CRA indicates that a functional currency reporter realized a capital gain when a Cdn. dollar refund claim appreciated until receipt
Canco, which had elected to use a functional currency, claimed a refund (made in Canadian dollars as required by s. 261(11)) by filing an amended return for a year (apparently for the carryback of a loss to that year). As a result of the subsequent appreciation of the Canadian dollar as compared to the rate applicable to the particular year, it realized an FX gain (relative to the qualifying currency) when it received the refund in Canadian dollars. Was this gain ordinary income, a capital gain or a nothing?
After noting that “where a loss from a subsequent taxation year is carried back to a particular taxation year, the revised income taxes payable and any resulting refund are computed using the exchange rates applicable to that particular year, regardless of the exchange rate in the subsequent year,” CRA indicated that this situation was essentially dealt with in Folio S5-F2-C1, which addresses the reverse situation of FX gains in Canadian dollars on foreign tax refunds or payments – so that, here, the FX gain was a capital gain to be computed based on the FX rate change between that appliable to the previous year and that at the time of receipt. The response was quite vague as to how to compute the FX rate applicable to the previous year (the ILBD didn't seem to be asking for detailed guidance on this point).
Neal Armstrong. Summary of 31 July 2018 Internal T.I. 2016-0649631I7 under s. 261(5)(c).