8 September 2005 External T.I. 2004-0085081E5 - Conversion of a foreign currency denominated debt

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.

Principal Issues: Whether a foreign exchange gain or loss was realized by a corporate debtor when its foreign currency denominated convertible debentures were converted into common shares?

Position: It is not clear.

Reasons: The cost to the corporation of the settlement of the debentures extinguished on the conversion would generally be the amount added to the stated capital of the corporation in respect of the shares issued. That amount is not mentioned in the facts provided.

XXXXXXXXXX 2004-008508
S. Leung
September 8, 2005

Dear XXXXXXXXXX:

Re: Conversion of Convertible Debentures into Shares
Subsection 39(2) -- Foreign Exchange Gains or Losses

We are writing in reply to your letter of July 9, 2004 in which you request our view whether Pubco in the situation outlined below has made a gain or sustained a loss by virtue of the fluctuation in the value of U.S. currency relative to Canadian currency on the conversion of its convertible debentures into common shares.

The situation outlined in your letter is summarized as follows:

1. Pubco is a taxable Canadian corporation (as defined under subsection 89(1) of the Income Tax Act (the "Act")) whose common shares are listed on a prescribed stock exchange outside Canada (within the meaning assigned by section 3201 of the Income Tax Regulations).

2. In 2000, Pubco raised US$1,000,000 by issuing U.S. dollar denominated convertible debentures to arm's length debenture holders at their face value. The terms of the debentures allowed the debenture holders at their option to convert the debentures into common shares of Pubco at any time. The conversion ratio was that for each US$10 of face value of debentures converted the debenture holder would receive one share (the trading value of the shares at the time of the issuance was US$10). Furthermore, Pubco could convert the debentures into common shares at any time after the end of 2002 on the same terms.

3. At the end of 2003 the debenture holders converted all of the debentures into 100,000 common shares of Pubco when the trading value of Pubco's common shares was US$20 per share. The U.S. dollar had declined in value relative to the Canadian dollar during the time the convertible debentures had been outstanding.

It is your view that Pubco has not made a gain by virtue of the fluctuation in the value of the currency of the U.S. relative to Canadian currency on the conversion of the debentures into common shares of Pubco. In fact, it is your view that Pubco has suffered a loss on such conversion because the trading value of the common shares issued on conversion exceeded the principal amount of the debentures at the time of their issuance. You indicated that your view is consistent with the decision of MacMillan Bloedel Ltd. v. Her Majesty the Queen, 99 DTC 5454 (FCA) where the taxpayer was considered to have sustained a foreign exchange loss on the redemption of its U.S. dollar denominated preferred shares by virtue of the fluctuation of U.S. currency relative to Canadian currency between the date of issuance of the shares and the date of their redemption.

Our comments

The situation outlined in your letter appears to relate to an actual situation involving an identifiable taxpayer. Accordingly, the applicable Tax Services Office should be consulted. However, we can offer the following general comments.

It is the general view of the Canada Revenue Agency that the cost of property to a corporation acquired in consideration for the issuance of shares should generally reflect the price agreed to between the parties. However, where no price is ascertainable, the amount added to the stated capital account maintained for the class or series of shares issued on the exchange is relevant to determining cost. Similarly, where a debt of a corporation is settled by issuing shares to the lender in consideration therefor, absent evidence to the contrary, the amount added to the stated capital account of the corporation is relevant in determining the cost to the corporation of settling the debt.

The facts set out above are silent as to the stated capital of the Pubco shares issued to the debenture holders on the conversion. Accordingly, it is not clear whether Pubco made a gain or sustained a loss. However, since the US dollar declined in value relative to the Canadian dollar during the period the debentures were outstanding, if the amount added to the stated capital of the corporation in respect of the shares issued on the conversion of the debentures was equal to the face value of the debentures in US dollars or such amount in Canadian dollars converted at the exchange rate prevailing at the time of the debenture conversion, Pubco would have made a gain. In our view, such gain would be a gain described in subsection 39(2) of the Act.

We trust you will find the above to be of assistance.

Yours truly,

Olli Laurikainen, C.A.

Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Planning Branch

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