18 October 1989 Ministerial Correspondence 58074 F - Foreign Accrual Property Income and Currency Swaps

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.

October 18, 1989

Dear Sirs:

Re:  Foreign Accrual Property Income Clause 95(2)(b)(i)(A) of the Income Tax Act (the "Act")

This is in reply to your letter of May 9, 1989 concerning the application of clause 95(2)(b)(i)(A) of the Act to a particular situation.

The fact situation that you have presented is as follows:

1.     A Canadian financial institution ("Canco") has significant U.S. dollar liabilities on the books.

2.     In order to reduce the risk of loss from an increase in the value of the U.S. dollar, Canco enters into a "swap" arrangement with a wholly-owned subsidiary (FA) that is a foreign affiliate of Canco and that actively carries on the business of a financial institution outside Canada.

3.     The terms of the "swap" arrangement provide that FA agrees to pay to Canco a notional "U.S. dollar principal amount" at the end of the term of the arrangement. In return, Canco agrees to pay to FA a notional "Canadian dollar principal amount" is equal to the U.S. dollar principal amount translated into Canadian dollars at the spot exchange rate on the date on which the arrangement commenced.

Our understanding of "currency swaps" is that they are arrangements that are made to lower the cost of financing. It is not apparent to us that this arrangement is a "currency swap" as we use that term; the situation presented by you seems to simply involve future obligations to pay a principal amount (the "hedge").

Although the situation described in your letter lacks sufficient detail to allow for determinations, it appears that the following income tax consequences apply to the facts described above:

1)     It is not clear that FA's income in respect of the hedge will be active business income. It is conceivable that the transactions may result in property income to FA or may be on account of capital.

2)     Paragraph 95(2)(b) of the Act may apply. "Services" is a very broad word. It may mean "help, benefit or advantage conferred" and can in our view include financial services.  However, it is a question of fact whether something constitutes a service.

3)     Subsection 15(1) of the Act may apply to Canco in respect of the hedge provided by FA.

It is not apparent why no other income or expenses would be related to the above arrangements.

Should you wish to request an advance income tax ruling in respect of a particular proposed transaction, we would be pleased to give further consideration to such foreign exchange hedging arrangements.

Yours truly,

for DirectorReorganizations and Non-Resident DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch