16 August 2000 External T.I. 1999-0009615 - Paragraphs 95(2)(f) and (g)

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Paragraph 95(2)(f) and (g) and foreign currency gains and losses.

Position: Several issues - please see letter

Reasons: Law.

XXXXXXXXXX 		1999-000961
J. Stalker
Attention:  XXXXXXXXXX 

August 16, 2000

Dear Sirs/Mesdames:

Re: Paragraphs 95(2)(f) and (g) of the Income Tax Act (the "Act")

We are writing in reply to your letter in respect of the interpretation of paragraphs 95(2)(f) and (g) of the Act in their application to foreign currency gains and losses.

You have presented the following hypothetical example:

• FA1 is a controlled foreign affiliate of Canco, a corporation resident in Canada. FA1 is resident in the United States.
• FA2 is a foreign affiliate of Canco in which Canco has a qualifying interest. FA2 is resident and carries on an active business in Germany.
• FA1 lends money (the "loan") to FA2. The loan is denominated in Deutsche Marks and is capital property to FA1.
• The loan proceeds are used in FA2's active business, and the interest on the loan is included in FA1's income from an active business by virtue of subparagraph 95(2)(a)(ii) of the Act. The loan is excluded property to FA1 within the meaning of subsection 95(1) of the Act.
• The fluctuation in the value of the relevant currencies results in FA1 realizing a foreign exchange gain.

You have asked the following questions:

1. Assuming that the loan is "settled" in the above circumstances, and subparagraph 95(2)(f)(ii) applies for the purposes of calculating the capital gain to FA1 on the disposition of the loan:

a) What is the appropriate currency to be used for the purposes of determining FA1's foreign exchange gain?

b) Would paragraph 95(2)(g) apply to deem the gain to be nil?

c) If paragraph 95(2)(g) does not apply, in what circumstances would it be applicable (i.e. does paragraph 95(2)(g) apply only where paragraph 95(2)(f) requires that the gain be computed in Canadian currency)?

2. If the loan were denominated in Canadian dollars (instead of Deutsche Marks), and the fluctuation in the values of the relevant currencies results in FA1 realizing an allowable capital loss:

a) which currency would be used to calculate the foreign exchange loss?, and

b) would paragraph 95(2)(g) apply to deem the foreign exchange loss to be nil?

We respond to your questions in the order you asked them:

1. Loan denominated in Deutsche Marks

a) The appropriate currency to be used for the purposes of determining FA1's foreign exchange gain is U.S. dollars as that is the currency of the country in which FA1 is resident, as stipulated by subparagraph 95(2)(f)(ii) of the Act.

b) Paragraph 95(2)(g) of the Act would not deem the gain to be nil in this situation since the gain has not arisen "by virtue of a fluctuation in the value of the currency of a country other than Canada relative to the value of the Canadian dollar". Instead the gain would result from a fluctuation in the value of German Deutsche Marks relative to U.S. dollars.

c) Paragraph 95(2)(g) deals with capital gains and allowable capital losses that have arisen from currency fluctuations vis à vis the Canadian dollar on settlement of a debt, regardless of whether the gain or loss is computed under 95(2)(f)(i) or (ii) of the Act.

2. Loan denominated in Canadian currency

a) If the loan were denominated in Canadian dollars, U.S. dollars would be used to calculate the loss as that is the currency of FA1's country of residence.

b) As there has been a currency fluctuation vis à vis the Canadian dollar on the settlement of a debt, paragraph 95(2)(g) would deem the loss to be nil.

You have also asked for guidance on the words "in any other case" in subparagraph 95(2)(f)(ii). Subparagraph 95(2)(f)(ii) applies where a controlled foreign affiliate is disposing of excluded property in a transaction to which none of paragraphs 95(2)(c), (d) or (e) or 88(3)(a) apply, or where a non-controlled foreign affiliate is disposing of any property.

Finally, you have asked when the phrase "or such other currency as is reasonable in the circumstances" in subparagraph 95(2)(f)(ii) would apply to require the gain or loss to be computed in a currency other than the local currency of the foreign affiliate. We refer you to the Revenue Canada Round Table in 1992 CMTC Tax Conference Question 7, where we indicated that there are no hard-and-fast rules to determine when it is reasonable to use another currency rather than the home country's as the calculating currency. We stated:

Where a particular currency has become a generally accepted currency for conducting business in a country, such currency may be considered "reasonable in the circumstances," notwithstanding that some other currency is the official currency of that country. As well, the currency that is used for income tax purposes in the foreign jurisdiction would normally be considered "reasonable in the circumstances."

We do not envisage a situation where Canadian currency would be reasonable in the circumstances, as you have suggested.

We also note that the proposed amendments to paragraph 95(2)(g) will allow that provision to apply in the more usual situation where such a loan from a financing affiliate would be inventory to that affiliate and the gain or loss is incurred on income account.

The above comments represent our general view with respect to the subject matter of your letter. These comments do not constitute an advance income tax ruling and therefore, as described in paragraph 22 of Information Circular 70-6R3, are not binding on the Canada Customs and Revenue Agency.

We trust our comments are helpful.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings Directorate