40366 Federal Register / Vol. 63, No. 145 / Wednesday, July 29, 1998 / Rules and Regulations

List of Subjects in 21 CFR Part 862 These regulations provide rules relating subunits of the . The transition Medical devices. to adjustments required for qualified period is referred to as the ‘‘no Therefore, under the Federal Food, business units operating in such prohibition, no compulsion’’ period Drug, and Cosmetic Act and under and rules relating to the tax because during this time amounts may authority delegated to the Commissioner effect of holding such currencies or generally be denominated in the legacy financial instruments or contracts of Food and Drugs, 21 CFR part 862 is currencies and/or the euro at the option denominated in such currencies. The amended as follows: of individuals and businesses. Finally, text of these temporary regulations also by July 1, 2002, the legacy currencies PART 862ÐCLINICAL CHEMISTRY serves as the text of proposed will no longer be accepted as legal AND CLINICAL TOXICOLOGY regulations published elsewhere in this tender. DEVICES issue of the Federal Register. On May 3, 1998, the European Union DATES: These regulations are effective announced the eleven countries that 1. The authority citation for 21 CFR July 29, 1998. would initially participate in the part 862 continues to read as follows: FOR FURTHER INFORMATION CONTACT: conversion and the expected rates at Authority: 21 U.S.C. 351, 360, 360c, 360e, Howard Wiener of the Office of which the respective currencies would 360j, 371. Associate Chief Counsel (International), convert to the euro. The eleven 2. Section 862.1825 is added to (202) 622–3870, regarding the change in countries are Austria, , Finland, subpart B to read as follows: functional rules and Thomas France, Germany, Ireland, Italy, Preston of the Office of Assistant Chief , , Portugal, and § 862.1825 Vitamin D test system. Counsel (Financial Institutions and Spain. Four current members of the Products), (202) 622–3930, regarding European Union (Denmark, Greece, (a) Identification. A vitamin D test section 1001 (not toll free calls). Sweden, and the ) will system is a device intended for use in SUPPLEMENTARY INFORMATION: not participate in the initial conversion clinical laboratories for the quantitative to the euro. These countries, along with determination of 25-hydroxyvitamin D Background other countries that later join the (25–OH–D) and other hydroxylated On March 9, 1998, the IRS issued European Union, however, may convert metabolites of vitamin D in serum or Announcement 98–18 (1998–9 IRB 44) their currencies to the euro at some plasma to be used in the assessment of requesting comments relating to the tax future time. vitamin D sufficiency. issues for U.S. taxpayers operating, II. Temporary Regulations (b) Classification. Class II (special investing or otherwise conducting controls). business in a currency that is converting 1. In General Vitamin D test systems must comply to the euro. Numerous comments were with the following special controls: (1) These temporary regulations provide received. After consideration of these guidance regarding certain of the federal Labeling in conformance with 21 CFR comments, these regulations are 809.10 and (2) compliance with existing income tax consequences arising from adopted as a temporary Treasury the introduction of the euro. Consistent standards of the National Committee on decision to provide immediate guidance Clinical Laboratory Standards. with comments received from taxpayers, to taxpayers. the regulations generally minimize the Dated: July 17, 1998. Explanation of Provisions tax consequences that arise by reason of D.B. Burlington. the euro conversion. In a limited Director, Center for Devices and Radiological I. Background number of circumstances, however, the Health. The Treaty on European Union signed Treasury and IRS determined that [FR Doc. 98–20241 Filed 7–28–98; 8:45 am] February 7, 1992, (31 I.L.M. 247) considerations, such as administrative BILLING CODE 4160±01±F (entered into force November 1, 1993), feasibility, made a different result more sets forth a plan to replace the national appropriate. currencies of participating members The regulations provide guidance DEPARTMENT OF THE TREASURY (legacy currencies) that meet certain with respect to two issues: (i) the economic criteria with a single circumstances under which the euro Internal Revenue Service European currency (euro). Pursuant to conversion creates a realization event directives of the European Council, the with respect to instruments and 26 CFR Part 1 process of converting the legacy contracts denominated in a legacy [TD 8776] currencies into the euro will take place currency, and (ii) the circumstances in three phases. under which the euro conversion RIN 1545±AW34 On