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 subsections 40(3.3) and 40(3.4) and subparagraph 40(2)(g)(i) apply to deny a foreign exchange loss realized on the disposition of foreign cash
Reasons: In the context of a foreign exchange loss on the disposition of cash, the cash would not be "property" for the purposes of those provisions.
International & Large Business Audit Section
Montreal Tax Services Office 2008-028011
305 Rene-Levesque Boulevard West, 10th Floor S.E. Thomson
Montreal QC H2Z 1A6 (613) 957-2122
January 6, 2009
Dear Ms. Poirier:
Re: Foreign Exchange Loss on Disposition of "Funds on Deposit"
This is in reply to your letter of May 28, 2008 in which you ask for our views on the tax treatment of foreign exchange losses on the disposition of "funds on deposit". The facts can be summarized as follows:
Canco is a corporation resident in Canada. Forco is a corporation resident in XXXXXXXXXX , and is a wholly-owned subsidiary of Canco. Forco is the financing entity for Canco and other foreign affiliates in the group. It makes loans to other foreign affiliates and to Canco, receives loans from other foreign affiliates and from Canco, invests in equity of and receives dividends from foreign affiliates, and pays dividends to Canco. As a result, the cash balances of Forco are always fluctuating.
From XXXXXXXXXX to XXXXXXXXXX , Forco invested excess cash in $US term deposits. After XXXXXXXXXX , Forco simply kept the $US cash in an interest bearing bank account. Forco considers (and you agree) that the term deposits and the bank account are held on capital account, and are not excluded property. Therefore, in computing its foreign accrual property income ("FAPI") in respect of Canco, Forco computes the foreign exchange ("FX") capital gains or losses in Canadian dollars, as if Forco were a taxpayer resident in Canada, in accordance with paragraph 95(2)(f) and subsection 39(2) of the Income Tax Act (the "Act"). Forco used the Gaynor 1 principle, and new subsection 261(2) of the Act to convert the cash acquired and disposed of. That is, Forco translated the US cash to Canadian using the rate of exchange in effect when the cash was acquired, and used the averaging rule in section 47 of the Act to compute the adjusted cost base of the cash. It used the rate of exchange in effect when the cash was disposed of to compute the proceeds of disposition.
Forco has not reported FX gains or losses on the cash when it is used to purchase term deposits, or on the term deposits as they are rolled over or converted back to cash, in accordance with the CRA's position in paragraph 13 of IT-95R Foreign Exchange Gains and Losses, which says:
The Department considers that a taxpayer has "made a gain" or "sustained a loss" in a foreign currency only where there has been a transaction resulting in a gain or loss. Subsection 39(2) does not apply where a loss has been made "on paper" but no transaction has taken place. As a result the "accrual" method of accounting for foreign exchange gains or losses is not acceptable for purposes of reporting foreign exchange gains or losses on capital account. The following are examples of the time when the Department considers a transaction resulting in the application of subsection 39(2) to have taken place.
(a) at the time of conversion of funds in a foreign currency into another foreign currency or into Canadian dollars,
(b) at the time funds in a foreign currency are used to make a purchase or a payment (in such a case the gains or loss would be the difference between the value of the foreign currency expressed in Canadian dollars when it arose and its value expressed in Canadian dollars when the purchase or payment was made, and
(c) at the time of repayment of part or all of a capital debt obligation.
Foreign currency funds on deposit are not considered to be disposed of until they are converted into another currency or are used to purchase a negotiable instrument or some other asset, i.e. foreign funds on deposit may be moved from one form of deposit to another as long as such funds can continue to be viewed as "on deposit". Term deposits, guaranteed investment certificates and other similar deposits which are in fact not negotiable, are considered funds on deposit. Transactions in which foreign currency funds are invested in negotiable instruments such as notes, bonds mortgages, debentures, U.S. government treasury bills and notes and U.S. commercial paper, will require a foreign exchange gain or loss calculation at the time the foreign currency funds are used to purchase these investments and as well, each time such investments mature or are otherwise disposed of, whether or not the funds are rolled over into like securities.
However, Forco is reporting gains and losses from the use of $US cash to make loans or investments, or to pay dividends to Canco, in accordance with IT-95R. In XXXXXXXXXX , the US dollar depreciated against the Canadian dollar, and Forco incurred large FX losses that it would like to deduct from its FAPI. XXXXXXXXXX
We believe that Forco has correctly reported its FX gains and losses, taking into account the CRA's position in paragraph 13 of IT-95R. Forco has not reported any FX gains or losses on the dispositions of the $US cash when it was used to purchase a term deposit, or on a disposition of the term deposit when it was rolled over into another term deposit, or converted back to cash.
Rather, Forco is reporting FX gains and losses realized when the cash is used to make an investment or a loan, or pay a dividend. There is clearly a disposition of the cash in this case. The fact that Forco later received new cash, which was subsequently used to purchase a term deposit, does not refute the fact that the cash has been disposed of initially.
The CRA's long-standing position is that subsection 39(2) of the Act applies (and not subsection 39(1)) when a taxpayer's gain or loss on the disposition of capital property arose solely as a result of the fluctuation of foreign currency relative to the Canadian dollar. In addition, our position is that subsection 39(2) cannot apply unless the taxpayer "made a gain or sustained a loss". If the loss is deemed to be nil by section 40, then, for purposes of subsection 39(2), the taxpayer has not "sustained a loss".
Subparagraph 40(2)(g)(i) of the Act provides that a taxpayer's superficial loss from the disposition of property is nil. The term "superficial loss" is defined in section 54 to be essentially, a loss from the disposition of a property where the taxpayer or an affiliated person acquires the property or an identical property within the period that begins 30 days before and ends 30 days after the disposition, and still owns it at the end of that period. If the loss is a superficial loss, the loss is denied, and instead is added to the cost of the property under paragraph 53(1)(f). However, a loss is not a superficial loss if the disposition is subject to subsection 40(3.4).
Subsections 40(3.3) and 40(3.4) apply when a corporation, trust or partnership (referred to as the "transferor") disposes of a particular property. The effect of subsections 40(3.3) and 40(3.4) is similar to the superficial loss rule in that the loss from the disposition of a property is deemed to be nil where the transferor or an affiliated person acquires the property or an identical property within the period that begins 30 days before and ends 30 days after the disposition, and still owns it at the end of that period. When subsections 40(3.3) and 40(3.4) apply, the transferor's loss is "suspended" until neither the transferor nor an affiliated person owns the property for 30 days.
In IT-387R2 Meaning of "Identical Properties", we say that identical properties are properties which are the same in all material respects, so that a prospective buyer would not have a preference for one as opposed to another. The word "property" is defined in subsection 248(1) for purpose of the Act. Paragraph (b) of the definition provides that money is property, unless a contrary intention is evident. Clearly cash is a different property from a term deposit, and the stop-loss rules would not apply where the cash is replaced by a term deposit. However, when cash expended is replaced by more cash, an argument can be made that subsections 40(3.3) and 40(3.4) apply to "suspend" the FX losses on the $US cash. However, if these provisions applied to the disposition of cash, the suspended losses may be suspended indefinitely if Forco or any affiliated person receives additional $US cash.
Therefore, XXXXXXXXXX , we have concluded that in the context of a foreign exchange loss on the disposition of cash, the cash would not be "property" for the purposes of subsections 40(3.3) and 40(3.4) and subparagraph 40(2)(g)(i). Consequently, those provisions do not apply to deny the foreign exchange loss realized by Forco when the $US cash was used to make an investment or a loan, or pay a dividend.
We trust that we have been of some assistance.
Olli Laurikainen, C.A.
International & Trusts Division
Income Tax Rulings Directorate
1 Hope R. Gaynor v. The Queen, 91 DTC 5288
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