SECTION 4. EXCHANGE RATES

Under section 986(a)(1), as amended by the Taxpayer Relief Act of 1997 (TRA 97), P.L. 105–34, section 1102(a)(1) (1997), taxpayers claiming foreign tax credits on an accrual basis generally must translate foreign taxes, including withholding taxes, into U.S. dollars at the average exchange rate for the taxable year to which the taxes relate. Previously, taxpayers claiming foreign tax credits on an accrual basis translated foreign taxes into U.S. dollars at the so-called “spot” rate on the date the taxes were paid. The spot rate reflects a fair market value rate of exchange available to the public for currency under a spot contract in a free market and involving representative amounts. See Treas. Reg. § 1.988–1(d)(1). TRA 97 did not change this translation rule for taxpayers claiming foreign tax credits on the cash basis. Thus, these taxpayers still translate foreign taxes into U.S. dollars at the spot rate on the payment date. See section 986(a)(2).

Nonfunctional currency dividends, including the tax credit treated as a dividend under paragraph (2)(a)(iii) of Article 10, are treated as property distributions and are included in income on the date of payment. In accordance with section 989(b)(1), such dividends are translated into dollars at the spot rate on the payment date, regardless of whether the tax

2000–6 I.R.B. 517 February 7, 2000

payer claims foreign tax credits on an accrual or cash basis.

Thus, for taxpayers claiming foreign tax credits on an accrual basis, the gross dividend is translated into U.S. dollars and included in income at the spot rate on the payment date, but taxes withheld from the dividend are translated into U.S. dollars at the average rate for the taxable year for foreign tax credit purposes. A taxpayer claiming foreign tax credits on the cash basis translates both the dividend and withholding tax into U.S. dollars at the spot rate on

26 CFR 601.202: Closing agreements.

Rev. Proc. 2000–16

the date the dividend is paid.