Rev. Rul. 57-166

Advice has been requested as to the treatment for Federal income tax purposes of capital gains and losses allocable to blocked foreign income the reporting of which as taxable income has been deferred under the provisions of Mimeograph 6475, C.B. 1950-1, 50.

The taxpayer, a United States citizen previously residing in England, has resumed residence in the United States. After he gave up his English residence, he was able from time to time to convert certain of his blocked sterling assets into United States dollars. Included in the converted assets are amounts representing net gains resulting from a series of transactions occurring over a period of some ten years involving both long-term capital gains and long and short-term capital losses.

It has been questioned whether, upon conversion of the blocked sterling assets, there shall be treated as taxable long-term capital gain that proportion of each dollar realized at the date of conversion which the suspended net long-term capital gain (consisting of total long-term capital gains reduced by total long and short-term capital losses) bears to the total of such blocked sterling assets taken at book value.

Mimeograph 6475, supra , is primarily concerned with the time of reporting income arising in countries having monetary or exchange restrictions. It provides a method of accounting pursuant to which the reporting of `deferable income' may be postponed until the income ceases to be `deferable income,' at which time it is includible in gross income. The Mimeograph provides that, for the taxable year in which any `deferable income' is includible in gross income under the method provided for, the taxpayer shall include such income in gross income and claim the deductions allocable thereto, the income thus reported together with such deductions to be verified against the returns of deferable income previously filed. It is provided that expenses paid or accrued or incurred in the currency of the country in which there is deferable income will be deductible in any subsequent taxable year in the same proportion as the deferable income is includible in gross income. The same treatment is accorded to depreciation, obsolescence and depletion measured in terms of such currency.

Paragraph 8 of Mimeograph 6475, supra , provides that, where the taxpayer adopts the method of accounting provided for by the Mimeograph, losses shall also be taken into account under the rules for deferment stated therein. The question is, then, whether the `losses' referred to in this case, which may be taken into account under the rules for deferment, include capital losses. The intention of the Mimeograph is to defer such deductions as are generally allocable to the deferred income. Thus, losses incurred in the production of deferable income, as, for instance, losses incurred in carrying on a trade or business, would be deferred if the income from such business is deferred. On the other hand, a capital loss from the sale of securities, as in the present case, has no direct relation to the production of deferable income and is not attributable to income from any other operation. The recognition of capital losses is a matter of statutory grace, and the extent to which such losses may be taken into account is expressly limited by the provision of section 1211(b) of the Internal Revenue Code of 1954, that section provides that, in the case of a taxpayer other than a corporation, losses from sales or exchanges of capital assets are allowable only to the extent of the gains from such sales or exchanges, plus the taxable income of the taxpayer or $1,000.00, whichever is smaller. The Mimeograph does not expressly authorize the deferment of capital losses, and it should not be so construed, since to do so would in effect amount to the allowance of the deduction of losses which the Internal Revenue Code does not recognize.

Subchapter P of Chapter 1 of the Internal Revenue Code of 1954 applies to all capital gains and losses of a particular taxpayer for a particular year wherever such gain or losses may be incurred. In the case of a particular taxpayer who has capital gains and losses in a foreign country and is subject to Mimeograph 6475, supra , the capital losses for each year from both foreign and domestic sources should be applied against the capital gains from all sources in accordance with the statute, computing the foreign gains and losses in terms of the foreign currency and then translating the result into terms of United States currency at the official rate of exchange at the time of sale. If the net result of the transaction of the particular year is a loss, such loss should be reflected in his regular return for that year and may be carried forward as provided in the statute but not otherwise. Section 1212 of the Internal Revenue Code of 1954. If the net result is a gain, then such gain, to the extent it is derived in the United States, must be included in his regular return. To the extent the gain is derived in the foreign country, it may properly be considered as `deferable income' within the meaning of Mimeograph 6475, supra .

Accordingly, it is held, that in determining the amount of the taxpayer's income which has ceased to be deferable in any taxable year, a proportionate part of the convertible blocked assets is considered unblocked capital gains and a proportionate part is considered return of capital. The proportionate parts shall be in the same ratio that the total blocked capital gains, computed in accordance with the foregoing paragraphs, bear to the total blocked assets.

Mimeograph 6475, supra , is hereby clarified.