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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Can foreign exchange losses be deducted pursuant to paragraph 20(1)(f) of the Act?
Foreign exchange losses incurred on the settlement of debt denominated in a foreign currency should not be deductible under paragraph 20(1)(f).
October 23, 2002
VANCOUVER TSO HEADQUARTERS
Tom Markota Corporate Financing Section
Audit Services G. Moore
Recharacterization of Foreign Exchange Losses to Amounts
Deductible Under Paragraph 20(1)(f) of the Income Tax Act
We are writing in reply to your memo of April 19, 2002, in which you requested our opinion regarding the recharacterization of foreign exchange losses from capital in nature to amounts deductible under paragraph 20(1)(f) of the Income Tax Act (the "Act").
As we understand it, the taxpayer in question, XXXXXXXXXX, has incurred foreign exchange losses on long-term debt denominated in US currency for the XXXXXXXXXX taxation years. The loans were used for capital purposes and therefore, in each of those years, the taxpayer filed its returns on the basis that the losses incurred on repayment of the US denominated debt were on capital account and reported those amounts as capital losses on its corporate income tax returns. The taxpayer has requested reassessments such that the losses be deducted under paragraph 20(1)(f) of the Act. The balance of any loss not claimed under that paragraph would then be claimed by the taxpayer as a capital loss. If the foreign exchange loss is not deductible under paragraph 20(1)(f) of the Act, the taxpayer believes that it may be deductible under paragraph 20(1)(e) of the Act. You have also enclosed a submission prepared by XXXXXXXXXX. regarding this issue.
You have asked us for our views on whether the foreign exchange losses realized on debt denominated in a foreign currency, where the loans were capital in nature, can be recharacterized as discounts on debt and therefore deductible from income under paragraph 20(1)(f) under the Act.
Paragraph 18(1)(f) provides that "in computing the income of a taxpayer from a business or property no deduction shall be made in respect of an amount paid or payable as or on account of the principal amount of any obligation described in paragraph 20(1)(f) except as expressly permitted by that paragraph".
Paragraph 20(1)(f) is as follows:
"(f) an amount paid in the year in satisfaction of the principal amount of any bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation issued by the taxpayer after June 18, 1971 on which interest was stipulated to be payable, to the extent that the amount so paid does not exceed,
(i) in any case where the obligation was issued for an amount not less than 97% of its principal amount, and the yield from the obligation, expressed in terms of an annual rate on the amount for which the obligation was issued (which annual rate shall, if the terms of the obligation or any agreement relating thereto conferred on its holder a right to demand payment of the principal amount of the obligation or the amount outstanding as or on account of its principal amount, as the case may be, before the maturity of the obligation, be calculated on the basis of the yield that produces the highest annual rate obtainable either on the maturity of the obligation or conditional on the exercise of any such right) does not exceed 4/3 of the interest stipulated to be payable on the obligation, expressed in terms of an annual rate on
(A) the principal amount of the obligation, if no amount is payable on account of the principal amount before the maturity of the obligation, or
(B) the amount outstanding from time to time as or on account of the principal amount of the obligation, in any other case,
the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding year in satisfaction of its principal amount exceeds the amount for which the obligation was issued, and
(ii) in any other case, 1/2 of the lesser of the amount so paid and the amount by which the lesser of the principal amount of the obligation and all amounts paid in the year or in any preceding taxation year in satisfaction of its principal amount exceeds the amount for which the obligation was issued;"
In subsection 248(1) of the Act, "amount" means "money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing, ...", and "principal amount", in relation to any obligation, means "the amount that under the terms of the obligation or any agreement relating thereto, is the maximum amount or maximum total amount, as the case may be, payable on account of the obligation by the issuer thereof, otherwise than as or on account of interest or as or on account of any premium payable by the issuer conditional on the exercise by the issuer of a right to redeem the obligation before the maturity thereof".
To ascertain the "principal amount" of a debt denominated in a foreign currency, should the amount be fixed based on the foreign currency rate on the date of issue of the obligation or should the "principal amount" be determined based on the spot rate at the time the debt is paid or based on the average of fluctuating rates from time to time? We have examined paragraph 20(1)(f) and the definition of "principal amount" in subsection 248(1) to determine when the "principal amount" is to be determined in respect of a foreign currency obligation: at the time the debt is issued; at the time of settlement of the debt; or some other relevant time. We believe that foreign currency denominated debts were not contemplated when this paragraph was drafted and as such is silent on this point. If the "principal amount" is to be determined at the time of issue, then in this particular case, there is no discount since the amount of foreign currency exchange loss would not have been ascertained yet. The taxpayers are arguing that the definition of "principal amount" in subsection 248(1) of the Act does not stipulate whether the "principal amount" is to be determined on the basis of the maximum amount payable under a debt obligation at any time throughout the period that it is outstanding, or at a particular time. Since the use of the term "principal amount" throughout the Act does not specify the time at which the "principal amount" has to be determined, an argument can be made that the time of determination is dependent on the context of the wording of a particular provision and the intent and purpose of that provision.
For purposes of paragraph 20(1)(f) of the Act, we believe that the time at which the "principal amount" is to be determined should be at the time of issue and this is the relevant time at which the discount, if any, should also be ascertained. The "97% test" and the "yield test" should also be applied at the time of issue of the debt. We believe that this is the better view given the intent of the provision and the overall scheme of the Act, as discussed below.
Intention of Parliament/Overall Scheme of the Act
Using the modern approach to statutory interpretation, the words of the Act are to be read in their entire context in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament. One of the conventions of statutory interpretation is that a section of the Act should not be interpreted in a way that would render another provision meaningless. If paragraph 20(1)(f) were to be used to fully deduct a foreign exchange loss on long-term debt denominated in a foreign currency, then this would effectively void the application of subsection 39(2) to these transactions and render that provision meaningless. The taxpayer has argued that a negative implication argument might be made and there is reason to believe that if Parliament had meant to include a particular condition (for example, that the principal amount should be determined at the time of issue) within the ambit of a provision, it would have referred to the condition expressly. The omission of the word "discount" and the absence of any reference to the time at which the "principal amount", the "97% test" and the "yield test" should be determined is problematic; however, these omissions should not be used to defeat the purpose of the application of subsection 39(2). We would also like to point out that the heading of paragraph 20(1)(f) is "discount on certain obligations" with the implication being that the title is a component of the statute and an indication of the legislators' intention that this provision should apply to discounts on debt obligations and not to foreign exchange losses. Also, the 97% test is a test directly attempting to calculate a discount on a debt.
We also refer to the general interpretative rules that when two provisions are in conflict, the more specific provision prevails over the more general. In our view, subsection 39(2) is clearly more specific than paragraph 20(1)(f) in applying to capital losses in respect of foreign currencies and therefore the more specific provision of the Act would apply. It is also our view that it was not the intention of Parliament that a deduction for foreign exchange losses be provided under paragraph 20(1)(f) of the Act. By way of examining this intention, we look to the Technical Notes to Bill C-139 (Received Royal Assent on September 13, 1988) issued by the Department of Finance, which accompanied amendments to paragraph 20(1)(f):
"Paragraph 20(1)(f) sets out rules concerning the deductibility of discounts paid by a taxpayer in satisfaction of the principal amount of any bond, debenture, bill, note, mortgage, hypothecat or similar obligation issued by the taxpayer on which interest was stipulated to be payable. Subparagraph 20(1)(f)(ii) limits the deductibility of discounts on obligations where the discount is greater than 3% of the principal amount of the obligation or where the annual rate of return exceeds four-thirds of the interest stipulated to be payable on the obligation. Discounts such as these are commonly called deep discounts. Subparagraph 20(1)(f)(ii) is being amended as a consequence of the changes to the inclusion rates for capital gains."
Subsection 39(2) provides for the tax treatment of foreign exchange gains and losses which result from the fluctuation after 1971 in the value of currency or currencies of one or more countries other than Canada relative to Canadian currency. It is our view that the taxpayer is not entitled to a deduction under paragraph 20(1)(f) of the Act for the foreign exchange losses that were realized on the long-term debt denominated in US dollars since subsection 39(2) of the Act is the more relevant provision.
The taxpayer has submitted that subsection 39(2) is the more specific provision over paragraph 20(1)(f) if the foreign exchange loss is on account of capital, not on account of income. If the foreign exchange loss is on account of income, then section 9 would apply and paragraph 20(1)(f) would be a more specific provision than section 9. However, in our view, this is a moot point because if the foreign exchange loss were on account of income and fully deductible under section 9, then there would be no tax advantage to deduct the foreign exchange loss under paragraph 20(1)(f). There is obviously a tax advantage in deducting 100% of a foreign exchange loss that is capital in nature under paragraph 20(1)(f) then as a capital loss under subsection 39(2) of the Act.
Income Tax Rulings' Published Positions
In an interpretation (9999-1234560), the Rulings Directorate confirmed that foreign exchange losses arising as a result of a debt denominated in a foreign currency are not deductible under paragraph 20(1)(f) and are deductible under subsection 39(2) if the loss is capital in nature. The interpretation refers to the "separate transactions" theory whereby the foreign currency component of a foreign currency borrowing is considered as a transaction separate from the borrowing itself. In Canadian Pacific Ltd. v. Canada, the Minister argued that Canadian Pacific's act of denominating the debentures in Australian dollars was in and of itself a transaction and relied on the definition of "transaction" in subsection 245(1) as including "an arrangement or event" to argue that the designation of Australian dollars in the debenture amounted to an arrangement. The Minister also argued that the designation of the borrowing in Australian dollars was a separate transaction and was entered into solely for tax purposes. The Court rejected this reasoning and indicated that it is not possible to separate the currency of the borrowed funds from the borrowing itself so as to make the denomination of the borrowing a discrete transaction in and of itself. The Court indicated that it is the borrowing which is the transaction not the denomination of the currency.
Various interpretations issued by the Directorate infer that the principal amount is the greatest Canadian dollar amount that could become payable under the debt obligation other than interest and therefore, the principal amount is a floating amount and nothing in the definition of "principal amount" in subsection 248(1) of the Act requires that it be fixed at the time of issue. In document # 9703377, we indicated that "for purposes of paragraph 20(1)(f) the principal amount under the terms of the CBL (Consumer Based Loan) is the total amount paid on maturity plus the total of all payments in satisfaction of principal paid over the life of the obligation." In addition, documents (980964, 971941, 1999-0008753, 2002-0118827) relating to exchangeable debentures indicate that paragraph 20(1)(f) of the Act applies to the difference between the fair market value of the shares granted under the exchange rights in an "exchangeable debenture" and the amount for which the debenture was issued. In other words, if the issuer was required to deliver the target shares, the principal amount, within the meaning of subsection 248(1) of the Act, of this obligation would be an amount equal to the fair market value of the target shares. These rulings recognize that events and amounts unknown at the time that the debt was issued affect the computation of the "principal amount" for purposes of paragraph 20(1)(f) of the Act. Although these rulings and interpretations may have broadened our interpretation of the time at which a "principal amount" is to be determined, there was no issue in these cases that paragraph 20(1)(f) was the relevant provision of the Act. We can distinguish these interpretations and rulings from the present cases at hand in that we believe that paragraph 20(1)(f) is not the relevant provision of the Act in determining the income tax treatment of foreign exchange losses.
In our opinion, recharacterizing a foreign exchange loss on debt denominated in a foreign currency to an amount deductible from income under paragraph 20(1)(f) of the Act cannot be supported. It has been our long-standing position that such foreign exchange losses that are capital in nature are capital losses to which subsection 39(2) of the Act applies. It is our view that paragraph 20(1)(f) was not intended to apply to foreign exchange losses particularly since subsection 39(2) is the more specific applicable provision.
It is also our view that Parliament, in enacting paragraph 20(1)(f), intended to permit a deduction for a "discount" arising from payment of an amount in satisfaction of a taxpayer's obligations under a debenture or similar obligation where the amount paid exceeds the amount received on the issuance of the obligation. A foreign exchange loss that is realized on a debt denominated in a foreign currency in not such a discount. Moreover, the Income Tax Act specifically addresses gains or losses that arise from a foreign currency translation. In this regard, Parliament has made special provision to address precisely this situation in subsection 39(2) of the Income Tax Act. Parliament is presumed not to intend to alter a specific provision by a general provision unless that intention is manifested explicitly in the language and paragraph 20(1)(f), being a provision of general application, contains no such language.
An agreement that creates a debt obligation generally defines and ascertains the amount payable on account of the obligation (otherwise known as the "principal amount"). Where an agreement defines the "principal amount" in a foreign currency, any fluctuation in the foreign currency until settlement of the obligation is an event separate from and independent of the agreement. As a separate and independent event, it is quantified separately from the debt obligation.
It is also our view that if a deduction in respect of a discount is properly claimed under paragraph 20(1)(f) of subdivision b of Division B of Part I in computing income from a business or property source, then such amount would not be relevant for purposes of subparagraph 39(2)(a)(ii). Lastly, we are also of the view that any foreign exchange loss on a debt denominated in a foreign currency would not be deductible as a financing expense under paragraph 20(1)(e) of the Act.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CCRA's mainframe computer. 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 your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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