Understanding the Principles of DASTM Accounting

By Lena Y. Hines, J.D., LL.M., Washington, D.C.

Editor: Annette B. Smith, CPA

Tax Accounting

The U.S. dollar approximate separate transactions method of accounting (DASTM) rules of Regs. Sec. 1.985-3 govern the tax accounting of items from a qualified business unit (QBU) that uses a functional currency that becomes “hyperinflationary” for U.S. federal income tax purposes.

Generally, a U.S. taxpayer and each of its QBUs must make all determinations under subtitle A of the Code (regarding income taxes) in its respective functional currency (Regs. Sec. 1.985-1(a)(1)). However, U.S. taxpayers may not determine and report tax items of a QBU based on a hyperinflationary functional currency, because doing so generally would result in an overstatement or understatement of income, deduction, gain, or loss.

For U.S. federal income tax purposes, a currency becomes hyperinflationary when it has a cumulative compounded inflation rate of at least 100% over three consecutive calendar years (the base period) (Regs. Sec. 1.985-1(b)(2)(ii)(D)). U.S.-owned corporations and branches must use DASTM to determine and report gross income, taxable income or loss, or earnings and profits (E&P) of a QBU that used a hyperinflationary currency as its functional currency. A taxpayer must start using DASTM for the tax year that begins after the currency becomes hyperinflationary (Regs. Sec. 1.985-1(b)(2)(ii)).

Transition Rules

Prior to implementing the DASTM rules of Regs. Sec. 1.985-3, a taxpayer first must apply the transition rules of Regs. Sec. 1.985-7. The transition rules are intended to mitigate the impact of hyperinflation on a taxpayer’s U.S.-dollar tax basis with respect to assets in its QBU during the base period. Thus, to transition into DASTM, first the QBU must translate its hyperinflationary currency profit-and-loss statement (P&L), balance sheet, and E&P into U.S. dollars as of the last day of the tax year ending before the base period.

The transition rules recognize that a currency may become hyperinflationary over multiple tax years; accordingly, the first translation under DASTM occurs to the P&L statement and balance sheet as determined three years prior to when the currency becomes hyperinflationary. Therefore, to the extent tax attributes were affected by the currency’s attaining its hyperinflationary status, that effect is captured by the transition rules and taken into account in the first year in which DASTM applies.

Although DASTM requires the QBU to use the U.S. dollar as its functional currency for U.S. federal income tax purposes, the foreign jurisdiction’s reporting rules continue to require the foreign business to maintain books and records in the jurisdiction’s local currency. As a result, for each year that DASTM applies, the QBU must translate its P&L statement and balance sheet into U.S. dollars in a manner that adjusts for the embedded inflation of the local currency. The rules applicable to the P&L statement mitigate the hyperinflationary currency’s impact on the computation of the QBU’s income from sales and provision of services. The rules for determining DASTM gain or loss and assigning it to specific instruments prevent distortions of income and expense generated from the QBU’s financial assets and liabilities (i.e., balance sheet items that are subject to distortions caused by the hyperinflationary currency).

Further, once a currency ceases to qualify as hyperinflationary for three consecutive years, a QBU previously required to use the U.S. dollar as its functional currency pursuant to DASTM rules is required to change its functional currency (under the functional currency rules in the regulation) (Regs. Sec. 1.985-1(b)(2)(ii)(E)).

Translation Rules

A QBU using DASTM computes its income or loss in U.S. dollars for the tax year (and later adjusts it to account for DASTM gain or loss). For purposes of the P&L computations, the QBU prepares its P&L statement from the QBU’s hyperinflationary books and records and makes certain adjustments to conform to U.S. accounting and tax accounting principles. The amounts of hyperinflationary currency as shown on the adjusted statement are then translated into U.S. dollars.

The P&L rules provide specific translation period and exchange rate conventions designed to mitigate the effects of hyperinflation with respect to sales of inventory and provision of services. For example, to mitigate the effect of hyperinflation on the calculation of income from the cost of goods sold, inventory is translated into U.S. dollars for the month in which it was purchased and remains in U.S. dollars while in the QBU.

The dollar income or loss (or E&P) is adjusted to take into account the DASTM gain or loss for the tax year. DASTM gain or loss for a tax year equals the dollar change in the net worth of the QBU for the tax year, as adjusted for certain transfers from or to the QBU that decrease or increase its net worth but do not affect the QBU’s income or loss or its E&P (e.g., dividend distributions and capital contributions). The dollar net worth of the QBU is derived from the books of the QBU translated into dollars at specified rates and is defined as the translated aggregate U.S. dollar amount of assets on the balance sheet at the end of the year, less the translated aggregate dollar amount of liabilities on the balance sheet at the end of the year. For this purpose, certain items on the balance sheet (generally, financial assets and liabilities) are translated at the year-end exchange rate, and other assets (such as inventory, plant, and equipment) are translated into dollars at the rate for the period when purchased (historic exchange rate). Items translated at the year-end exchange rate generate DASTM gain or loss, while those translated at the historic exchange rate do not.

Financial Aspects

The QBU’s financial assets and liabilities generate distorted amounts of income and expense when determined in a hyperinflationary currency. DASTM essentially corrects for the impact of hyperinflation to ensure that income and expenses being reported are based on the actual economics of the QBU’s financial transactions. For example, if a QBU issued a note denominated in a hyperinflationary currency, the value of the principal amount of the note would decrease as the inherent value of the currency decreases. As a result, the lender would require an increase in the note’s stated interest rate to compensate for the loss of value in the principal.

Such additional “interest” expense reflects the distorted principal value caused by hyperinflation (rather than a charge for the time value of money); therefore, the DASTM rules make corrective adjustments to the amount of interest expense reported by the QBU. Those corrective adjustments occur with respect to each class of financial assets and liabilities on the balance sheet that is subject to a change in value due to currency fluctuations. That is, the amount of DASTM gain or loss computed on the balance sheet is allocated to the financial assets and liabilities that generate the DASTM gain or loss, and adjusts the income or expense of those items. Subpart F characterizations also must be taken into account to allocate DASTM gain or loss in the context of a controlled foreign corporation.

DASTM rules generally parallel financial accounting rules, which also apply a special regime for business units operating in hyperinflationary currency. Certain tax rules (e.g., subpart F characterizations), however, do not have a corollary in the financial accounting context. Moreover, for a currency that has both an official rate and a free market rate, the financial and tax accounting rules may not operate consistently when the official rate is used for financial accounting purposes, because the free market rate is the rule of thumb for tax purposes. Because DASTM gain or loss varies depending on the exchange rate used, this convention is a significant aspect of applying the DASTM rules. This apparent conflict is resolved by requiring the exchange rate convention used for DASTM computations to conform to the taxpayer’s method for financial accounting purposes.


The DASTM rules are of particular relevance to U.S. multinational corporations doing business in Venezuela because its currency became hyperinflationary in January 2010, and for the 2013 calendar year its currency no longer qualifies as a hyperinflationary currency for U.S. federal income tax purposes.

In light of the complexity of the DASTM tax regime and its limited application in the current environment, taxpayers are encouraged to proceed cautiously in determining how the rules may apply to their QBUs. The preceding discussion outlines certain aspects of the DASTM tax regime, but many other details of applying DASTM warrant the taxpayer’s attention.


Annette Smith is a partner with PwC, Washington National Tax Services, in Washington, D.C.

For additional information about these items, contact Ms. Smith at 202-414-1048 or annette.smith@us.pwc.com.

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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