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 issues of foreign currency transactions relate to the timing of recognition, the character, and the geographic source of the gains or losses. Section 988 addresses those issues. Generally, the recognition of foreign currency exchange gain or loss must be separately accounted for; that is, the gain or loss must be accounted for separately from any gain or loss attributable to the underlying transaction. For example, a U.S. company may purchase inventory from a foreign manufacturer. If the purchase price is to be paid in U.S. dollars, the inventory will be recorded at the U.S. dollar cost, and no foreign exchange gain or loss will be recognized regardless of changes in the exchange rate between U.S. currency and the foreign currency. If, on the other hand, the purchase price of the inventory items is to be paid in the currency of the foreign country and the exchange rate changes between the transaction date and the payment date (that is, when the payment in foreign currency is made), gain or loss is recognized on any change in the exchange rate between the date of purchase and the date the payment is made in foreign currency and is treated as ordinary income. The inventory is recorded at the dollar value as of the date of purchase. In addition, there must generally be a closed and completed transaction or realization event, such as the actual payment of a liability.
R. Smith, a U.S. citizen, converted $20,000 into Swiss francs at a time when the exchange rate of Swiss francs to U.S. dollars was 0.33. The 60,000 francs were deposited in a Swiss bank. One year later, when the exchange rate of francs to dollars was 0.25, Smith had not converted the 60,000 francs into other property; therefore, no loss is recognized. If the funds had been converted to U.S. dollars or any property distinguishable from a bank deposit, the loss would be recognized.
Foreign currency gain means any gain from a Section 988 transaction to the extent such gain does not exceed the gain realized because of changes in exchange rates on or after the booking date and before the payment date. A foreign currency loss means any loss from a Section 988 transaction to the extent that such loss does not exceed the loss realized because of changes in the exchange rates on or after the booking date and before the payment date. The booking date is (a) the date of acquisition, (b) the date on which the taxpayer becomes obligor, (c) the date on which an item is accrued or otherwise considered, or (d) the date a position is entered into or acquired. The payment date is the date on which payment is made or received or the date the taxpayer’s rights with respect to the position are terminated.
A taxpayer whose functional currency is the dollar acquires a debt instrument denominated in Qs for Q5,000. The debt is not part of a Section 988 hedging transaction. The exchange rate at the time of the acquisition was Q1 = $.20. If the taxpayer sells the debt instrument for Q6,000 when the exchange rate is Q1 = $.24, of the $440 gain ([Q6,000 × $.24] − [Q5,000 × $.20]), $200 is a foreign currency gain ([$.24 − $.20] × Q5,000). If the taxpayer sells the debt instrument for Q6,000 when the exchange rate is Q1 = $.167, there would be no gain or loss on the Section 988 transaction ([Q6,000 × $.1667] − [Q5,000 × $.20]) and therefore no foreign currency gain or loss. If the exchange rate at the time of the sale was Q1 = $.19, there is a gain of $140 ([Q6,000 × $.19] − [Q5,000 × $.20]) but none of it is a foreign currency gain. If the exchange rate was Q1 = $.15,