15 September 2009 External T.I. 2009-0332771E5 - Functional currency tax reporting

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: Application of the functional currency tax reporting rules

Position: General comments provided

								2009-033277
XXXXXXXXXX 							D. Boychuk
(613) 948-5274
September 15, 2009 

Dear XXXXXXXXXX :

Re: Functional Currency Tax Reporting

This is in response to your letter of July 13, 2009 in which you asked us to advise you on the application of the functional currency tax reporting rules in section 261 of the Income Tax Act , R.S.C. 1985, c.1, as amended (the "Act") in the circumstances described below. We have reproduced your questions (in bold print) followed by our responses.

What line amounts on the T2 return are to be reported in functional currency and what line amounts are to be reported in Canadian currency?

Pursuant to subsection 261(5) of the Act, a functional currency tax reporter is required to determine its "Canadian tax results" using its elected functional currency.

The "Canadian tax results" of a taxpayer for a taxation year are defined in subsection 261(1) of the Act as:

(a) the amount of the income, taxable income or taxable income earned in Canada of the taxpayer for the taxation year;

(b) the amount (other than an amount payable on behalf of another person under subsection 153(1) or section 215 of the Act) of tax or other amount payable under the Act by the taxpayer in respect of the taxation year;

(c) the amount (other than an amount refundable on behalf of another person in respect of amounts payable on behalf of that person under subsection 153(1) or section 215 of the Act) of tax or other amount refundable under the Act to the taxpayer in respect of the taxation year; and

(d) any amount that is relevant in determining the amounts described in paragraphs (a) to (c).

Since the Canadian tax results of a functional currency taxpayer are determined in the taxpayer's elected functional currency, any amount described in paragraphs (a) to (d) above will be reported on the taxpayer's T2 return in the taxpayer's elected functional currency. However, special rules apply to ensure that any amounts that are payable by (or refundable to) a taxpayer under the Act are determined in Canadian dollars. These special rules are described in more detail below.

How are monthly instalment payments and balance of tax due amounts calculated and reported under the different scenarios set out below assuming the taxpayer is a functional currency reporter? Please specify which rate is to be used in the calculation.

The computation of the tax instalments and the remainder of the taxes payable by a functional currency taxpayer as described in subsections 157(1) and (1.1) of the Act 1 are determined in accordance with subsection 261(11) of the Act. Among other things, subsection 261(11) ensures that the first and second instalment bases for the taxpayer for any particular year are in Canadian dollars. In addition, subsection 261(11) contains rules for computing, in Canadian dollars, the remainder of the taxes payable by a functional currency taxpayer as described in paragraphs 157(1)(b) and (1.1)(b) of the Act.

Instalments

Assuming that a functional currency taxpayer is subject to subsection 157(1) of the Act (i.e., monthly instalments), the taxpayer's instalment obligations under subparagraph 157(1)(a)(i) (i.e., instalments based on estimated tax payable) are determined by taking 1/12 of the taxpayer's tax payable for the year under Parts I, VI, VI.1 and XIII.1 of the Act, as computed in the taxpayer's elected functional currency, and converting this amount to Canadian dollars at the relevant spot rate for the day that an instalment is due. 2

The taxpayer's instalment obligations described in subparagraphs 157(1)(a)(ii) and (iii) or 157(1.1)(a)(ii) and (iii) of the Act are based on the taxpayer's instalment bases, which will continue to be maintained in Canadian dollars. For example, in the first functional currency year of the taxpayer, the taxpayer's instalment bases, if any, are determined by reference to the Canadian dollar amounts payable by the taxpayer under the relevant parts of the Act 3 for Canadian currency years preceding the first functional currency year. Where the relevant preceding taxation year of the taxpayer is also a functional currency year, the taxpayer's first instalment base is based on the amount the taxpayer was required to pay in respect of the preceding year, in Canadian dollars, on account of the taxes payable by the taxpayer under the relevant parts of the Act. 4 More generally, in determining the taxpayer's first instalment base for a taxation year following a particular functional currency year (or the second instalment base for the year after that year), the total of the taxes payable by the taxpayer under the relevant parts of the Act are considered to be equal the total of the Canadian dollar amounts that the taxpayer was required to pay on account of those taxes in respect of the particular taxation year.

Computing the Remainder of Taxes Payable

For the purpose of computing the remainder of the taxes payable by a functional currency taxpayer under paragraph 157(1)(b) or 157(1.1)(b) of the Act, each of the taxpayer's required instalments, as determined in Canadian dollars, is converted to the taxpayer's elected functional currency using the relevant spot rate for the day each of the instalments was due. The total of the required instalments, as expressed in the taxpayer's elected functional currency, is then deducted from the taxpayer's tax payable for the year under the relevant parts of the Act and the difference, if any, is converted to Canadian dollars using the relevant spot rate on the taxpayer's balance-due day. 5 This two-step conversion process ensures that the remainder of the taxes payable by the taxpayer is a Canadian dollar amount. In addition, it insulates the taxpayer from exchange rate fluctuations in the value of the taxpayer's elected functional currency vis-a-vis the Canadian dollar between the taxpayer's instalment due dates and the taxpayer's balance-due day.

Taxes for which Instalments are not Required

The amounts payable by a functional currency taxpayer in respect of taxes not referenced in subsections 157(1) and 157(1.1) is computed by converting those amounts, as determined in the taxpayer's elected functional currency, to Canadian dollars using the relevant spot rate for the day those amounts are due. 6 Similarly, an amount that is deemed to be paid by the taxpayer on account of an amount payable (e.g., a refundable investment tax credit), is computed by converting that amount, as determined in the taxpayer's elected functional currency, to Canadian dollars using the relevant spot rate for the day on which the amount is deemed to be paid. 7

Interest and Penalties

Interest and penalties under Parts I, VI, VI.1 and XIII.1 that are derived from taxes payable are determined as if the taxes payable of a functional currency taxpayer were the aggregate, in Canadian dollars, of its required instalments and the remainder of its taxes payable. 8

Scenario 1: No instalments required

In this scenario, the remainder of the taxes payable by the taxpayer under paragraph 157(1)(b) or 157(1.1)(b) is determined by taking the taxes payable for the taxation year by the taxpayer under the relevant parts of the Act, as determined in the taxpayer's elected functional currency, and then converting the amount to Canadian dollars using the relevant spot rate for the taxpayer's balance-due day for the year.

Scenario 2: The minimum instalment due for each month is equal to the 1/12 of the taxpayer's first instalment base

The taxpayer's first instalment base for its first functional currency year is determined in the same manner as it would be if the taxpayer were not a functional currency taxpayer Where the taxpayer's relevant preceding taxation year is a functional currency year, the taxpayer's first instalment base is determined in the manner described above under the heading "Instalments".

The remainder of the taxes payable by the taxpayer, as described in paragraph 157(1)(b) of the Act, is determined by converting each Canadian dollar amount that the taxpayer was required to remit in monthly instalments into the taxpayer's elected functional currency at the relevant spot rate for the day each instalment is due. The total of the instalments, as determined in the taxpayer's elected functional currency, is then deducted from the taxes payable by the taxpayer for the year under Parts I, VI, VI.1 and XIII.1 of the Act. The remaining amount is then converted into Canadian dollars at the relevant spot rate for the taxpayer's balance-due day to arrive at the remainder of taxes payable.

Scenario 3: The minimum instalment due for each month is equal to 1/12 of the estimated tax payable for the year

The taxpayer's monthly instalments are computed by taking 1/12 of the taxes payable by the taxpayer for the year under the relevant parts of the Act, as computed in the taxpayer's elected functional currency, and converting this amount into Canadian dollars at the relevant spot rate on each of the taxpayer's monthly instalment due dates. These Canadian dollar amounts are the amounts that the taxpayer is required to remit on or before the instalment due date for each month.

When a taxpayer requests a loss carryback from a functional currency year to a Canadian currency year, what exchange rate is used to convert the functional currency loss amount to Canadian currency?

Where a taxpayer incurs a non-capital loss in a functional currency year, subsection 261(15) of the Act provides that, for the purposes of determining the amount that may be deducted in respect of an earlier Canadian currency year, the amount of the loss is to be converted to Canadian currency at the relevant spot rate for the last day of the taxpayer's last Canadian currency year.

If a taxpayer is using functional currency reporting in the current year, how are loss amounts carried forward from a prior Canadian currency year reported on the T2 Schedule 4 - Corporation Loss Continuity and Application? If the prior year loss from a Canadian taxation year is applied against the current functional currency year, how is this loss converted and reported on the T2 return?

Subsection 261(7) of the Act provides that, in applying the Act to a taxpayer for a particular functional currency year, certain amounts are to be converted from Canadian currency to the taxpayer's elected functional currency using the relevant spot rate for the last day of the taxpayer's last Canadian currency year. Subsection 261(7) applies to amounts, such as losses and other amounts carried forward, that were determined in, or in respect of, a taxation year preceding the taxpayer's first functional currency year but that are relevant in determining the taxpayer's Canadian tax results for a particular functional currency year. Thus, the amount of the taxpayer's loss carryforward, as converted to the taxpayer's elected functional currency, would be reported on the T2 Schedule 4.

The transitional rules in place for taxpayers who made an election on or before June 27, 2008, allow taxpayers to use the average exchange rate of each day in the 12-month period that ends on a particular day instead of the relevant spot rate. How does this impact the calculations in the questions above?

Assuming that the transitional rules apply to a taxpayer, the taxpayer would use the average of the relevant spot rates in lieu of the relevant spot rate for the purposes of applying subsections 261(7) to (10) of the Act. Subsection 261(7) deals with the translation of the taxpayer's Canadian dollar tax attributes to the taxpayer's elected functional currency where such attributes were determined in, or in respect of, a taxation year preceding the taxpayer's first functional currency year, but that are relevant in determining the taxpayer's Canadian tax results for a particular functional currency year. Subsections 261(8) to (10) contain rules for the treatment of "pre-transition debts" of the taxpayer. 9

Where the transitional rules apply, they will not directly affect any of the calculations referred to in the questions above except the question dealing with the computation of the taxpayer's loss carryforward. In the situation where the taxpayer was subject to the transitional rules, the amount of the taxpayer's non-capital losses carried forward would be converted to the taxpayer's elected functional currency using the average of the rates referred to above.

In what currency is the CRA going to report changes to the total tax payable, tax payments and tax account balances for functional currency tax reporters on the CRA's notices of assessment?

Subsection 261(11) of the Act applies such that amounts payable by, or refundable to, a functional currency taxpayer are ultimately expressed in Canadian dollars. In addition, paragraph 261(11)(g) of the Act provides that all amounts payable under the Act are to be paid in Canadian dollars. Accordingly, we expect that the notice of assessment for a functional currency taxpayer will reflect the amounts reported on the T2 return (i.e., the taxpayer's Canadian tax results) in the taxpayer's elected functional currency and the actual amounts payable, including interest and penalties (if applicable), in Canadian dollars.

We trust that our comments are of some assistance. If you have any questions, please contact me at (613) 948-5274.

Yours truly,

Daryl Boychuk
Manager, International Section I
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
ENDNOTES

1 Subsection 157(1) deals with taxes payable under Parts I, VI, VI.1 and XIII.1 of the Act while subsection 157(1.1) deals with taxes payable under Parts I and VI.1 by certain Canadian-controlled private corporations.

2 Subparagraph 261(11)(a)(i).

3 The relevant parts of the Act for the purposes of subsection 157(1) are Parts I, VI, VI.1 and XIII.1 while the relevant parts of the Act for the purposes of subsection 157(1.1) are Parts I and VI.1.

4 Clause 261(11)(a)(ii)(B).

5 Paragraph 261(11)(b).

6 Paragraph 261(11)(d).

7 Paragraph 261(11)(e).

8 Paragraph 261(11)(c).

9 The term, "pre-transition debt" of a taxpayer is defined in subsection 261(1) as a debt obligation of the taxpayer that was issued before the beginning of the taxpayer's first functional currency year.