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: CICA 3855 provides for financial liabilities held for trading to be carried at fair value. Are fair value adjustments to the carrying value of these liabilities included in computing income for tax purposes?
Position: General comments.
Reasons: Our general view is that an adjustment to the value of a debt for accounting purposes, due to a fluctuation in interest rates, does not represent a gain or loss that is relevant for the computation of income for tax purposes.
February 22, 2012
Dear XXXXXXXXXX :
Re: Fair Value Accounting Adjustments
This is in reply to your letter dated June 21, 2008, in which you requested our views concerning the effect of the revaluation of certain liabilities at fair value as a consequence of CICA Handbook Section 3855 ("CICA 3855") for income tax purposes. We also acknowledge our conversations (Young/XXXXXXXXXX). We apologize for the delay in responding.
In your letter, you note that CICA 3855 permits, or possibly requires, certain taxpayers to carry financial liabilities held for trading on their financial statements at their fair value. Since a taxpayer that is a financial institution incurs liabilities at various interest rates and for varying terms, such a taxpayer could incur a liability that would be revalued at year-end because of fluctuations in interest rates between the date the liability was incurred and the end of the fiscal period in accordance with CICA 3855. As an example, a taxpayer that borrows an amount at par under a fixed interest rate term deposit may record a larger liability at year-end than the principal amount of the obligation if interest rates decline subsequent to the taxpayer's incurring the deposit liability. The resulting gain or loss from the revaluation of a liability is included in computing net income for the period the gain or loss arises pursuant to CICA 3855.76(a). You would like to know whether the taxpayer can, or must, recognize income or losses for tax purposes as a result of revaluing liabilities under CICA 3855.
In our discussions, you noted that the revaluing of liabilities is similar to the treatment of certain assets under the mark-to-market rules in the Income Tax Act (the "Act"). In many cases, the liabilities will be part of a portfolio of identified financial instruments that are managed together. In your view, if the gains or losses in the value of mark-to-market properties are included in or deducted from income for Part I purposes, it makes sense that the gains or losses in the value of the corresponding liabilities should be included in or deducted from income as well. This would result in an appropriate measure of income by matching the treatment of assets and liabilities. You further noted that in practice, some taxpayers may incur certain debts that will be revalued to reflect both movements in currency and interest rates. Such taxpayers may face administrative difficulties if they are required to split out the effects of currency and interest rates in respect of a liability that is revalued as a consequence of both foreign exchange fluctuations and changes in interest rates.
As discussed, the mark-to-market property rules in the Act apply to property held by financial institutions. Since the type of debt described in your letter is not property and therefore is not subject to the mark-to-market rules, the question is whether an adjustment to revalue such a debt in accordance with CICA 3855 should be included in computing income for tax purposes.
Based on the hypothetical situation described, it is our general view that an adjustment to the value of a debt for accounting purposes, due to a fluctuation in interest rates, does not represent a gain or loss that is relevant for the computation of income for tax purposes. If the debt is held to maturity, that gain or loss from revaluing the debt will not be realized. A gain or loss can only be realized if the debt is assumed by some other party at market value. Paragraph 18(1)(e) of the Act specifically denies a deduction for reserves and contingent liabilities.
In your letter you asked if the case of Canadian General Electric Co. Ltd. v. MNR, 61 DTC 1300 (S.C.C.), could be relied on to permit a debt that is on income account to be revalued each year for tax purposes. In that case, the Supreme Court of Canada determined that the company was entitled to revalue the amount of Canadian dollars necessary to pay off the outstanding notes at each balance sheet date and take into income the foreign exchange profit annually. We accepted that decision but its application is limited to the conversion of the principal amount of a foreign currency debt held on income account. The decision does not apply to the revaluation of a debt due to interest, credit or other adjustments.
Finally, until we have had an opportunity to examine the specific facts in the context of an audit or an advance income tax ruling request, it is difficult for us to comment on the possible administrative difficulties that a taxpayer might face with regard to liabilities that are revalued to reflect both foreign exchange fluctuations and changes in interest rates.
We hope that our comments are of assistance.
Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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