An American-based multinational must pay Federal income tax on its worldwide income. The American branch or subsidiary of a foreign business must pay Federal tax on its United States income. In both these cases, profits may be affected by fluctuations in the rates of exchange between the dollar and the other currency involved. In Part 1 of this article ([1980] 2 LMCLQ, at p. 179) we looked at the accounting problems, and the purpose of Part II is to review the income tax situation.

The general rule in Federal law is that no gain or loss is recognised for tax purposes if it results from changes in the value of currencies unless and until there has been an actual conversion into U.S. dollars. When a taxpayer receives foreign currency, however, he must include the remittance in income at the rate of exchange prevailing at the time of receipt. It will make no difference to the tax liability if the rate of exchange subsequently changes. Another situation comes about when the taxpayer has a foreign branch, because at the end of each year taxpayers must declare in U.S. dollars the value of their current assets. Stock-in-trade, for example, will be shown in the financial statement at the year-end at the U.S. value according to the rate of exchange prevailing at the date of the statement. The cost of sales for the overseas branch will be controlled by the values of the stock at the beginning and end of the period, and thus the trading profit will be affected by any difference in the exchange rates used for the stock at the two dates.

If the branch remits profits to head office during the year, remittances will be translated into dollars at the rate of exchange prevailing at the time of receipt, but any profits not remitted at the year-end will be shown in head office returns at the rate prevailing at the date of the financial statement. The overseas profits will not have been actually converted into dollars, but the tax liability will have been affected by the rates of exchange.

The requirements of the Internal Revenue Service may well in these examples accord with acceptable accounting practices, but we cannot take for granted that conformity with accounting principles will necessarily be acceptable to the IRS. A recent decision of the U.S. Supreme Court (Thor Power Tool v. Commissioner, 439 U.S. 522, 1979) has made it clear that, in the eyes of the IRS, acceptable accounting procedures do not always produce a result that represents true profits. The Thor case had to do with the valuation of stock-in-trade, and had nothing to do with foreign