Removal in new definition of principal business and consolidated financial statement requirements (pp. 35:32-33)
The new definition removed the requirements relating to "principal business activities" and "consolidated financial statements." The former requirement was arguably not significant in terms of establishing whether or not a taxpayer could qualify because the threshold for a qualifying business activity (which was left undefined) was presumably low enough that any sort of business activity would suffice. ...
The removal of the term "consolidated financial statements" from the definition of "functional currency" was significant because it also served to remove the reference to GAAP financial statements. The removal of the reference to GAAP arguably provides greater latitude in interpreting the term "functional currency" and perhaps broadens the circumstances in which a taxpayer is entitled to elect under section 261.
Carve-out for commerical transactions
Although this provision is now a broadly applicable anti-abuse rule, it contains a dual-step carve-out for commercial transactions where, first, the currency planning was not a main purpose and, second, the CRA would not direct the tax results to be determined in a different currency. In situations where a Canadian parent company whose functional currency is the US dollar transfers, say, a Canadian-dollar asset to its wholly owned subsidiary (which has not made a functional currency election), it is advisable to obtain a ruling from the CRA to be sure that the Canadian dollar will be respected for the purposes of computing the Canadian tax results. Subparagraph 216(18)(c)(i) refers to a "functional currency year" for the transferor. Therefore this anti-abuse rule will not apply to a transfer where the transferor has not made a functional currency election, because the transferor would otherwise not have a functional currency year. This result is consistent with the policy intent of the version in the original rules.
Loss denial arising where U.S. commercial paper issued through U.S. sub (pp. 35:42-43)
Canco…uses the Canadian dollar as its functional currency. Canco has a wholly owned Canadian subsidiary, Cansub, that (under the applicable GAAP) uses the US dollar as its functional currency. Canco issues US-dollar commercial paper and loans the same to Cansub in US dollars. Canco is perfectly hedged from both a book and a tax perspective. Assume that on maturity the Canadian dollar has appreciated relative to the US dollar so that Canco has an inherent loss on the US-dollar loan to Cansub and a gain on the commercial paper.
In this case, it is reasonable to say that the relevant fluctuation occurred during the accrual period. Thus, Canco's currency loss on the loan to Cansub will be deemed not to have occurred, resulting in an unsheltered gain on the settlement of the commercial paper. While there is clearly no abuse of the functional currency rules in this example, the absence of a purpose test results in an adverse outcome.
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