30 October 2008 Internal T.I. 2008-0297081I7 - Foreign Exchange

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: Are foreign exchange gains or losses on account of income or capital?

Position: Depends on the purpose of the use of the funds

Reasons: Ethicon Sutures and various court decisions

Patricia Ross
Large Files
Calgary TSO							HeadquartersT
								Claude Tremblay, CMA
(613) 957-8979
(819) 281-2916

								October 30, 2008

Re: Foreign Exchange Gains on Commercial Paper

This is in reply to your memorandum of October 21, 2008 regarding the above-noted subject. We agree that paragraph 3 of Interpretation Bulletin IT-95R, Foreign Exchange Gains and Losses, refers to corporations that inadequately capitalized. Generally, where a corporation is adequately capitalized, paragraphs 1 and 2 of that Bulletin apply.

Generally, it is the purpose of the use of the funds that determine whether the gain or loss is on account of income or capital. The Courts have repeatedly referred to the purpose for which the borrowed funds were acquired and after analyzing the actual use of the borrowed funds, finds the use of the funds the confirmation of the purpose.

As stated by the courts in Ethicon Sutures Ltd. 85 DTC 5293, "to determine whether a foreign exchange gain is to be treated as income or capital, it is necessary to look at the nature of the underlying transaction that led to the gain. Where the foreign currency was acquired as a result of the taxpayer's trading operations, or for the purpose of carrying on trading operations, any gains will be treated as occurring in the course of the taxpayer's trade and will be treated as income."

Generally, if funds are borrowed for general corporate purposes, gains are probably on account of income unless it can be demonstrated that the company was "grossly" undercapitalized in which case the gains will be on account of capital. Montreal Coke was cited with approval in Tip Top Tailors Limited vs the Minister of National Revenue 57 D.T.C. 1232, a case where the Supreme Court of Canada dealt with the taxation of foreign exchange profits and concluded that the foreign exchange profits in that case were on income account.

At the 1995 CTF Conference at question 19 of the Round Table we concluded that whether gains or losses on investment transactions are on income or capital account is a question of fact. In general, it is the Department's view that a statement of powers in the incorporating documents, while certainly a factor, is not in itself determinative. Where the realization of investments is part of the corporation's ordinary business, the resulting gains or losses would normally be on income account.

Further, at the 1994 CTF Conference, Revenue Canada Round Table at question 2, we examined IT-95R, paragraph 3 and the fact that where borrowed funds are used in the ordinary course of a taxpayer's business, any foreign exchange gain/loss is considered to be on income account. An exception is made if the borrowed funds form part of the permanent or fixed capital of the company. We stated that here are no specific criteria under which funds borrowed in a foreign currency would be considered to be fixed or permanent capital and each case must be reviewed and determined on its own facts. In making this determination, the Department would assess, among other factors, the level of capitalization of the corporation (prior to obtaining the foreign currency borrowing) in relation to the corporate operations and whether there was a need for the particular borrowing to enable the corporation to carry out its day to day activities.

R. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch