14 March 2014 Internal T.I. 2013-0507661I7 - Foreign Exchange - Loan Renewal

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Does the automatic renewal of a loan, in and of itself, trigger a disposition and requiring the recognition of a gain or loss?

Position: Question of fact.

Reasons: Whether a loan has been disposed of or not depends on a number of factors such the intention of the parties involved and whether there has been a significant material change in the contract such that there has been a novation.

March 14, 2014

XXXXXXXXXX Tax Services Office Headquarters
Large Business Audit Income Tax Rulings
Attention: XXXXXXXXXX Directorate
Large File Case Manager

2013-050766

XXXXXXXXXX
Foreign Exchange Gain on Loan Renewal

This is in reply to your memorandum of October 8, 2013, requesting that we provide our views as to whether an automatic renewal of a loan triggers a disposition of the loan that results in a foreign exchange gain or loss.

Facts

XXXXXXXXXX is a private corporation and has been an indirect subsidiary of XXXXXXXXXX ("the Ultimate Parent") since XXXXXXXXXX. Prior to XXXXXXXXXX's acquisition by the Ultimate Parent, XXXXXXXXXX was an indirect subsidiary of XXXXXXXXXX, a US public corporation. On XXXXXXXXXX, XXXXXXXXXX borrowed $XXXXXXXXXX in US funds from XXXXXXXXXX, a related company at the time. The loan was used in the ordinary course of XXXXXXXXXX's business operations and was due on XXXXXXXXXX. On XXXXXXXXXX, the loan was not repaid; however, in accordance with the terms of the loan agreement, the loan was renewed and has since been renewed on a yearly basis. XXXXXXXXXX reported a foreign exchange gain in its income statement in the amount of $XXXXXXXXXX for the taxation year ended XXXXXXXXXX. However, XXXXXXXXXX deducted the $XXXXXXXXXX on Schedule 1 of its corporate tax return. The taxpayer's view is that the loan has not been repaid and thus, no disposition has occurred and no foreign exchange gain has been realized.

Question

Since the loan has been automatically renewed every year, you ask whether there has been a disposition which triggered a gain or loss on the foreign exchange.

Our Comments

Subsection 39(2) of the Income Tax Act (the "Act") applies where a taxpayer realized a foreign exchange gain or a foreign exchange loss. Paragraph 3 of Interpretation Bulletin IT-95, Foreign Exchange Gains and Losses, provides that generally, where borrowed funds are used in the ordinary course of a taxpayer's business operations, any foreign exchange gain realized on the repayment of the loan is considered to be an income gain and any foreign exchange loss incurred on repayment of the loan is considered to be an income loss. Paragraph 13 of IT-95 provides that a taxpayer has "made a gain" or "sustained a loss" in a foreign currency only where there has been a transaction resulting in a gain or loss. Subsection 39(2) does not apply where a loss has been made "on paper" but no transaction has taken place. As a result the "accrual" method of accounting for foreign exchange gains or losses is not acceptable for purposes of reporting foreign exchange gains or losses on capital account. Given the comments made in IT-95, a taxable event will trigger the application of subsection 39(2) only if it results in a novation, which is the only case where such modification to the terms of an obligation can result in a settlement of it.

The CRA's current views regarding changes in the terms of debt obligations are set out in Income Tax Technical News No. 14, dated December 9, 1998. In that publication, we state that we have reviewed our comments in paragraph 7 of IT-448 and:

"As a result of the review, it is now our position that if a debt obligation is renegotiated otherwise than as provided for in its original terms, the determination of whether a change in its terms is a substitution of a debt obligation for another should be made in accordance with the law of the relevant jurisdiction.
. . . a rescission of a debt obligation will be implied when the parties have effected such an alteration of its terms as to substitute a new obligation in its place, which is entirely inconsistent with the old, or, if not entirely inconsistent with it, inconsistent with it to an extent that goes to the very root of it."

It is to be noted that in Rulings document 2011-042248, in a situation where there were no other changes to a note other than an extension of the note for XXXXXXXXXX months, Rulings found that there was no disposition and we issued a favourable ruling on that aspect.

The courts have found that one of the main conditions for a novation to occur is that the parties have the intention to novate. In the present situation, you have not provided us with any information with respect to the intention of the parties. However, we presume that since the taxpayer deducted the amount of the gain on Schedule 1 of the corporate return, this may suggest that the parties did not have the intention to novate. Based on the information provided, we are of the view that, although it is a question of fact, the automatic renewal of a loan does not, in and of itself, result in a novation and therefore, does not trigger the application of subsection 39(2) of the Act.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Celine Charbonneau at (613) 952-1361. A copy will be sent to you for delivery to the client.

We trust that these comments will be of assistance.

G. Moore
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch