# United States: How To Calculate Gain Or Loss On Payables & Receivables Denominated In Nonfunctional Currency

Last Updated: May 8 2017
Article by

### INTRODUCTION

If all currencies were pegged to one single standard and did not fluctuate in value among themselves, the concept of currency gain and loss would not be needed. To illustrate, if two foreign currency units ("F.C.U.") were to equal one U.S. dollar ("U.S.D."), each time an invoice for F.C.U. 50 would be received and ultimately paid, a U.S. taxpayer would know that the amount set forth in the invoice and the amount of the payment would equal U.S.D. 25. However, major currencies tend to fluctuate. An invoice received for F.C.U. 50 may be worth U.S.D. 25 at the time the invoice is received but worth only U.S.D. 23 at the time the invoice is paid. In this set of circumstances, a uniform method must be applied to identify the amount of the transaction when the books and records of the business are stated in U.S.D. In our example, a U.S. business satisfying an invoice denominated in the amount of F.C.U. 50 could be booked at (i) U.S.D. 25, the value of the foreign currency on the date of receipt, or (ii) at U.S.D. 23, the date of the payment, or (iii) at U.S.D. 25 as a payable satisfied with U.S.D. 23 and U.S.D. 2 as some income or gain.

In an International Practice Unit,1 the Large Business and International ("LB&I") Di­vision of the I.R.S. provided a broad overview of how currency gains and losses are recognized for U.S. tax purposes. In simple terms, currency gains and losses reflect the movement in value of a transaction between the booking date and the payment date when the transaction is denominated in a foreign currency in relation to the taxpayer.

### BASIC CONCEPTS

Transactions generally are accounted for in a taxpayer's functional currency. The functional currency of a U.S. taxpayer, such as a U.S. corporation, generally is U.S.D.

Regardless of its functional currency, a taxpayer's U.S. tax liability must be deter­mined and paid in U.S.D. Thus, when U.S. taxpayers engage in business or invest­ment transactions denominated in foreign currency, foreign currency amounts must be translated into U.S.D. As discussed in detail below, such transactions may give rise to functional currency gain or loss.

A qualified business unit ("Q.B.U.") is a separate and clearly identified unit of a trade or business of a taxpayer which maintains separate books and records. Ev­ery corporation, whether domestic or foreign, is a Q.B.U. Further, an activity of a corporation may be a Q.B.U. if it is a trade or business and a separate set of books and records are maintained. For example, the London office of a U.S. corporation may be a Q.B.U. if its activities constitute a trade or business and if separate books are kept for the office.

A Q.B.U., as a separate and clearly identified unit of a U.S. taxpayer, may have a functional currency other than U.S.D. if (i) the economic environment in which a sig­nificant part of the Q.B.U.'s activities are conducted is not U.S.D. and (ii) the Q.B.U. does not keep its books and records in U.S.D. For example, a foreign branch of a U.S. corporation may have a functional currency that is not U.S.D.

### SECTION 988 TRANSACTIONS

Since transactions generally are accounted for in the taxpayer's or Q.B.U.'s func­tional currency, certain nonfunctional currency transactions, called "Section 988 Transactions" give rise to functional currency gain or loss. Internal Revenue Code ("Code") §988 applies to several types of transactions involving a taxpayer's non­functional currency.

Among the Section 988 Transactions are those described as "accruing (or otherwise taking into account) any item of expense or gross income or receipts which is to be paid or received after the date on which so accrued or taken into account."2 Thus, for example, an account payable or account receivable that is held by a taxpayer and denominated in nonfunctional currency is subject to Code §988. Also, treated as Section 988 Transactions are the acquisition of a debt instrument (or becoming the obligor of a debt instrument); the acquisition of any forward contract, futures contract, option, or similar financial instrument; and the disposition of nonfunctional currency.

The following diagram illustrates that, in a simple cross-border loan, one party or the other will incur a currency loss or gain in connection with movements in the value of the currency in which the principal is denominated. In the example, the C.F.C. is exposed to currency risk, as the amount owed to its parent, U.S. Corp, will rise and fall with the relative fluctuations in currency.

Note that for financial accounting purposes the gain or loss is realized on an im­mediate basis.3 For tax purposes, the gain or loss is deferred until a payment of principal is made.

The following diagram illustrates that not all movements in the value of a currency result in a foreign currency gain or loss. In the example, U.S. Corp is an accrual basis taxpayer with U.S.D. as its functional currency. It borrows F.C.U. 100 from a bank in 2017. Interest accrues quarterly on the loan. The loan from bank is a five-year note with a face amount of F.C.U. 100.

U.S. Corp separately orders a machine for F.C.U 100. The invoice for the machine is payable at 60 days upon delivery. The value of F.C.U. 100 at the time of delivery is U.S.D. 110. At the time the invoice is paid, the value of F.C.U. 110 is U.S.D 105.

In the foregoing scenario, the tax results of the loan and the purchase are as follows:

• The purchase of the machine is not a Section 988 Transaction. U.S. Corp records an asset for \$110 and an account payable of \$110 when the machine is received.
• The payment of the F.C.U. account payable is a Section 988 Transaction and gives rise to foreign currency gain or loss. Here, there is ordinary gain of \$5. The gain is U.S.-source gain under the residence rule of sourcing.
• The five-year note denominated in terms of F.C.U. gives rise to currency gain or loss at the time of payment of principal. To the extent that accrued interest is paid with currency that has appreciated or depreciated in value between the booked date and the payment date, the gain or loss will be recognized.

### THE CALCULATION

As discussed above, a U.S. taxpayer or Q.B.U. must compute its foreign currency gains or losses on its Section 988 Transactions,4 which include transactions involv­ing the accrual of an expense (such as an account payable) or income (such as an account receivable) that is paid or received after the accrual date and denominated in a currency other than the taxpayer's or the Q.B.U.'s functional currency.

The exchange gain or loss on an account payable or an account receivable is rec­ognized on the date that the payment of nonfunctional currency is made or received.

The exchange gain or loss on an item of gross income or receipt recorded as an account receivable that is denominated in a nonfunctional currency is computed as follows:

1. Determine the nonfunctional currency accrued as an account receivable.
2. Multiply that amount by the spot rate at the booking date.
3. Determine the nonfunctional currency received as payment on the account receivable.
4. Multiply that amount by the spot rate on the payment date.
5. Subtract 2 from 4.

The exchange gain or loss on an item of expense recorded as account payable that is denominated in a nonfunctional currency is computed in a similar fashion:

1. Determine the nonfunctional currency paid on the account payable.
2. Multiply that amount by the spot rate at the booking date.
3. Determine the nonfunctional currency accrued as an account payable.
4. Multiply that amount by the spot rate on the payment date.
5. Subtract 2 from 4.

Further, the regulations allow a taxpayer or Q.B.U. to utilize a spot rate convention, to be determined at intervals of one quarter year or less, when computing exchange gains or losses on nonfunctional currency accounts receivable and payable. Al­ternatively, the taxpayer or Q.B.U. may use the spot rate at the actual booking or payment dates. The recognition date is the date on which the payment is made or received.

The following examples illustrate the calculation of exchange gain on an account payable and exchange loss on an account receivable. In each example, U.S. Corp is a calendar year corporation with U.S.D. as its functional currency. The last exam­ple illustrates the spot rate convention option on a monthly basis.

Example 1: Exchange Gain or Loss on Satisfaction of an Account Payable in Nonfunctional Currency

On January 15, 2017, U.S. Corp purchases inventory on account from a whol­ly-owned foreign subsidiary, C.F.C. 1, for F.C.U. 10,000. The spot rate on that day is F.C.U. 1 = U.S.D. 0.55.

On February 23, 2017, when U.S. Corp makes payment of the F.C.U. 10,000 ac­count payable, the spot rate is F.C.U. 1 = U.S.D. 0.50. Accordingly, U.S. Corp will realize an exchange gain on the F.C.U. 10,000 account payable.

