6 December 2011 TEI-CRA Liason Meeting Roundtable Q. 4, 2011-0426981C6 - Functional Currency 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: Whether subsection 261 applies to a transaction involving the repayment of a Canadian dollar loan owed by subsidiary using US dollar tax reporting currency to parent company using Canadian dollar tax reporting currency.

Position: Yes.

Reasons: Based on the example described in the November 2008 Explanatory Notes, the arrangement meets the conditions outlined in subsection 261(20).

2011 TEI-CRA Liaison Meeting
December 6, 2011

Question 4 - Functional Currency Reporting Rules

The technical notes to subsections 261(20) and (21) state that they are intended to prevent abuses of the functional currency tax reporting regime. At the May 2011 International Fiscal Association (IFA) Roundtable, CRA was asked to provide scenarios where it would apply the anti-avoidance rule in subsection 261(21). The facts of the example CRA provided were as follows:

1. Canadian dollar functional currency parent lends to US dollar functional currency subsidiary.
2. The loan is denominated in Canadian dollars.
3. On the repayment of the loan, the subsidiary incurs a foreign exchange loss.
4. The foreign exchange loss in the subsidiary is denied.

Why does CRA consider this scenario to be abusive and subject to the anti-avoidance rule? The impetus for a taxpayer to make a functional currency election for tax purposes is that Canadian generally accepted accounting principles may require a taxpayer to maintain one or more (but not all) of its corporate accounts in the foreign currency. By making the election, the taxpayer is endeavouring to save the time and expense of maintaining two sets of books of original entry for the affected accounts. We invite CRA to elaborate on its response at the IFA Roundtable.

Response

Subsection 261(21) of the Income Tax Act (Canada) (the "Act") provides that fluctuations in the relative values of tax reporting currencies of related taxpayers are deemed not to have occurred when determining the income, gain or loss in respect of a transaction if the following conditions described in subsection 261(20) are satisfied:

1. The transaction was entered into, directly or indirectly, at any time by a taxpayer and a related corporation.

2. The taxpayer and the related corporation had different tax reporting currencies at any time during the period in which the income, gain or loss in respect of the transaction accrued (the "accrual period").

3. In the absence of subsections 261(20) and (21), it would be reasonable to consider that a fluctuation in the relative values of the respective tax reporting currencies of the taxpayer and the related corporation, which occurred during the accrual period, either increased the taxpayer's loss, reduced the taxpayer's income or gain, or caused the taxpayer to have a loss instead of income or gain in respect of the transaction.

Subsections 261(20) and (21) were enacted by section 80 of the Budget Implementation Act, 2009, (footnote 1) and apply in respect of taxation years commencing after June 27, 2008. The Department of Finance published Explanatory Notes relating to these provisions on November 10, 2008. (footnote 2) In addition to indicating that subsections 261(20) and (21) were intended to protect against potential abuses of the functional currency tax reporting regime, the Explanatory Notes include an example in which a foreign exchange loss arising on the repayment of an amount owing by a subsidiary to its parent corporation would, in effect, be disallowed by subsection 261(21) in computing the subsidiary's income. (footnote 3)

At the IFA Roundtable, we were asked to provide examples of situations in which the CRA would consider applying subsection 261(21). In response, we referred to the example contained in the Explanatory Notes. Further to this, we would add that subsection 261(21) applies whenever the conditions in paragraphs 261(20)(a), (b) and (c) are met.

Jackson MacGillivray
2011-042698

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 S.C. 2009, c.2.
2 Canada, Department of Finance, "Legislative Proposals and Explanatory Notes Relating to Functional Currency Tax Reporting" November 2008 [hereinafter the "Explanatory Notes"].
3 Ibid. at 39.