9 November 1992 External T.I. 9218915 F - Foreign Currency Hedges

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.

Attention:  19(1)

November 9, 1992

Dear Sirs:

Re:  Foreign Currency Hedges

This is in reply to your letter dated June 19, 1992 wherein you requested our confirmation of five propositions dealing with foreign currency hedging issues. 

The Department is continuing its review of the taxation of financial products including the review of the tax treatment of foreign exchange gains and losses in general as noted in our discussion paper dated January 22, 1992.  Where this review results in a change in publicly stated positions taken by our Department, we would expect that such a change would be applied on a prospective basis.  You should note that in the course of our review, positions may be taken with respect to issues where there is no formal policy or with respect to issues which have previously not been considered by our Department in any detail.  In this regard the lack of assessing action in prior years should not be interpreted as an indication that the Department has taken a position with respect to a particular issue. 

We are unable at this time to confirm the proposition which is set forth in the second item of your letter.  As was mentioned in our discussion paper dated January 22, 1992, it remains our position that hedging gains and losses of a bank are normally on income account unless the bank can demonstrate that a particular hedging transaction is on capital account.   The Department's position is that liabilities of a bank that are used to acquire a capital asset, such as shares of a wholly-owned subsidiary of the bank or owner-occupied premises, will be viewed as being on capital account such that where the liabilities are denominated in a foreign currency any related foreign exchange gains or losses will be on capital account.  To the extent that the foreign currency liability is specifically hedged any gains or losses realized or sustained in respect of the hedging instrument will also be on capital account.  However, the Department is not prepared to take a general position with respect to assets denominated in a foreign currency.  For example, the mere holding of shares denominated in a foreign currency does not mean that a bank can take an opposing position in an equivalent amount of the foreign currency.  If there is no intention to dispose of the shares then it would seem that a strong argument is present that a speculative foreign currency position is being taken in the ordinary course of the bank's business as opposed to the hedging of a capital asset.  This will be considered in more detail in the course of our review referred to above.  We also would like to reiterate the comments made in our January 22, 1992 letter to the effect that we do not see any basis under the Canadian income tax law which would permit the pooling concept which you referred to in the second item of your letter.

We are not prepared to accept your proposition that intermittent hedging as opposed to continuous hedging as described in the third item of your letter will be determinative of whether the related gains and losses are on income or capital account.  While we would agree with your statement that intermittent hedging should be given income treatment for tax purposes it should not be taken as a corollary that the fact that financial instruments are employed on a continuous basis will result in capital treatment.  On the contrary, as mentioned earlier, we are still of the general view that hedging gains and losses of a bank, whether intermittent or continuous, are normally on income account.

In item four of your letter you refer to our general position that foreign exchange gains and losses of a bank are generally on income account.  We also extend this position to hedging gains and losses as described above. You then mention that foreign exchange gains and losses on foreign currency denominated capital investments in shares of wholly-owned subsidiaries and owner-occupied premises are considered to be taxable on capital account.  We confirm this statement, however, as noted above this view does not necessarily extend to financial products which may appear to be associated with such assets.

As was stated in our discussion paper dated January 22, 1992, the administrative position set forth in paragraph 13 of Interpretation Bulletin IT95R, is limited to capital transactions involving the deposits of foreign currency funds as provided therein.  This position did not take into account hedging transactions with respect to foreign currency liabilities and until we have had an opportunity to study this matter further we are unable to confirm the proposition stated in item five of your letter.  As you noted, where a foreign currency liability is used to acquire a capital asset the foreign exchange gains or losses in respect of the liability or the gains or losses of any related hedge cannot be deferred beyond the maturity of the liability or hedging instrument even though the asset may not have been disposed of.

In concluding, our Department recognizes the importance to the banks of providing some guidance as to the tax implications that arise in connection with foreign currency borrowings and various financial products.  This, however, is a complex area that needs to be fully analyzed taking into account jurisprudence and accounting conventions including those proposed in the Exposure Draft dated September 1991 issued by the CICA Accounting Standards Committee dealing with financial instruments.  Furthermore it would be prudent to take into account the guidelines from the Office of the Superintendent of Financial Institutions in this area which we understand are presently being formulated.

Given current demands on human resources arising from the current workload in the Rulings Directorate we are unable to speculate as to when this project will be completed, however, we will keep you advised as to our progress.

We trust our comments will be of assistance to you.

Yours truly,

DirectorFinancial IndustriesRulings DirectorateLegislative and Intergovernmental Affairs Branch