Rev. Rul. 74-351

The purpose of this Revenue Ruling is to up-date and restate, under the current statute and regulations, the positions set forth in Mim. 6475, 1950-1 C.B. 50; Mim. 6494, 1950-1 C.B. 54; Mim. 6584, 1951-1 C.B. 19; and I.T. 4037, 1950-2 C.B. 31.

The questions presented pertain to the treatment of blocked foreign income for Federal income tax purposes.

Question 1. What does the term "deferrable income" mean in the context of blocked foreign income?

Answer: For the purpose of this Revenue Ruling the term "deferrable income" is used to describe income received by, credited to the account of, or accrued to a taxpayer that, owing to monetary, exchange or other restrictions imposed by a foreign country, is not readily convertible into United States dollars or into other money or property which is readily convertible into United States dollars.

Question 2. How does a taxpayer account for and report "deferrable income" for Federal income tax purposes?

Answer: A taxpayer, whether individual, corporate, or other, may elect, pursuant to the provisions of section 446 of the Internal Revenue Code of 1954, to use a method of accounting to which the reporting of "deferrable income" as taxable income is deferred until the income ceases to be deferrable.

A taxpayer who elects to use the deferred income method of accounting shall file with his Federal income tax return an information return upon which is affixed the heading "Report of Deferrable Foreign Income, pursuant to Rev. Rul. 74-351," using for this purpose a separate Federal income tax return of the same type as that with which it is filed. The taxpayer shall declare in such information return that the "deferrable income" will be included in taxable income for the year in which such income, to the extent thereof, ceases to be "deferrable income" and that he waives any right to claim that the "deferrable income," or any part thereof, was includible in his gross income for any earlier year.

All amounts reported on the information return shall be reported in terms of foreign currency involved. If "deferrable income" is received, credited, or accrued to the account of the taxpayer in more than one foreign country, a separate information return shall be included for each country.

Where the taxpayer adopts the method of accounting provided for by this Revenue Ruling, losses incurred in the production of "deferred income" shall be taken into account under the rules for the deferment stated herein. See Rev. Rul. 57-166, 1957-1 C.B. 191, which pertains to the treatment for Federal income tax purposes of capital gains and losses allocable to blocked foreign income under the "deferred income" method of accounting.

Question 3. When should the taxpayer make an election mentioned above?

Answer: An election to use the method of accounting described in this Revenue Ruling shall be made no later than the time prescribed by law (including any extension thereof) for filing the income tax return for the first taxable year for which the election is made.

A taxpayer who adopts such method of accounting shall, before making any changes or variation therein, secure the consent of the Commissioner of Internal Revenue pursuant to the provisions of section 1.446-1(e) of the Income Tax Regulations.

Question 4. When will "deferrable income" cease to be "deferrable income?"

Answer: Income will cease to be "deferrable income" under the following conditions:

(a) When such money or property in such foreign country is readily convertible into United States dollars or into other money or property which is readily convertible into United States dollars;

(b) When, notwithstanding the existence of any laws or regulations forbidding the exchange of money or property into United States dollars, conversion is actually made into United States dollars or into other money or property which is readily convertible into United States dollars; or

(c) When such income is used for non-deductible personal expenses, is disposed of by way of gift, bequest, devise, inheritance, or by dividend or other distribution, or, in the case of a resident alien, such alien terminates his residence in the United States.

Question 5. How are expenses "paid or incurred" or "paid or accrued" in the foreign country in which there is "deferrable income" treated for Federal income tax purposes?

Answer: Expenses paid or incurred or paid or accrued in the currency of the country in which there is "deferrable income" are not deductible from the gross income reported in United States dollars, except in the manner and to the extent provided in section 1.461-1(a)(4) of the regulations, which pertain to deductions attributable to certain foreign income. Thus, such expenses will be deductible in any subsequent taxable year in the same proportion as the "deferrable income" is includible in gross income. The same treatment shall be accorded depreciation, obsolescence and depletion measured in terms of the currency of the foreign country involved. Similarly, no credit may be taken for foreign taxes paid or accrued with respect to "deferrable income" except in the manner and to the extent provided in section 1.905-1(b) which pertains to foreign income subject to exchange controls.