January 1, 1999, the currency of constitutes a change in functional Conversion to the Euro participating member states of the currency for a qualified business unit European Union shall be the euro. At (QBU) whose functional currency is a AGENCY: Internal Revenue Service (IRS), that time, the euro will be substituted legacy currency, and certain Treasury. for the currency of each state at a consequences thereof. conversion rate established pursuant to ACTION: Final and temporary 2. Realization regulations. the Treaty on European Union. Thereafter, the bills and coins of each of The temporary regulations provide SUMMARY: This document contains the legacy currencies will remain in that the conversion of legacy currencies temporary Income Tax Regulations circulation but will cease to have to the euro does not result in a relating to U.S. taxpayers operating, independent value apart from the euro. realization event under section 1001. investing or otherwise conducting On January 1, 2002, euro bills and coins This rule is broadly applicable to all business in the currencies of certain will be introduced into circulation. situations where the rights and European countries that are replacing From January 1, 1999, until June 30, obligations of a taxpayer are altered their national currencies with a single, 2002 (transition period), the legacy solely by reason of the euro conversion. multinational currency called the euro. currencies will remain in circulation as Thus, conversion to the euro of legacy Federal Register / Vol. 63, No. 145 / Wednesday, July 29, 1998 / Rules and Regulations 40367 currency held by a taxpayer and The euro conversion implicates the accounts are generally turned over conversion of legacy currency policy concerns underlying § 1.985–5, rapidly and the administrative burdens denominated contractual relationships, namely, the preservation of built-in in tracking exchange gains and losses financial instruments, and other claims exchange gains and losses arising from outweigh the benefits of deferral. or obligations are not realization events the fact that positions that had once The regulations also provide special solely as a result of the conversion. In been denominated in a nonfunctional rules for taking into account exchange addition, as a result of this rule, currency will now be made or received gain or loss when the taxpayer and a exchange gains and losses on section in a QBU’s functional currency. branch of the taxpayer change their 988 transactions denominated in a In the context of the euro conversion, functional currencies to the euro. The legacy currency will not be taken into two items are of particular concern in rules provide that exchange gains and account until a subsequent realization properly accounting for exchange gains losses on unremitted earnings of event with respect to the underlying and losses: (1) section 988 transactions affected branches be recognized ratably instrument. For example, when the denominated in a legacy currency other over a four-year period beginning in the Dutch is converted into the euro, than the QBU’s legacy functional year of change. Some commentators a U.S. dollar functional currency currency, and (2) unremitted earnings of recommended that the principles of taxpayer will not recognize either a branch with a legacy functional section 987 continue to be applied after market gain or loss or exchange gain or currency different from the home the conversion. As in the case with loss on a fixed interest rate Dutch office’s legacy functional currency. In cash, however, the Treasury and IRS guilder debt instrument. both these instances, positions that had believe that the administrative burdens Other aspects of the euro conversion previously been accounted for in a for taxpayers and the government as may result in taxable events. For nonfunctional currency (against which well as the potential for abuse, outweigh example, if an unscheduled fractional exchange gains and loses would be the benefit of extended deferral. principal payment is made on a debt computed) will, after the conversion, be These temporary regulations also instrument in order to facilitate a accounted for in (against which provide rules for the proper translation rounding convention, this payment is exchange gains and losses would not be of a QBU’s balance sheet accounts in a accounted for under the rules governing computed when a QBU’s functional manner that preserves any accrued but payments on debt instruments (such as currency is also the euro). unrecognized currency gain or loss. §§ 1.446–2 and 1.1275–2) and under Rather than requiring immediate These rules are consistent with the section 988 (in the case of a section 988 recognition, as would be required under existing § 1.985–5, change in functional transaction). Other