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: 1. Does subsection (21) apply to reduce the foreign exchange loss of a taxpayer in respect of a hedging arrangement between the taxpayer and a related corporation that is a non-resident of Canada and is not subject to the provisions of the Act? 2. If a taxpayer enters into a hedging arrangement to hedge its foreign exchange risk in respect of a loan issued by the taxpayer any loss from which would be denied under subsection 261(21), does 261(21) also apply to deny a foreign exchange loss in respect of the hedging arrangement?
Position: 2. No. 2. No.
Reasons: Paragraph 261(20)(b) is not satisfied. Either the non-resident corporation does not have a tax reporting currency, or it has the Canadian dollar tax reporting currency – the same as the Canadian-resident corporation. The hedging arrangement must be considered separately from the loan.
March 9, 2016
HEADQUARTERS
XXXXXXXXXX Tax Services Office Income Tax Rulings
Large File Case Audit Directorate
Corporate Taxation Jeffrey Johns
(416) 973 9084
Attention: XXXXXXXXXX
2015-061250
Functional Currency Anti-avoidance Rules
We are writing in response to your Referral Letter of October 7, 2015, regarding the application of subsections 261(20) and (21) of the Income Tax Act (Canada) (the “Act”). Unless otherwise stated, all references in this letter to a statute are to the Act, and all terms used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.
Facts
1. XXXXXXXXXX (“Holdco”) is a corporation resident in Canada. All of the issued shares of Holdco are owned by XXXXXXXXXX (“Parent”).
2. Parent is not a resident of Canada for purposes of the Act.
3. XXXXXXXXXX (“Opco”) is a corporation resident in Canada all of the issued shares of which are owned by Holdco.
4. In XXXXXXXXXX, Holdco advanced a loan (the “Loan”) to Opco. The Loan was denominated in US dollars.
5. At all times during the period in which the Loan was outstanding, Holdco’s tax reporting currency, as that term is defined in subsection 261(1), was Canadian dollars and Opco’s tax reporting currency was US dollars.
6. During the period in which the Loan was outstanding, Holdco entered into agreements (the “Hedging Agreements”) with Parent that hedged Holdco’s income tax foreign exchange exposure in respect of the Loan. For its XXXXXXXXXX, taxation years, Holdco realized foreign exchange losses on the settlement of the Hedging Agreements.
7. In XXXXXXXXXX, the Loan was settled. Holdco realized a foreign exchange gain on the settlement of the Loan for its XXXXXXXXXX, taxation year. As the Loan was denominated in Opco’s tax reporting currency, Opco did not realize a foreign exchange gain or loss on the settlement.
Issue
You have asked for our views regarding whether subsection 261(21) applies to the losses realized by Holdco on the settlement of the Hedging Arrangements for its XXXXXXXXXX, taxation years.
Analysis
Subsection 261(21) of the Act provides that for the purposes of determining a taxpayer’s income, gain or loss in respect of a “specified transaction”, fluctuations in the relative values of the taxpayer’s tax reporting currency and that of a related taxpayer are deemed not to have occurred, if the following conditions of subsection 261(20) are satisfied:
1. The specified 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 specified 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 specified transaction.
In our analysis, we considered two possible approaches to determine the application of subsection 261(21). In the first approach, we considered whether the conditions in subsection 261(20) were met looking only to each Hedging Agreement as the specified transaction. As you have requested, the second interpretive approach we considered was to determine whether, because the Hedging Agreements were entered into specifically to hedge the Loan, they form part of the same transaction as the Loan and, as a result, the conditions of subsection 261(20) are satisfied.
A. Hedging Agreements as specified transaction
In our view, each Hedging Agreement would be a specified transaction for purposes of subsection 261(20). Holdco, as its wholly-owned subsidiary, would be related to Parent under subparagraph 251(2)(b)(i) for purposes of the Act. Thus, the first condition of subsection (20) would be satisfied.
In order to determine whether the second condition has been met, it is necessary to consider whether Holdco and Parent have different tax reporting currencies.
If Parent had Canadian tax results for the taxation years in that period, subsection 261(2) would require that Parent’s Canadian tax results be determined in Canadian currency, as Parent is not eligible as a non-resident to make a functional currency election. As a result, Parent’s tax reporting currency for those taxation years would be Canadian currency, the same tax reporting currency as Holdco. Alternatively, if Parent did not have any Canadian tax results for the taxation years in which the Hedging Agreements were outstanding, it would not have had a tax reporting currency for those years. As a result, the second requirement of subsection 261(20), that the parties to the specified transaction have different tax reporting currencies, would not be satisfied.
Therefore, in the present fact scenario, it is not necessary to conclude whether Parent had a tax reporting currency in the period the Hedging Agreements were outstanding. Whether Parent has Canadian tax results or not, subsection 261(21) will not apply.
B. Loan and Hedging Agreements as single specified transaction
During the period in which the Loan was outstanding, Holdco and Opco were related and had different reporting currencies. Therefore, if Holdco had realized a loss on the disposition of the Loan, each condition of subsection 261(20) would have been satisfied and subsection 261(21) would have applied to deny that loss. You have requested our views regarding whether the Loan and the Hedging Arrangements could be viewed as part of the same “specified transaction” and as a result, make the Hedging Arrangements subject to subsection 261(21) thus denying Holdco’s losses on the Hedging Arrangements.
Under the Act, the characterization of a gain or loss in respect of the settlement of a hedging arrangement as being on account of income or capital will depend on the characterization of the liability that the arrangement is designed to hedge. However, the gain or loss in respect of the settlement of the hedging arrangement and the gain or loss in respect of the settlement of the liability are nevertheless still taxed as separate transactions. In our view, the same principles apply for purposes of subsection 261(21), and the Hedging Agreements would not be considered part of the same specified transaction as the Loan. In this regard, we specifically note that Parliament chose to limit the application of subsection 261(21) by not making it applicable in respect of a series of transactions.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.
We trust these comments will be of assistance.
Terry Young, CPA, CA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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