Question 6. How is the taxpayer to deduct costs and direct expenses paid or incurred in United States dollars in a transaction that gives rise to "deferrable income?"

Answer: Costs in United States dollars involved in a transaction that gives rise to "deferrable income" are not deductible from gross income as stated in the Answer to Question 5. When any part of such "deferrable income" ceases to be "deferrable income" the unrecovered costs in United States dollars shall be applied against the amount released for the purpose of determining the amount to be reported in gross income. The foregoing rules as to costs apply not only to the cost of goods taken out of inventory but also to the cost (or other basis) of other assets sold or exchanged. Direct expenses paid or incurred in United States dollars involved in a transaction giving rise to "deferrable income" are not deductible from gross income until after recovery of costs. Such direct expenses are then deductible but only in the proportion that the part of the released "deferrable income" includible in gross income for the taxable year bears to the proceeds from the transaction in excess of the amount applied against costs (or such expenses may, with the consent of the Commissioner, be deducted to the extent that such proceeds are includible in gross income).

The above provisions may be illustrated by the following example: A United States manufacturer sold merchandise in foreign country X for 2,000 units of country X currency. The cost of the merchandise sold was $700 and the direct expenses attributable to the sale were $100. One unit of country X's currency was worth 50cent. at the prevailing foreign exchange rate. In the taxable year of the sale, the manufacturer was allowed by the Government of country X to exchange 1,500 units into United States dollars at the exchange rate of 50cent. per unit, or $750. The amount to be included in gross income is computed as follows:

           Item         Total        Reportable       Deferred

Direct Expenses X Released "deferrable income" included in gross

Rev. Rul. 57-379, 1957-2 C.B. 299, provides that a partial remittance of unblocked foreign income from prior years, constituting that part of deferred income that ceased to be deferrable, shall be included in taxable income, with proper deductions allocated thereto, in the year it is unblocked on the basis of first-in first-out, so that such remittance shall be regarded as part of the earliest blocked income.

Where the same costs and direct expenses in United States dollars are applied in foreign operations in more than one country (as, for example, in the case of an article exhibited or circulated in various countries), and the taxpayer in keeping its books does not regularly allocate such costs and expenses on a country-by-country basis under a recognized method, the taxpayer shall, for the taxable year in which he elects "deferrable income" make an allocation under a recognized method in "Report of Deferrable Foreign Income. . . ." attached to the taxpayer's Federal income tax return. See Answers to Questions 2 and 3 of this Revenue Ruling for rules relating to reporting of "deferrable income" and time for election. The method of allocation will be subject to verification and approval by the District Director upon examination of the income tax return and "Report of Deferrable Foreign Income. . . ."

If and when it becomes apparent that any foreign holdings which reflect the receipt of "deferrable income" are substantially worthless, the taking into account for tax purposes of costs and direct expenses pertaining thereto shall no longer be deferred.

Nothing contained in this Revenue Ruling shall be construed as passing on the question of whether expenditures attributable to foreign operations constitute ordinary and necessary business expense.

Question 7. How are the provisions of this Revenue Ruling to be applied where funds representing "deferrable income" are used to purchase investment or business property?

Answer: Where funds representing blocked income which have been deferred are used for the purchase of investment or business property, such property has a "deferred income basis" measured by its costs in terms of the blocked foreign currency. This transaction must be reported in the "Report of Deferrable Foreign Income. . . ." filed for the taxable year in which such transaction occurs. Such "report" must show, in terms of foreign currency, the amount of blocked income, the amount invested in such property together with all the adjustments thereto of the type authorized by the Internal Revenue Code.

When such income ceases to be "deferrable income", the amount thereof, translated into terms of United States currency at the rate of exchange prevailing at that time, is includible in the taxpayer's gross income and the amount invested in the property, as adjusted must similarly be translated into United States dollars. The amount thus translated is the actual basis of the property. See the Answer to Question 5 with respect to depreciation on such property. Upon the subsequent disposition of the property, such basis will be used in ascertaining gain or loss under the provisions of the Code and regulations.

Mims. 6475, 6494, 6584, and I.T. 4037 are hereby superseded, since the positions stated therein are restated under the current law in this Revenue Ruling.

¹ Prepared pursuant to Rev. Proc. 67-6, 1967-1 C.B. 576.