changes may or may § 1.985–5, the temporary regulations currency rules. not constitute realization events provide special rules for the euro III. Other Issues depending on the terms of the changes. conversion. These rules provide that for For example, accrual periods, holiday affected section 988 transactions (other Finally, these regulations do not conventions or indices on a floating rate than transactions in or holdings of address certain issues that taxpayers instrument may be altered. Whether nonfunctional currency cash), exchange have commented upon that are not these changes are realization events gains and losses that would have been unique to the euro conversion. In must be determined under existing law. recognized immediately if the § 1.985–5 particular, these regulations do not See, e.g., § 1.1001–3. change in functional currency rules address the deductibility of costs Limitations that under otherwise applied will be deferred until otherwise associated with the euro conversion and applicable principles prevent or defer realized. This is accomplished by foreign tax credit mismatches that can the recognition of realized gains and providing that section 988 transactions occur as a result of tax accounting losses continue to apply. Thus, for continue to be treated as nonfunctional differences between the example, recognition of losses between currency transactions under the and other countries. related parties under section 267 and principles of section 988 even though Special Analysis § 1.988–1(a)(10) remain subject to the the remaining payments on the asset or limitations set forth in those sections. liability will be made in the QBU’s new It has been determined that this functional currency (i.e., the euro). Treasury decision is not a significant 3. Change in Functional Currency In response to comments by regulatory action as defined in The regulations provide that QBUs taxpayers, an election is provided for Executive Order 12866. Therefore, a with a legacy functional currency will QBUs to realize exchange gain or loss on regulatory assessment is not required. It be deemed to have automatically accounts receivable and payable has also been determined that section changed their functional currency to the immediately prior to the year of change. 553(b) of the Administrative Procedures euro at the beginning of the year they A QBU making this election must Act (5 U.S.C. chapter 5) and the are required to make such change. realize exchange gains and losses on all Regulatory Flexibility Act (5 U.S.C. Because of the significant administrative of its accounts receivable and payable chapter 6) do not apply to these burdens that will be imposed on QBUs that are legacy currency denominated regulations, and therefore, a Regulatory when they are required to change their section 988 transactions. The election Flexibility Analysis is not required. internal systems to accommodate the responds to the administrative burdens Pursuant to section 7805(f) of the introduction of the euro, the regulations associated with tracking exchange gains Internal Revenue Code, these temporary provide that a QBU that currently uses and losses on large quantities of regulations will be submitted to the a legacy functional currency is deemed accounts receivable and payable. Chief Counsel for Advocacy of the Small to automatically change its functional Taxpayers not making the election will Business Administration for comment currency to the euro in the year the QBU continue to treat these positions as on their impact on small business. changes its books and records to the section 988 transactions under the Drafting Information: The principal euro. That change, however, must be general rule described above. authors of these regulations are Howard made no later than the last taxable year Exchange gains and losses on A. Wiener of the Office of the Associate beginning on or before the first day such transactions in, or holdings of, Chief Counsel (International) and legacy currency is no longer valid legal nonfunctional currency cash are Thomas Preston of the Office of tender. recognized immediately because cash Associate Chief Counsel (Domestic). 40368 Federal Register / Vol. 63, No. 145 / Wednesday, July 29, 1998 / Rules and Regulations

