28 May 2015 IFA Roundtable Q. 1, 2015-0577691C6 - IFA 2015, Q.1: George Weston decision

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 the CRA accepts the decision in the G. Weston decision.

Position: Yes.

Reasons: The decision reflected the taxpayer's intent as supported by surrounding evidence.

2015 International Fiscal Association Conference
CRA Roundtable

Question 1 - George Weston: impact on CRA's position re: hedges

The Tax Court of Canada recently rendered its decision in the George Weston Ltd. (GWL) case (footnote 1), which considered the income or capital characterization of the taxpayer's gains on foreign currency derivatives.

In 2001, the taxpayer borrowed significant funds to finance the acquisition of a U.S. based business (the "US Operations") by its indirectly held subsidiaries. Due to the risk of currency fluctuations, the taxpayer entered into a series of cross-currency swaps in order to protect against the impact of currency fluctuations on the translated value of the US Operations reported on its consolidated balance sheet. In 2003, the risk of currency fluctuations had been reduced and the taxpayer chose to terminate the swaps. The taxpayer realized a gain on the termination of the swaps and reported the gain on account of capital, which the CRA reassessed as being on account of income. The Court held in favour of the taxpayer finding the taxpayer entered into the swaps to hedge a capital investment and the gain was appropriately reported as being on account of capital.

The GWL case was not appealed. How does this decision impact the CRA's position with respect to foreign currency hedges for net investments in foreign operations and their characterization for income tax purposes?

CRA Response

The CRA accepts the decision in GWL. While the decision affirmed that there are circumstances in which a foreign currency derivative can be considered a hedge of a taxpayer's net investments in foreign operations there must, however, be evidence that demonstrates that the derivative is sufficiently linked to the underlying capital assets. The determination of whether there is sufficient linkage to the underlying capital assets will be a question of fact and can only be made after considering all of the surrounding circumstances.

In GWL, the Court found sufficient evidence to conclude the taxpayer's intent and purpose for entering into the swap contracts was to hedge the risk of currency fluctuations on its investment in the US Operations in order to counteract their impact on the taxpayer's capital structure and the value of its direct investments in its subsidiaries. The Court concluded that the taxpayer would not have entered into the swaps if it had not acquired the US Operations. The Court took into consideration, among other things, that the notional value of the swaps closely approximated the investments in the US Operations, the taxpayer's formal derivative policy and its credit facilities prohibited it from speculating in derivatives, and in arriving at its finding, that there was no evidence that the swaps were related to an underlying item that was on income account and that there was no evidence of a profit or speculation motive on the part of the taxpayer.

The Court did not consider the early termination of the derivative in these circumstances, to cause the derivatives to be considered speculative in nature. The termination occurred after the taxpayer's risk had declined (its debt to equity ratio had returned to acceptable levels) and the derivatives were no longer required to protect GWL's capital structure.

R. Ferrari
2015-057769
May 28, 2015

FOOTNOTES

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

1 George Weston Limited v. The Queen (TCC) 2015 TCC 42