U.S. Corp's gain is computed by first multiplying F.C.U. 10,000 by the spot rate on the booking date:

• F.C.U. 10,000 x U.S.D. 0.55 = U.S.D. 5500

Then, F.C. 10,000 is multiplied by the spot rate on the payment date:

• F.C.U. 10,000 x U.S.D. 0.50 = U.S.D. 5000

Finally, the translated amount booked is subtracted from the translated amount paid:

• U.S.D. 5500 – U.S.D. 5000 = U.S.D. 500

Accordingly, U.S. Corp's exchange gain on the transaction is U.S.D. 500. The char­acter of the exchange gain is ordinary.

Also, note that there could be an exchange gain or loss on the disposition of F.C.U. by U.S. Corp, depending on when U.S. Corp acquired the F.C.U.

Example 2: Exchange Gain or Loss on Receipt of an Account Receivable in Nonfunctional Currency

On January 15, 2017, U.S. Corp sells inventory to a wholly-owned foreign subsidi­ary, C.F.C. 2, for F.C. 10,000. The spot rate on that day is F.C.U. 1 = U.S.D. 0.55.

On February 23, 2017, when U.S. Corp receives the payment of the F.C.U. 10,000 account receivable from C.F.C. 2, the spot rate is F.C.U.1 = U.S.D. 0.50. Accord­ingly, on that date, U.S. Corp will realize an exchange loss on the F.C.U. 10,000 account receivable.

U.S. Corp's loss is computed by first multiplying F.C.U. 10,000 by the spot rate on the date the F.C.U. 10,000 are received.

• F.C.U. 10,000 x U.S.D. 0.50 = U.S.D. 5000

Then, F.C.U. 10,000 is multiplied by the spot rate on the booking date:

• F.C.U. 10,000 x U.S.D. 0.55 = U.S.D. 5500

Finally, the translated amount booked is subtracted from the translated amount re­ceived:

• U.S.D. 5000 – U.S.D. 5500 = U.S.D. (500)

Accordingly, U.S. Corp's exchange loss on the transaction is U.S.D. 500. The char­acter of the exchange loss is ordinary.

Again, note that there could be an exchange gain or loss on the disposition of F.C.U. by U.S. Corp, depending on when U.S. Corp acquired the F.C.U.

Example 3: Spot Rate Convention Option

U.S. Corp uses a spot rate convention to determine the spot rate as provided under the regulations.

The spot rate determined under the spot rate convention for the month of January is F.C.U. 1.00 = U.S.D. 0.54 and for the month of February is F.C.U. 1.00 = U.S.D. 0.51.

On January 15, 2017, U.S. Corp sells inventory for F.C.U. 10,000. On February 23, 2017, U.S. Corp receives payment for the inventory of F.C. U. 10,000.

As a result, on the last date in February, U.S. Corp will realize exchange loss. The exchange loss is computed by first multiplying the F.C.U. 10,000 by the spot rate convention for the month of February:

• F.C.U. 10,000 x U.S.D. 0.51 = U.S.D. 5100

Then, F.C. 10,000 is multiplied by the spot rate convention for the month of January:

• F.C.U. 10,000 x U.S.D. 0.54 = U.S.D. 5400

Finally, the spot rate translated amount received in February is subtracted from the spot rate translated amount accrued in January:

• U.S.D. 5,100 – U.S.D. 5400 = U.S.D. (300)

Accordingly, U.S. Corp has an exchange loss in the amount of U.S.D. 300.

### CONCLUSION

Because the value of currency fluctuates, a cross-border financial transaction that is booked in a nonfunctional currency will likely give rise to currency gain or loss when the transactional value (measured in terms of a functional currency) varies between the date of booking and the date of payment.

Footnotes

1 Document Control Number ("D.C.N.") FCU/CU/C-18.2.1_04(2016), Character of Exchange Gain or Loss on Currency Transactions, as of June 1, 2016.

2 Code §988(c)(1)(B)(ii).

3 ASC 830-20-35, formerly FAS 52.

4 The rules of Code §988 may apply to foreign taxpayers, however only in the relatively unusual case of a foreign taxpayer with a U.S. investment or business transaction denominated in a foreign currency.

To print this article, all you need is to be registered on Mondaq.com.

Authors

In association with
Related Topics

Related Articles

Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels

|
|
© Mondaq® Ltd 1994 - 2019

Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Select Regions

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

• To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
• To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
• To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

### Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

### Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

### Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

### General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions