12 January 1993 Income Tax Severed Letter 9222575 - Foreign Exchange Loss on Non-arm's Length Debt

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.

922257
XXXXXXXXXX
B.G. Dodd
(613) 957-3495

Attention: XXXXXXXXXX

January 12, 1993

Dear Sirs:

• We are writing in reply to your letter dated July 21, 1992 concerning the income tax treatment arising on the repayment of foreign currency denominated debt between related parties. We apologize for the delay.
• In particular, you have requested our views on the application of subsections 39(2) and 85(4) and paragraph 40(2)(e) of the Income Tax Act (the "Act") in a hypothetical situation in which a Canadian resident corporation makes a loan to its controlled non-resident subsidiary. The Canadian corporation receives a loan from its non-resident parent corporation. Both the loan receivable and the loan payable are of a capital nature and are denominated in U.S. dollars. Both of the loans are repaid in the same taxation year in the amount of U.S. dollars originally advanced. Due to fluctuations in currency rates, a foreign exchange loss is realized on the repayment of the loan receivable and a foreign exchange gain is realized on the payment of the loan payable.
• While all the facts of a specific situation would be relevant, including the reasons for such an arrangement, the Department's general views in this area are as follows:
• • Section 40 of the Act determines whether or not a taxpayer has made a gain or sustained a loss as a result of the disposition of property.
• • Once a gain or loss has been determined pursuant to section 40, section 39 of the Act is applied to compute the capital gain or capital loss as a result of the disposition of that property.
• • If the gain or loss determined pursuant to section 40 arises by virtue of the fluctuation of the value of a currency, subsection 39(2) of the Act applies to compute the capital gain or capital loss.
• • Where a loss otherwise determined from the disposition of property is nil pursuant to the provisions of section 40, for example, pursuant to paragraph 40(2)(e), there is no loss for the purposes of applying subsection 39(2) of the Act.
• • With respect to the repayment of the Canadian corporation's loan receivable, it is our opinion that while this is a disposition of property (ie. the loan receivable) by the Canadian corporation, it is not a disposition to the controlled non-resident subsidiary. As such, neither paragraph 40(2)(e) nor subsection 85(4) of the Act would apply to deem the Canadian corporation's loss to be nil.

However, given that it is a disposition of a debt, the provisions
of paragraph 40(2)(g) of the Act would have to be considered to
determine whether the loss would be deemed to be nil. If not,
subsection 39(2) would apply to the Canadian corporation's loss.

• • With respect to the repayment of the loan payable by the Canadian corporation to its non-resident parent, it is our view that a liability is not a property and therefore, the repayment is not a disposition of property by the Canadian corporation.

Subsection 39(2) of the Act would thus apply to the Canadian
corporation's foreign exchange gain.

In the alternative situation to which you refer, whereby the
Canadian corporation sustains a foreign exchange loss upon
repayment by it of the loan payable to its parent, there would
similarly be no disposition of property by the Canadian
corporation. As such, the provisions of paragraphs 40(2)(e) and
(g) and subsection 85(4) of the Act would not apply to deny the
foreign exchange loss. Subsection 39(2) of the Act would,
therefore, apply to the Canadian corporation's loss.

• The foregoing is an expression of opinion only and may not necessarily be applicable in the circumstances of a particular situation. Nevertheless, we hope our comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate