8 May 2008 External T.I. 2008-0267831E5 - FX gain, debt, amalgamation

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: 1. Whether on the amalgamation of a debtor and creditor, a foreign currency denominated loan that is deemed settled pursuant to 80.01(3) will result in a capital gain or capital loss to the creditor pursuant to subsection 39(2) of the Income Tax Act? 2.Whether on the amalgamation of a debtor and creditor, a foreign currency denominated loan that is deemed settled pursuant to 80.01(3) will result in a forgiven amount (as defined in subsection 80(1)) to the debtor or result in a capital gain pursuant to subsection 39(2) of the Income Tax Act?

Position: 1. By virtue of 80.01(3), there is no capital gain or capital loss to the creditor. "2. There is also no forgiven amount under subsection 80(1) and, under the facts of this particular case, no capital gain or loss to the debtor".

Reasons: Interaction of 80.01(3) and 80(2)(k)

XXXXXXXXXX 						2008-026783
							Angelina Argento
May 8, 2008

Re: Technical Interpretation regarding subsections 80.01(3) and 39(2)

This is in reply to your letter dated February 7, 2008.

FACTS AND ASSUMPTIONS

1. X Co and Y Co are both taxable Canadian corporations. Y Co is a wholly owned subsidiary of X Co.

2. On January 1, 2002, Y Co borrowed US $1000 (the "Debt") from X Co to finance the purchase of a business. At the time, the exchange rate was US$1=CDN$1.50.

3. The Debt is capital property to X Co and is on account of capital to Y Co.

4. X Co has an adjusted cost base in the Debt of CDN $1,500, which is equal to both the principal amount of the Debt and the amount for which the Debt was issued by Y Co (all computed in Canadian dollars at the time of issuance).

5. Since January 1, 2003, the Canadian dollar has strengthened in comparison to the U.S. dollar. Assuming a current exchange rate of US$1=CDN$1, the value of US currency needed to repay the Debt, as determined in Canadian dollars, is less than the amount for which the Debt was issued (computed in Canadian dollars at the time of issuance).

ISSUE 1:

In the event of the amalgamation of X Co and Y Co, would subsection 39(2) of the Income Tax Act (the "Act") deem a capital gain or loss to either X Co or Y Co?

OUR COMMENTS

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not the Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments, which may be of assistance.

Impact of the Proposed Amalgamation

Pursuant to subsection 80.01(3) of the Act, upon the proposed amalgamation of X Co and Y Co, the Debt will be deemed to have been settled immediately before the time that is immediately before the proposed amalgamation by a payment made by the debtor (Y Co) and received by the creditor (X Co) of an amount equal to the cost amount (being the adjusted cost base ¹ ) to X Co of the Debt at that time.

Pursuant to the Federal Court of Appeal decision in Gaynor ² , in determining the value of amounts denominated in a foreign currency, for the purpose of computing a capital gain or loss, the amounts "must be value in Canadian currency which is the only monetary standard of value known to Canadian law". Furthermore, paragraph 261(2)(a) of the Act confirms that the Canadian tax results of a taxpayer for a particular taxation year are to be determined using Canadian currency. In addition, paragraph 261(2)(b) of the Act provides that "if a particular amount that is relevant in computing the taxpayer's Canadian tax results for the particular taxation year is an amount expressed in a currency other than Canadian currency, that amount is to be converted to an amount expressed in Canadian currency using the rate of exchange quoted by the bank of Canada at noon on the day on which that amount first arose for the exchange of a unit of that other currency for a unit of Canadian currency."

Since the amount deemed paid by Y Co to X Co pursuant to subsection 80.01(3) is determined by reference to the cost amount of that Debt to X Co, that amount paid is the amount denominated in Canadian dollars. The cost amount of the Debt to X Co (in Canadian currency) at the time that is immediately before the time that is immediately before the proposed amalgamation is calculated using the exchange rate in effect at the time the Debt was issued. That cost amount is therefore CDN $1500 (US $1000 x 1.5). Thus, the amount paid is CDN$1,500.

