Amounts allocated to non-subpart F income qualify for the business needs exclusion, and amounts allocable to subpart F income are included in FPHCI. This provision eliminates the “cliff effect” that prevents the exclusion from applying if there is even a de minimis amount of subpart F income. The proposed regulations allow certain transactions of a CFC undertaken to manage the exchange rate risk with respect to a CFC’s investment in a qualified business unit (QBU) to qualify for the business needs exclusion.
Timing of Foreign Currency Gains or Losses
Reg. §1.446-4 generally requires that gain or loss from a hedging transaction, as defined in Reg. §1.1221-2(b), be taken into account at the same time as the gain or loss from the item being hedged. The rules, however, do not currently explicitly apply to all bona fide hedging transactions. The proposed regulations provide that a bona fide hedging transaction, as defined in Reg. §1.954-2(a)(4)(ii), is subject to the hedge timing rules of Reg. §1.446-4. The extension of the hedge timing rules will eliminate timing mismatches for gains and losses arising from all bona fide hedging transactions and from hedged property or transactions. The proposed regulations revise the definition of a bona fide hedging transaction in Reg. §1.954-2(a)(4)(ii) to include the acquisition of a debt instrument by a CFC with respect to an interest-bearing liability of the CFC, if the acquisition has the effect of managing the CFC’s exchange rate risk.
Revocations of Elections
The proposed regulations allow a CFC to revoke its election to characterize foreign currency gain or loss arising from a specific category of subpart F income as gain or loss in that category without the consent of the IRS. Similarly, an election to treat all foreign currency gain or loss as FPHCI may be revoked without the consent of the IRS. If either election is revoked, a subsequent election cannot be made until the sixth tax year following the year of revocation. In addition, any subsequent election cannot be revoked until the sixth year following the year of the subsequent election.
Written or electronic comments and requests for a public hearing must be received by March 18, 2018. Mail comments to: CC:PA:LPD:PR (NPRM REG-119514-15), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044. Also, submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (NPRM REG-119514-15), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW., Washington, D.C. 20224, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-119514-15).
Proposed Regulations, NPRM REG-119514-15
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