16 May 1994 TEI Roundtable Q. 1, 9410620 - FOREIGN EXCHANGE GAINS AND LOSSES

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Foreign Exchange Gains and Losses

Position TAKEN:

Various - See Document

Reasons FOR POSITION TAKEN:

See Document

Revenue Canada Round Table
TEI Conference
May 16, 1994

Question XI

FOREIGN EXCHANGE GAINS AND LOSSES

1.As a result of the decision reached in Netupsky vs The Queen (92 DTC 2283), will Revenue Canada treat the exchange gain/loss on the forward exchange contract used to fix the exchange exposure on a foreign currency denominated loan and the gain/loss on the retirement of the same loan as two separate and distinct transactions in determining income or capital treatment or will Revenue Canada treat the exchange gain/loss on the forward contract in the same manner as the exchange gain/loss on the foreign loan?

Department's Position

The finding of the Tax Court of Canada in the Netupsky case was based upon the particular facts of that situation. While the foreign currency borrowing and the forward contract are two separate transactions, the Department generally considers that the use to which funds borrowed in a foreign currency have been put will be a factor in determining of the nature of any gain or loss incurred or realized with respect to a forward contract used to hedge any exchange exposure relative to that borrowing.

2.In IT-95R, paragraph 3 states that where borrowed funds are used in the ordinary course of a taxpayer's business, any foreign exchange gain/loss is considered to be on income account. An exception is made if the borrowed funds form part of the permanent or fixed capital of the company.

(A) How does Revenue Canada determine if borrowed funds are part of permanent or fixed capital?

(B) Does a three-year loan constitute permanent or fixed capital?

(C) Does a five-year loan constitute permanent or fixed capital?

Department's Position

There are no specific criteria under which funds borrowed in a foreign currency would be considered to be fixed or permanent capital and each case must be reviewed and determined on its own facts. In making this determination, the Department would assess, among other factors, the level of capitalization of the corporation (prior to obtaining the foreign currency borrowing) in relation to the corporate operations and whether there was a need for the particular borrowing to enable the corporation to carry out its day to day activities.

Either a three year or a five year loan denominated in a foreign currency could be considered as part of the fixed or permanent capital of a corporation depending upon the facts of a particular situation. The Department would not generally consider the term of a particular loan to be determinative in and of itself of whether that loan constituted part of the fixed or permanent capital of a corporation.

3.Companies often borrow funds in a foreign currency and enter into forward exchange contracts to fix the cost of borrowing foreign funds. In view of the decision in the MacMillan Bloedel case (90 DTC 6219), will Revenue Canada view the exchange gain/loss on the forward exchange contract as an expense incurred in the year in the course of borrowing money as described in paragraph 20(1)(e) of the Act?

Department's Position

The Department considers that the decision reached by the Federal Court in the MacMillan Bloedel case is limited to the particular facts of that situation.

We are not prepared to adopt as a general position that foreign currency gains or losses that arise as the consequence of the sale of a currency pursuant to the exercise of a forward contract would be an expense incurred in the year in the course of borrowing money for purposes of paragraph 20(1)(e). In particular we have difficulty characterizing a gain as an expense incurred in the course of borrowing money.