From the perspective of X Co (the creditor), the deemed payment by Y Co to X Co arising from the application of subsection 80.01(3) will not give rise to a subsection 39(2) gain or loss to X Co for purposes of the Act:

Amount deemed received by X Co

CDN $1500

Less: X Co's adjusted cost base of the Debt immediately before the proposed amalgamation

(CDN $1500)

Equals: X Co's gain or loss on the settlement of the Debt

$0

ISSUE 2:

The issue is whether, under the proposed amalgamation, from the perspective of Y Co (the debtor), the deemed settlement of the Debt as a result of the application of subsection 80.01(3), gives rise to a subsection 80(1) "forgiven amount" or a subsection 39(2) gain or loss.

OUR COMMENTS

Interaction of subsection 80.01(3), subsection 80(1) "Forgiven amount" and paragraph 80(2)(k)

Subsection 80(1) defines the term "forgiven amount", in part, as follows:

" 'forgiven amount' at any time in respect of a commercial obligation issued by a debtor is the amount determined by the formula

A - B

Where

A is the lesser of the amount for which the obligation was issued and the principal amount of the obligation,

B is the total of,

a) The amount, if any, paid at that time in satisfaction of the principal amount of the obligation,

...."

Thus, in the case of Y Co (the debtor), subsection 80(1) of the Act would apply if the amount for which the Debt was settled or extinguished was less than the lesser of the principal amount thereof and the amount for which the obligation was issued.

As noted above, subsection 80.01(3) deems the debtor (Y Co) to have paid to the creditor (X Co), immediately before the time that is immediately before the proposed amalgamation, an amount equal to the creditor's cost of the Debt, namely, Cdn $1,500.

Furthermore, pursuant to paragraph 80(2)(k) of the Act foreign currency fluctuations after the time an obligation is issued are ignored for the purposes of section 80 and the forgiven amount is determined with reference to the exchange rate at the time that the Debt was issued. Since the amount deemed paid pursuant to subsection 80.01(3) was converted at the historical exchange rate (i.e. the exchange rate at the time the Debt was issued), it will not be adjusted by paragraph 80(2)(k) to arrive at the amount paid, for purposes of subsection 80(1). Thus, paragraph 80(2)(k) has no impact in this case.

As noted above, the amount deemed paid by subsection 80.01(3) is CDN $1500. Thus, variable B(a) in the definition of "Forgiven Amount" is CDN$1,500. Consequently, there is no excess to which subsection 80(1) of the Act would apply.

In particular, pursuant to subsection 80(1), the "Forgiven Amount" in Canadian currency is calculated as follows:

A - B

A (the principal amount of the obligation)

$1,500 (US$1,000 x 1.5)

Less

B (amount paid)

$1,500 (US$1,000 x 1.5)

Equals

$0 forgiven amount

Accordingly, the deemed payment to X Co arising from the application of subsection 80.01(3) will not give rise to a section 80 "Forgiven Amount" to Y Co in respect of the Debt.

Subsection 39(2)

Subsection 39(2) deems a taxpayer to realize a capital gain or loss where the taxpayer has "made a gain or sustained a loss" that is not on account of income "by virtue of any fluctuation" of a foreign currency relative to the Canadian dollar. Thus, subsection 39(2) deems a foreign currency gain or loss that is made on the repayment or settlement of a foreign currency denominated capital debt to be a gain or loss from the disposition of foreign currency.

Since a liability is not considered to be a property, there are no provisions of the Act other than subsection 39(2) to deal with a foreign exchange gain or loss on account of capital, on the repayment in whole or in part of a debt. A taxpayer has only made a gain or sustained a loss under subsection 39(2) in respect of foreign currency where there has been a transaction resulting in a gain or loss.

From the perspective of Y Co (the debtor), the deemed payment under subsection 80.01(3) by Y Co to X Co does not give rise to a gain or loss for purposes of subsection 39(2) of the Act. In particular, the principal amount of the Debt to Y Co, computed in Canadian dollars (namely, $1,500) is the same as the amount for which the Debt is deemed settled pursuant to subsection 80.01(3) (namely, $1,500).

Yours truly,

Olli Laurikainen, C.A.

Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

1 Pursuant to paragraph (b) of the definition of "cost amount" in subsection 248(1) and the definition of "adjusted cost base" in section 54 of the Act.

2 Gaynor v The Queen 91 DTC 5288.