CCA 200004006: Foreign currency expenses use the spot rate when accrued

Plain-English summary

A group claimed deductions for expenses paid in a foreign currency under IRS closing agreements and had translated them using the exchange rate at year end. Chief Counsel advised using the spot rate on the date each expense was accrued, consistent with § 988 and the regulations for foreign currency payables. The memo addressed expenses accrued by the specified foreign accounts for the business described in the agreements. Its analysis assumed those accounts were not qualified business units and might need revision if that assumption proved wrong.

Ruling snapshot

• Question: Which exchange rate translates the expenses allocated to income under the closing agreements?
• Outcome: Advice given: use the spot rate on each expense's accrual date.
• Key authorities: IRC § 988; Treas. Reg. §§ 1.988-1(d), 1.988-2(c)(3).

Full text (IRS public release)

                            DEPARTMENT OF THE TREASURY
                               I NTERNAL REVENUE SERVI CE
                                  WASHINGTON, D.C. 20224


                                         September 21, 1999

 Number: 200004006
 Release Date: 1/28/2000
 CC:INTL:Br5
 WTA-N-104078-99
 JWRogersIII
UILC: 988.02-03

  INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE


MEMORANDUM FOR


FROM:                 Roger M. Brown
                       Special Counsel to the Assistant Chief Counsel
                       (International - Technical)

SUBJECT:


This Field Service Advice responds to your memoranda dated February 18, 1999,
and April 22, 1999. Field Service Advice is not binding on Examination or Appeals
and is not a final case determination. This document is not to be used or cited as
precedent.


LEGEND:

Business Persons                     =
ABC                                  =
X                                    =
FX                                   =


U.S. X                               =

Country 1                            =
Country 1 X                          =
Country 1 FX                         =
Country 2                            =
Country 2 FX                         =


Expenses                             =


City 1                               =
Group 1                              =
Group 1 Manager                      =
Business 1                           =
Business 1 Activity                  =

Date 1                               =
Date 2                               =
Type 1 Income                        =
Type 2 Income                        =
Type 3 Income                        =

AA                                   =
BB                                   =
CC                                   =
DD                                   =
EE                                   =
FF                                   =
Excerpt 1                            =




ISSUE:

What is the appropriate exchange rate for translating Expenses attributable to Type
1 Income, as defined under the Closing Agreements?


CONCLUSION:

The spot rate in effect on the date the Expenses are accrued by the Country 1 X(s)
is the appropriate exchange rate for translating Expenses.


FACTS:

Our understanding of the facts is as follows. ABC, based in City 1, is an EE where
Business 1 Activity is conducted. ABC is not a traditional FF. ABC consists of
Business Persons that are organized into Group 1s controlled by Managers. Group
1s accept no AA; rather, a Group 1 provides the means by which a Manager can


accumulate and commit DD to Business 1 AA. Generally, each Business Person
belonging to a Group 1 agrees to accept a predetermined percentage of all
Business 1 on behalf of a Group 1. Business Persons delegate to Managers
authority to select AAs, set BB rates, hold BB and pay CC on their behalf. For each
Group 1, ABC maintains separate U.S. dollar, Country 1 FX, and Country 2 FX X.
We understand that it is ABC policy to match and manage BB income, Type 2
Income, and payment of CC in the same currency to avoid currency risks.

The U.S. tax consequences of ABC activities are governed by the provisions in two
sets of Closing Agreements entered into between ABC Business Persons and the
Service on Date 1, and on Date 2 (hereafter, the “Date 1 Closing Agreement” or the
“Date 2 Closing Agreement,” as the case may be; or collectively, the “Date 1 and
Date 2 Closing Agreements”). Under these closing agreements, the Type 1 Income
of each Business Person is computed separately for each taxable year and is then
Excerpt 1.

The Date 1 and Date 2 Closing Agreements provide that Business Persons shall be
entitled to claim a deduction for expenses attributable to Type 1 Income.
Generally, the portion of expenses attributable to each taxable year is to be
determined by direct allocation, where appropriate. Otherwise, attributable
expenses are determined by apportionment by multiplying such expenses by a
fraction, the numerator of which is BB included in Type 1 Income for that taxable
year and the denominator of which is all BB for that taxable year included in ABC
income.

In the vast majority of cases, Expenses are accrued ratably throughout the year and
are paid on a continuous basis in Country 1 FX through a Group 1’s Country 1 X.1
For purposes of determining Type 1 Income, the Date 1 and Date 2 Closing
Agreements do not specify the rate at which they are to be translated into U.S.
dollars or when such expenses are to be accrued. We understand that ABC current
practice is to translate Expenses into U.S. dollars at the exchange rate in effect on
the last day of each taxable year and to accrue them at that time.

You have asked whether Expenses should be translated into U.S. dollars at the
spot rate on the date they were accrued by the Country 1 X rather than at the spot
rate at the end of the taxable year. In responding to your question, we note that for


1
  As agreed, this memorandum specifically does not address those de minimis cases
where the U.S. X(s) pays Expenses attributable to U.S. dollar business or those
situations where an Business Person does not have a Country 1 X that pays Expenses
attributable to U.S. dollar business. In other words, this memorandum only addresses
those situations where a Business Person has (1) a U.S. business and (2) a Country 1
business.


the purposes of our analysis, we assume that the Country 1 X is not a qualified
business unit within the meaning of Subpart J.


LAW AND ANALYSIS:

Code section 988(c)(1)(A) defines a “section 988 transaction” as any transaction
described in Code section 988(c)(1)(B) if the amount which the taxpayer is required
to pay by reason of such transaction is denominated in terms of a nonfunctional
currency, or is determined by reference to the value of one or more nonfunctional
currencies. Code section 988(c)(1)(B)(ii) describes accruing (or otherwise taking
into account) any item of expense which is to be paid after the date on which so
accrued or taken into account. Section 988(b) and Treas. Reg. § 1.988-2(c)(3)
provide rules to measure exchange gain or loss with respect to an item of expense
that is accrued and paid on different dates. These provisions contemplate the use
of the spot rate (determined under Treas. Reg. § 1.988-1(d) principles) on the
booking date (i.e., the accrual date) to translate an item of expense into U.S.
dollars.

Based on the facts developed to date, it appears that section 988 and the
regulations thereunder govern. Under these provisions, it is the exchange rate on
the booking date that must be used to accrue the relevant expenses rather than the
exchange date at the end of the taxable year.

Similarly, under case law, an expense denominated in a foreign currency is
generally translated at the spot rate on the day the expense is accrued. See, e.g.,
Church’s English Shoes, Ltd. v. Commissioner, 24 T.C. 56 (1955), aff’d 229 F.2d
957 (2d Cir. 1956); Bennett’s Travel Bureau, Inc. v. Commissioner, 29 T.C. 350
(1957); Bernuth Lembcke Company, Inc. 1 B.T.A. 1051 (1925). Accordingly, the
Expenses, which are allocated to Type 1 Income pursuant to the Closing
Agreements, should be translated at the spot rate on the date the Expenses are
accrued by the Country 1 X.


CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS:

As noted above, the translation methodology should be the spot rate in effect on
the date Expenses are accrued by the Country 1 X(s).


Additionally, as noted above, our analysis assumes that the Country 1 X is not a
qualified business unit (QBU). If this X is a QBU, then our analysis will likely have
to be revised.

If you have any further questions, please call me at (202) 622-3830.


                                        ____________________________________
                                        Roger M. Brown
                                        Special Counsel to the Assistant Chief
                                        Counsel (International - Technical)
                                        CC:INTL