Other personnel from the IRS and (A) That begins on or after the day basis or amount of liabilities multiplied Treasury Department also participated that the euro is substituted for that by the applicable conversion rate. in their development. legacy currency (in accordance with the (3) Taking into account exchange gain Treaty on European Union); and List of Subjects in 26 CFR Part 1 or loss on legacy currency section 988 (B) In which the QBU begins to transactions—(i) In general. Except as Income taxes, Reporting and maintain its books and records (as provided in paragraphs (c)(3) (iii) and recordkeeping requirements. described in § 1.989(a)–1(d)) in the euro. (iv) of this section, a legacy currency Adoption of Amendments to the (ii) Notwithstanding paragraph denominated section 988 transaction Regulations (b)(2)(i) of this section, a QBU with a (determined after applying section legacy currency as its functional 988(d)) outstanding on the last day of Accordingly, 26 CFR part 1 is currency is required to change its the taxable year immediately prior to amended as follows: functional currency to the euro no later the year of change shall continue to be PART 1ÐINCOME TAXES than the last taxable year beginning on treated as a section 988 transaction after or before the first day such legacy the change and the principles of section Paragraph 1. The authority citation currency is no longer valid legal tender. 988 shall apply. for part 1 continues to read in part as (iii) Consent of Commissioner. A (ii) Examples. The application of this follows: change made pursuant to paragraph paragraph (c)(3) may be illustrated by Authority: 26 U.S.C. 7805 * * * (b)(2)(i) of this section shall be deemed the following examples: to be made with the consent of the Par. 2. In § 1.985–1, paragraph (c)(6) Example 1. X, a calendar year QBU on the is amended by adding a sentence at the Commissioner for purposes of § 1.985– cash method of accounting, uses the end to read as follows: 4. A QBU changing its functional deutschmark as its functional currency. X is currency to the euro pursuant to this not described in section 1281(b). On July 1, § 1.985±1 Functional currency. paragraph (b)(2) must make adjustments 1998, X converts 10,000 deutschmarks(DM) * * * * * as provided in paragraph (c) of this into Dutch (fl) at the spot rate of fl1 (c) * * * section. = DM1 and loans the 10,000 guilders to Y (an (6) * * * For special rules relating to (3) Statement to file upon change. unrelated party) for one year at a rate of 10% the conversion to the euro, see § 1.985– With respect to a QBU that changes its with principal and interest to be paid on June 8T. functional currency to the euro under 30, 1999. On January 1, 1999, X changes its functional currency to the euro pursuant to * * * * * paragraph (b)(2) of this section, an this section. The euro/deutschmark affected taxpayer shall attach to its conversion rate is set by the European § 1.985±4 [Amended] return for the taxable year of change a Council at ÷ 1= DM2. The euro/guilder Par. 3. In § 1.985–4, the last sentence statement that includes the following: conversion rate is set at ÷ 1 = fl2.25. of paragraph (a) is amended by ‘‘TAXPAYER CERTIFIES THAT A QBU Accordingly, under the terms of the note, on removing the reference ‘‘§ 1.985–2’’ and OF THE TAXPAYER HAS CHANGED June 30, 1999, X will receive ÷ 4444.44 adding ‘‘§ 1.985–2 or 1.985–8T’’ in its ITS FUNCTIONAL CURRENCY TO THE (f110,000/2.25) of principal and ÷ 444.44 place. EURO PURSUANT TO TREAS. REG. (fl1,000/2.25) of interest. Pursuant to this Par. 4. Section 1.985–8T is added to § 1.985–8T.’’ For purposes of this paragraph (c)(3), X will realize an exchange read as follows: loss on the principal computed under the paragraph (b)(3), an affected taxpayer principles of § 1.988–2(b)(5). For this § 1.985±8T Special rules applicable to the shall be in the case where the QBU is: purpose, the exchange rate used under European Monetary Union (conversion to a QBU of an individual U.S. resident (as § 1.988–2(b)(5)(i) shall be the guilder/euro the euro) (temporary). a result of the activities of such conversion rate. The amount under § 1.988– (a) Definitions—(1) Legacy currency. individual), the individual; a QBU 2(b)(5)(ii) is determined by translating the fl A legacy currency is the national branch of a U.S. corporation, the 10,000 at the guilder/deutschmark spot rate corporation; a controlled foreign on July 1, 1998, and translating that currency of a participating member state deutschmark amount into euros at the of the European Union used prior to the corporation (as described in section 957)(or QBU branch thereof), each deutschmark/euro conversion rate. Thus, X substitution of the euro for the national will compute an exchange loss for 1999 of currency of that state in accordance United States shareholder (as described ÷ 555.56 determined as follows: [÷ 4444.44 with the Treaty on European Union in section 951(b)); a partnership, each (fl10,000/2.25)–÷ 5000 ((fl10,000/1)/2) =– signed February 7, 1992. The term partner separately; a noncontrolled ÷ 555.56]. Pursuant to this paragraph (c)(3), legacy currency shall also include the section 902 corporation (as described in the character and source of the loss are . section 904(d)(2)(E)) (or branch thereof), determined pursuant to section 988 and (2) Conversion rate. The conversion each domestic shareholder as described regulations thereunder. Because X uses the rate is the rate at which the euro is in § 1.902–1(a)(1); or a trust or estate, cash method of accounting for the interest on this debt instrument, X does not realize substituted for a legacy currency. the fiduciary of such trust or estate. (c) Adjustments required—(1) In exchange gain or loss on the receipt of that (b) Operative rules—(1) Initial interest. adoption. A QBU (as defined in general. A QBU that changes its Example 2. (i) X, a calendar year QBU on § 1.989(a)–1(b)) whose first taxable year functional currency to the euro pursuant the accrual method of accounting, uses the begins after the euro has been to paragraph (b) of this section must deutschmark as its functional currency. substituted for a legacy currency may make the adjustments described in On February 1, 1998, X converts 12,000 not adopt that legacy currency as its paragraphs (c)(2) through (5) of this deutschmarks into Dutch guilders at the spot functional currency. section. Section 1.985–5 shall not apply. rate of fl1 = DM1 and loans the 12,000 (2) QBU with a legacy functional (2) Determining the euro basis of guilders to Y (an unrelated party) for one year currency—(i) Required change. A QBU property and the euro amount of at a rate of 10% with principal and interest to be paid on January 31, 1999. In addition, with a legacy currency as its functional liabilities and other relevant items. The assume the average rate (deutschmark/ currency is required to change its euro basis in property and the euro guilder) for the period from February 1, 1998, functional currency to the euro amount of liabilities and other relevant through December 31, 1998 is fl1.07 = DM1. beginning the first day of the first items shall equal the product of the Pursuant to § 1.988–2(b)(2)(ii)(C), X will taxable year: legacy functional currency adjusted accrue eleven months of interest on the note Federal Register / Vol. 63, No. 145 / Wednesday, July 29, 1998 / Rules and Regulations 40369 and recognize interest income of DM1028.04 (b)(3) of this section) shall attach a legacy currency to the euro for a taxable (fl1100/1.07) in the 1998 taxable year. statement to its tax return for the taxable year during which the functional (ii) On January 1, 1999, the euro will year of change which includes the currency of a branch of the taxpayer is replace the deutschmark as the national following: ‘‘TAXPAYER CERTIFIES the euro, the taxpayer shall take into currency of Germany pursuant to the Treaty THAT A QBU OF THE TAXPAYER on European Union signed February 7, 1992. account gain or loss as determined Assume that on January 1, 1999, X changes HAS ELECTED TO REALIZE under paragraph (c)(4)(ii) of this section. CURRENCY GAIN OR LOSS ON its functional currency to the euro pursuant (6) Additional adjustments that are LEGACY CURRENCY DENOMINATED to this section. The euro/deutschmark necessary when a corporation changes conversion rate is set by the European ACCOUNTS RECEIVABLE AND Council at ÷ 1 = DM2. The euro/guilder PAYABLE UPON CHANGE OF its functional currency to the euro. The conversion rate is set at ÷ 1 = fl2.25. In 1999, FUNCTIONAL CURRENCY TO THE amount of a corporation’s euro currency X will accrue one month of interest equal to EURO.’’ A QBU making the election earnings and profits and the amount of ÷ 44.44 (fl100/2.25). On January 31, 1999, must do so for all legacy currency its euro paid-in capital shall equal the pursuant to the note, X will receive interest denominated items described in section product of the legacy currency amounts ÷ fl denominated in euros of 533.33 ( 1200/ 988(c)(1)(B)(ii). of these items multiplied by the 2.25). Pursuant to this paragraph (c)(3), X applicable conversion rate. The foreign will realize an exchange loss in the 1999 (4) Adjustments when a branch taxable year with respect to accrued interest changes its functional currency to the income taxes and accumulated profits or computed under the principles of § 1.988– euro—(i) Branch changing from a legacy deficits in accumulated profits of a 2(b)(3). For this purpose, the exchange rate currency to the euro in a taxable year foreign corporation that were used under § 1.988–2(b)(3)(i) is the guilder/ during which taxpayer’s functional maintained in foreign currency for euro conversion rate and the exchange rate currency is other than the euro. If a purposes of section 902 and that are used under § 1.988–2(b)(3)(ii) is the branch changes its functional currency attributable to taxable years of the deutschmark/euro conversion rate. Thus, from a legacy currency to the euro for foreign corporation beginning before with respect to the interest accrued in 1998, a taxable year during which the ÷ January 1, 1987, also