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: Is a non-resident partner subject to tax in Canada on foreign exchange gains incurred by a partnership as a result of settling a foreign-currency denominated debt?
Position: No
Reasons: A gain on the repayment of debt that is deemed by subsection 39(2) to be from a disposition of a currency of a country other than Canada cannot be regarded as arising from a disposition of taxable Canadian property, and as such is not taxable under 115(1)(b) of the Act. Debt owed by the partnership is not property to the partnership. It is property to the creditor, but not to the partnership as debtor. The repayment of the loan discharged the debt owed. Subsection 39(2) of the Act, in the context of a debt repayment, creates a deemed gain from the disposition of currency of a country other than Canada. However, the notional currency referred to in subsection 39(2) does not really exist. Thus, it is not possible to test such notional currency of a country other than Canada under the definition of taxable Canadian property to assess whether it is property used in the business.
July 16, 2010
BURNABY-FRASER TSO HEADQUARTERS
International and Large Income Tax Rulings
Business Directorate Directorate
Henry Leung
Attention: Robert Thomson (613) 957-9232
2010-036512
Non-Resident Partner's Foreign Exchange Gain on Repayment of Debt
We are writing in reply to your e-mail dated April 26, 2010 regarding the taxability to a non-resident partner under paragraph 115(1)(b) of the Income Tax Act (the "Act") of a foreign exchange gain that is deemed by subsection 39(2) of the Act to be a gain from the disposition of currency of a country other than Canada.
Your enquiry relates to the following facts:
XXXXXXXXXX is a resident of Japan and a non-resident of Canada.
XXXXXXXXXX held a XXXXXXXXXX % interest in XXXXXXXXXX .
When XXXXXXXXXX repaid foreign-currency denominated debt pertaining to a business carried on by it in Canada, it made foreign exchange gains of $XXXXXXXXXX and $XXXXXXXXXX for the XXXXXXXXXX and XXXXXXXXXX taxation years respectively. Such gains were on account of capital.
When filing its Canadian income tax returns, XXXXXXXXXX did not report its portion of the foreign exchange gains for its XXXXXXXXXX and XXXXXXXXXX taxation years on the basis that it was a non-resident of Canada and foreign exchange gains on account of capital are not taxable under paragraph 115(1)(b) of the Act.
The Vancouver TSO disagreed and suggested that the foreign exchange capital gains are taxable to the non-resident partner since there was a disposition of currency in settling the debt. As currency is property, and the currency is used in carrying on the partnership business in Canada, the Vancouver TSO submits that the currency disposed of to settle the debt meets the definition of taxable Canadian property pursuant to subsection 248(1) of the Act. As such, the foreign currency capital gain that resulted in the disposition of money, a taxable Canadian property, should be included in calculating XXXXXXXXXX 's taxable income earned in Canada in accordance with subparagraph 115(1)(a)(iii) and paragraph 115(1)(b) of the Act. In addition, the Vancouver TSO is of the view that by virtue of paragraphs 2 and 4 of Article 13 of the Canada-Japan Treaty, Canada is allowed to tax the gain allocated to the non-resident partner.
The Vancouver TSO requests our view as to whether the non-resident partner should be subject to tax in Canada.
For income tax purposes, the classification of a foreign exchange gain or loss as on account of income or capital depends on the nature of the transaction in relation to which the gain or loss occurred. Where the borrowed funds are used to finance the acquisition or construction of a capital asset, the associated foreign exchange gains and losses arising on settlement are on the borrower's capital account. Subsection 39(2) of the Act applies to such gains and losses and deems them to be from a notional disposition of currency of a country other than Canada.
In order for a non-resident partner to get taxed on the allocation of amounts from the partnership, the amount allocated must be taxable under section 115 of the Act. Of relevance to this situation is whether paragraph 115(1)(b) of the Act applies to the foreign currency capital gains referred to in subsection 39(2) of the Act.
