Foreign Currency Transaction

If a domestic corporation has a foreign subsidiary, this subsidiary will usually maintain its books and records in the currency of the country where it exists. If this subsidiary repatriates its income to U.S parent company, the U.S parent must convert it to U.S dollar before reporting it to IRS. This can lead into currency exchange gains or losses depending upon the conversion rate. Subsidiary will pay all its taxes in the currency of country where it exists. These taxes paid must be converted to U.S dollar before reporting to IRS. 

Code Section 985 (a) (b)

In general unless otherwise provided in regulations, all determinations under this subtitle shall be made in the taxpayer’s functional currency.

In general for purposes of this sub title, the term “Functional Currency” means:

Except as provided in subparagraph (b) the dollar, or

In case of a qualified business unit, the currency of the economic environment in which a significant part of such unit’s activities are conducted and which is used by such unit in keeping its books and records.

Code Section 989 (a)

(a) Qualified business unit

For purposes of this subpart, the term “qualified business unit” means any separate and clearly identified unit of a trade or business of a taxpayer which maintains separate books and records.

All domestic corporations are bound to make all their U.S tax determinations in their functional currency, which is U.S dollar. Separately qualified business units of Domestic Corporation can maintain their books in currency of the country where they operate. A foreign branch is a qualified business unit if it is separately identified unit and maintains its books and records separately.

Code Section 989 (b)

(b) Appropriate exchange rate

Except as provided in regulations, for purposes of this subpart, the term “appropriate exchange rate” means—

(1) In the case of an actual distribution of earnings and profits, the spot rate on the date such distribution is included in income,

(2) In the case of an actual or deemed sale or exchange of stock in a foreign corporation treated as a dividend under section 1248, the spot rate on the date the deemed dividend is included in income,

(3) In the case of any amounts included in income under section 951 (a)(1)(A) or 1293 (a), the average exchange rate for the taxable year of the foreign corporation, or

(4) In the case of any other qualified business unit of a taxpayer, the average exchange rate for the taxable year of such qualified business unit.

For purposes of the preceding sentence, any amount included in income under section 951 (a)(1)(B) shall be treated as an actual distribution made on the last day of the taxable year for which such amount was so included.

Code Section 987

In the case of any taxpayer having 1 or more qualified business units with a functional currency other than the dollar, taxable income of such taxpayer shall be determined—

(1) By computing the taxable income or loss separately for each such unit in its functional currency,

(2) By translating the income or loss separately computed under paragraph (1) at the appropriate exchange rate, and

(3) By making proper adjustments (as prescribed by the Secretary) for transfers of property between qualified business units of the taxpayer having different functional currencies, including—

(A) Treating post-1986 remittances from each such unit as made on a pro rata basis out of post-1986 accumulated earnings, and

(B) Treating gain or loss determined under this paragraph as ordinary income or loss, respectively, and sourcing such gain or loss by reference to the source of the income giving rise to post-1986 accumulated earnings.

So according to Code Section 989 (b) and Code Section 987, if we have a foreign branch that qualifies as a Qualified Business Unit and has different functional currency than U.S Dollar, we must convert its taxable income and foreign taxes paid in U.S Dollar before reporting to IRS.

Also according to Code Section 987 (3), if a QBU remits foreign currency or a property to Domestic Corporation its value must be converted to U.S dollar for recognition of gain or a loss.

If a foreign subsidiary pays dividends in foreign currency these must be transferred to U.S dollars using spot rate. Deemed dividends of sub part F income is also translated in U.S by using the spot rate on the last day of controlled foreign corporation’s tax year. If a domestic corporation gets a distribution from previously taxed income, it must recognize a currency exchange gain or a loss.

Code Section 988 provides rules for:

Disposition of nonfunctional currency.

Acquisition or issuance of a debt obligation denominated in a nonfunctional currency.

Accruing an item of income or expense denominated in a nonfunctional currency.

Acquiring or entering into forward contract, future contract, options or similar instruments involving nonfunctional currency.

Disclaimer:

This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.

References:

www.jct.gov/publications.html

http://www.law.cornell.edu

http://www.irs.gov/publications

U.S Taxation of International Transactions by Robert J. Misey, Michael S. Schadewald

Introduction to United states International Taxation by Paul R. McDaniel, Hugh j. Ault and James R. Repetti

International Taxation by Joseph Isenbergh

International Taxation in a nutshell by Richard L. Doernberg.

International Income Taxation, Code and Regulations by Robert J. Peroni – CCH

Mansoor Suhail (Mani)

Accountant

BSBA – EA – ICIA – RA

Tax for Canada and U.S.A

Web: www.theaccountingandtax.com and www.taxservicesguru.com

Blog: http://taxservicesguru.blogspot.ca

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