A Section 987 loss is the loss recognized when the value of a remittance from a Qualified Business Unit (QBU), translated into the taxpayer's functional currency at the spot rate on the date of the remittance, is less than the basis associated with that remittance.
In simpler terms: Imagine a U.S. company has a foreign branch (the QBU) that operates in a foreign currency. If the company sends money (a remittance) from that branch back to the U.S., a Section 987 loss can occur if, when that money is converted back to U.S. dollars, it's worth less than the original value (basis) of the money in the foreign currency.
Key Components to Understand:
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Qualified Business Unit (QBU): A separate and clearly identified unit of a business that maintains its own books and records. This is usually a foreign branch or subsidiary.
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Functional Currency: The currency of the economic environment in which the QBU primarily operates.
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Remittance: The transfer of funds from the QBU to the U.S. parent company (or another related entity).
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Spot Rate: The exchange rate on a specific date, usually the date the remittance is made.
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Basis: The adjusted tax basis of the assets in the QBU.
How a Section 987 Loss Arises:
- A QBU operating in a foreign currency generates profits.
- These profits increase the QBU's net asset base (and therefore the basis).
- When a remittance is made, the foreign currency is translated back to the U.S. parent's functional currency (usually U.S. dollars) using the spot rate.
- If the spot rate has decreased since the profits were earned (meaning the foreign currency is weaker compared to the U.S. dollar), the value of the remittance in U.S. dollars will be less than the basis associated with it. This results in a Section 987 loss.
Example:
Let's say a QBU has a basis of 1,000,000 Euros. It remits 500,000 Euros to its U.S. parent. The spot rate on the date of the remittance is 1 Euro = 1.10 USD. Therefore, the remittance is worth $550,000 (500,000 Euros * 1.10 USD/Euro). The basis associated with the remittance would be $500,000 (since 500,000 is half of 1,000,000). Therefore there is no section 987 gain or loss.
Now, imagine the spot rate on the date of the remittance is 1 Euro = 0.90 USD. The remittance would then be worth $450,000 (500,000 Euros * 0.90 USD/Euro). In this case, the value of the remittance is less than its basis. The result is a Section 987 loss of $50,000 ($500,000 - $450,000).
Important Considerations:
- Section 987 is a complex area of tax law. Accurately calculating Section 987 gains and losses requires a thorough understanding of the regulations and careful tracking of the QBU's assets and liabilities.
- Different methods exist for determining the basis associated with a remittance.
- Section 987 gains and losses are generally treated as ordinary income or loss.