While we agree that currency is considered "property", and notwithstanding the fact that "taxable Canadian property" includes property used or held by the taxpayer in a business carried on in Canada, it is our position that a gain on the repayment of debt that is deemed by subsection 39(2) to be from a disposition of a currency of a country other than Canada cannot be regarded as arising from a disposition of taxable Canadian property, and as such, is not taxable under paragraph 115(1)(b) of the Act. Debt owed by the partnership is not property to the partnership. It is property to the creditor, but not to the partnership as debtor. The repayment of the loan discharged the debt owed. Subsection 39(2) of the Act, in the context of a debt repayment, creates a deemed gain from the disposition of currency of a country other than Canada. However, the notional currency referred to in subsection 39(2) does not really exist. For example it is possible that the funds used to settle the debt were Canadian dollars or another property of the debtor. Subsection 39(2) would nevertheless apply. For that reason, it is not possible to test such notional currency of a country other than Canada under the definition of taxable Canadian property to assess whether it is property used in the business.
The actual cash or other property that is generally disposed of by a debtor to a creditor on settlement of the debt is separate from the notional currency referred to in subsection 39(2) of the Act. Accordingly, a separate calculation is required to determine whether a gain or loss arises and if one does arise and the property is on account of capital, then the other property must be tested separately in the context of the taxable Canadian property definition.
One case that supports our view is Avis Immobilien G.M.B.H. v. R., [1994] 1 C.T.C. 2204 (TCC), aff'd 1196 Carswell Nat 2529 (FCA), where a non-resident repaid a foreign-currency denominated debt as required by the creditor before it was allowed to dispose of some rental properties it owned. In repaying the debt, the non-resident incurred a foreign exchange loss which it deducted in calculating the capital gain on the disposition of the rental properties. The Minister re-assessed the non-resident tax to deny the deduction of the foreign exchange loss in the computation of the gain from the disposition of the actual properties, on the basis that the foreign exchange loss was neither an outlay nor an expense to the extent that it was made or incurred for the purpose of making the disposition of the rental properties contemplated by subparagraph 40(1)(a)(i) of the Act. Rather, the loss was incurred for extinguishing the debt of the non-resident appellant to the bank. In agreeing with the Minister, Justice Rip, as he then was, stated at paragraph 54 of his judgment:
Foreign exchange losses are specifically dealt with in subsection 39(2) of the Act, as submitted by respondent's counsel. What the appellant appears to be trying to do is incorporate subsection 39(2) into subsection 115(1) and turn a deemed disposition of the type contemplated by subsection 39(2) into a disposition of taxable Canadian property within subsection 115(1). This attempt to rationalize the appellant's position cannot succeed.
The same reasoning described above would also apply to paragraphs 2 and 4 of Article 13 of the Canada-Japan Treaty, which makes reference to the "alienation of any property". As stated in the Commentary to Article 13 of the OECD Model Tax Convention on Income and on Capital, of which the Treaty is based,
[t]he words "alienation of property" are used to cover in particular capital gains resulting from the sale or exchange of property and also from a partial alienation, the expropriation, the transfer to a company in exchange for stock, the sale of a right, the gift, and even the passing of property on death.
Since the debt is not considered "property", the currency exchange gain associated with settling this debt does not qualify as an "alienation of property" in the sense intended by the Treaty.
Based on the reasons above, it is our position that the gains on the settlement of debt that are deemed to be from a disposition of a currency of a country other than Canada under subsection 39(2) of the Act cannot be considered to be from the disposition of taxable Canadian property and therefore, are not taxable to the non-resident partner.
A number of transactions lead to the creation of XXXXXXXXXX and the assumption by XXXXXXXXXX of the debt. We have not reviewed and therefore cannot provide any comment as to the accuracy of the calculation of the amount of the subsection 39(2) gain or of any foreign currency gain or loss made or incurred by a predecessor entity.
If you have any questions regarding the above please do not hesitate to contact Henry Leung.
For your information, unless exempted, 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 the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
Olli Laurikainen
Section Manager
For Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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