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MAJOR REFERENCES:
Secs 904(d), 952, and 985-989; Regs. Sec 1.985.
U.S. corporations engaged in international business currently operate in an economic environment with unparalleled currency fluctuations. In particular, the currencies of hyperinflationary countries are marked by continued, dramatic depreciation relative to the U.S. dollar. The magnitude of the change in currency values has created enormous difficulties for U.S. corporations and their foreign-based affiliates to accurately report their true economic posture for U.S. tax purposes. In an attempt to reduce distortions due to hyperinflation in the financial statements of U.S. multinational firms, the U.S. Internal Revenue Service (IRS) recently issued final regulations regarding the computation and characterization of income, earnings, profits, and foreign tax credits for U.S. corporations with foreign-based affiliates operating in hyperinflationary economies.(1)
Specifically, U.S. multinational firms with qualified business units(2) (QBUs) (e.g., foreign branches o subsidiaries) in hyperinflationary economies such as Brazil, Colombia, Ecuador, Peru, Uruguay, Venezuela, Hungary, Poland, and Russia are now required to use the dollar as their QBUs' functional currency and use the dollar approximate separate transactions method of accounting (DASTM) to compute income or earnings and profits (or branch income) of such QBUs. On July 22, 1994, the IRS issued final regulations under Sec 985 that replaced the former regulations issued in 1989 and the proposed regulations issued in 1991. In addition, the IRS issued proposed regulations that would require a QBU using DASTM to change its functional currency when the local currency ceases to be hyperinflationary. The final regulations are effective for taxable years beginning after August 24, 1994. This article outlines the background and motivation for the issuance of the new Sec 985 regulations, the recent changes in the rules regarding the computation of income or earnings and profits under DASTM, and the implications such changes have for U.S. multinationals.
BACKGROUND
As a general rule, U.S. taxpayers operating abroad through foreign branches or subsidiary corporations that maintain their financial statements in a currency other than the U.S. dollar are required to convert(3) the operating results of such entities into U.S. dollars to determine the U.S. tax consequences of the operations of such branches or subsidiaries. In particular, Sec 987 requires that the profit or loss of a branch must be included currently in the computation of...