987 gain refers to the exchange gain recognized under Section 987 of the Internal Revenue Code when a Qualified Business Unit (QBU) makes a remittance to its owner. This gain represents the currency exchange fluctuations impacting the QBU's financial performance.
Understanding Section 987 Gain
Section 987 addresses the translation of income and expenses of a QBU that operates in a currency different from its owner's functional currency. The goal is to properly account for the effects of currency fluctuations on the QBU's earnings. When a QBU makes a remittance, it may trigger the recognition of previously deferred exchange gain or loss.
Key Concepts:
- QBU (Qualified Business Unit): A separate and clearly identified unit of a taxpayer's trade or business that maintains its own books and records. It essentially functions as if it were independent.
- Remittance: A transfer of funds or property from the QBU to its owner. This is the event that triggers the potential recognition of 987 gain or loss.
- Pooled and Deferred Exchange Gain or Loss: The cumulative unrealized gains or losses arising from currency fluctuations that have not yet been recognized for tax purposes. Section 987 allows for the deferral and eventual recognition of these gains and losses when remittances occur.
- Net Unrecognized Gain or Loss: The accumulated exchange gains or losses that have not yet been recognized. The amount of recognized gain or loss is proportional to the remittance.
How 987 Gain is Recognized
When a remittance is made from a QBU to its owner, a portion of the pooled and deferred exchange gain or loss is recognized. The amount recognized is generally determined by a formula that considers the size of the remittance relative to the QBU's total assets. The calculation ensures that the appropriate portion of the accumulated exchange gain or loss is taken into account in the owner's taxable income.
Example
Imagine a U.S. corporation owns a QBU in a foreign country. The QBU's functional currency is the Euro. Over several years, due to fluctuations in the Euro-Dollar exchange rate, the QBU has accumulated a deferred exchange gain of $100,000. If the QBU remits a significant portion of its Euro-denominated profits to the U.S. parent, a portion of that $100,000 gain will be recognized and included in the U.S. corporation's taxable income.
Importance of Understanding 987 Gain
Properly calculating and reporting 987 gain or loss is crucial for multinational companies to comply with tax regulations and accurately reflect their financial performance. Failing to do so can result in tax penalties and misrepresentation of a company's true earnings.
