CRA indicates that a functional currency reporter realizes capital gains or losses from FX fluctuations when it receives a Cdn$ tax refund for an earlier functional currency year

Canco, which for all relevant years has filed its returns in U.S. dollars as its functional currency, becomes entitled to a Canadian dollar refund as a result of filing an amended return for an earlier such year (2012). The amount thereof, if it were converted to USD using the exchange rate as of the date of the refund, is greater than the USD amount that would be determined by converting the overpayment to USD using the exchange rate(s) that were initially used in determining Canco’s income tax payable for its 2012 taxation year.

CRA indicated that such FX fluctuation gives rise to a s. 39(1) gain that is included in computing Canco’s income, given that Canco, which in the first place, is required by s. 261(5)(a) to computing its Canadian tax results in the elected currency, must then, when determining the amount of the payment, convert to Canadian dollars, as per s. 261(11).

This made sense to it, stating that a functional currency reporter’s foreign-exchange risk arising from an overpayment of Canadian income tax is comparable to a Canadian resident’s foreign-exchange risk arising from the overpayment of tax to a foreign jurisdiction: s, 39 applies in either case.

Neal Armstrong. Summary of 15 May 2019 IFA Roundtable, Q.5 under s. 261(11).