shall be translated X will realize exchange loss of 25.13 under taxpayer’s functional currency is other § 1.988–2(b)(3) as follows: [÷ 488.89 (fl1100/ into the euro at the conversion rate. 2.25)–÷ 514.02 (DM1028.04/2) = –÷ 25.13]. than the euro, the branch’s euro equity pool shall equal the product of the (d) Effective date. This section applies With respect to the one month of interest to tax years ending after July 29, 1998. accrued in 1999, X will realize no exchange legacy currency amount of the equity gain or loss since the exchange rate when the pool multiplied by the applicable Par. 5. Section 1.1001–5T is added to interest accrued and the spot rate on the conversion rate. No adjustment to the read as follows: payment date are the same. basis pool is required. (iii) X will realize exchange loss of ÷ 666.67 (ii) Branch changing from a legacy § 1.1001±5T European Monetary Union on repayment of the loan principal computed currency to the euro in a taxable year (conversion to the euro)(temporary). in the same manner as in Example 1 during which taxpayer’s functional (a) Conversion of currencies. For [÷ 5333.33 (fl12,000/2.25)–÷ 6000 fl12,000/1)/ currency is the euro. If a branch changes purposes of § 1.1001–1(a), the 2)]. The losses with respect to accrued its functional currency from a legacy interest and principal are characterized and conversion to the euro of legacy sourced under the rules of section 988. currency to the euro for a taxable year currencies (as defined in § 1.985– during which the taxpayer’s functional 8T(a)(1)) is not the exchange of property (iii) Special rule for legacy currency is the euro, the taxpayer shall nonfunctional currency. The QBU shall for other property differing materially in realize gain or loss attributable to the kind or extent. realize or otherwise take into account branch’s equity pool under the for all purposes of the Internal Revenue principles of section 987, computed as (b) Effect of currency conversion on Code the amount of any unrealized if the branch terminated on the last day other rights and obligations. For exchange gain or loss attributable to prior to the year of change. Adjustments purposes of § 1.1001–1(a), if, solely as nonfunctional currency (as described in under this paragraph (c)(4)(ii) shall be the result of the conversion of legacy section 988(c)(1)(C)(ii)) that is taken into account by the taxpayer currencies to the euro, rights or denominated in a legacy currency as if ratably over four taxable years beginning obligations denominated in a legacy the currency were disposed of on the with the taxable year of change. currency become rights or obligations last day of the taxable year immediately (5) Adjustments to a branch’s denominated in the euro, that event is prior to the year of change. The accounts when a taxpayer changes to not the exchange of property for other character and source of the gain or loss the euro—(i) Taxpayer changing from a property differing materially in kind or are determined under section 988. legacy currency to the euro in a taxable extent. Thus, for example, when a debt (iv) Legacy currency denominated year during which a branch’s functional instrument that requires payments of accounts receivable and payable—(A) In currency is other than the euro. If a amounts denominated in a legacy general. A QBU may elect to realize or taxpayer changes its functional currency currency becomes a debt instrument otherwise take into account for all to the euro for a taxable year during requiring payments of euros, that purposes of the Internal Revenue Code which the functional currency of a alteration is not a modification within the amount of any unrealized exchange branch of the taxpayer is other than the the meaning of § 1.1001–3(c). gain or loss attributable to a legacy euro, the basis pool shall equal the (c) Effective date. This section applies currency denominated item described in product of the legacy currency amount to tax years ending after July 29, 1998. section 988(c)(1)(B)(ii) as if the item of the basis pool multiplied by the were terminated on the last day of the applicable conversion rate. No Michael P. Dolan, taxable year ending prior to the year of adjustment to the equity pool is Deputy Commissioner of Internal Revenue. change. required. Approved: July 17, 1998. (B) Time and manner of election. (ii) Taxpayer changing from a legacy With respect to a QBU that makes an currency to the euro in a taxable year Donald C. Lubick, election described in paragraph during which a branch’s functional Assistant Secretary of the Treasury. (c)(3)(iv)(A) of this section, an affected currency is the euro. If a taxpayer [FR Doc. 98–20023 Filed 7–28–98; 8:45 am] taxpayer (as described in paragraph changes its functional currency from a BILLING CODE 4830±01±U